Now more than ever, associations are best served by deploying a full arsenal of financial tools. In this article we’ll identify the “five must-have ratios” organizations should consider when assessing their finances. Ratio analyses are excellent ways for you to obtain critical insights into your organization’s fiscal health.
1. Operating Reserve Ratio
This ratio is probably the most well-known—but often ignored—ratio related to organizational security and liquidity. It indicates how long an organization can continue operations without any incoming revenue. It can be stated as a percentage or in number of months (the most common benchmark range is a minimum of three to six months of reserves).
This ratio evaluates the cushion for the unexpected should declines in revenue sources occur: having cash reserves can help sustain the association. The caveat is that bigger isn’t always better: a too-high operating reserve may indicate that the organization is missing opportunities to further its mission.
2. Current Ratio
This ratio indicates the organization’s ability to meet short-term obligations by comparing current assets to current liabilities. A ratio of at least one should be considered the minimum threshold, with the goal being two or greater. A current ratio below one means that current liabilities are more than current assets, which may indicate liquidity problems.
3. Liquid Funds Indicator
This ratio is used to reflect how many months of operation the organization has in liquid assets. It compares the total net assets, less restricted and fixed assets, to the average monthly expenses. It is more conservative than the Defensive Interval below because it removes assets with restrictions.
4. Defensive Interval
Much like the Liquid Funds Indicator, this ratio calculates the days of average expenses the organization’s highly liquid current assets would cover.
5. Profit Margin Ratio
The old saying “non-profit is a tax status, not a business philosophy” is more relevant today than ever. Identifying whether the organization is earning or receiving more than it is spending on operations is critical to the ability to deliver benefits and services for members, and to the association’s long-term sustainability. The target profit margin would depend greatly on the organization’s size, goals, and benefits or services offered. When the profit margin is too high, it may indicate that dues are too high, discouraging membership. Conversely, when the profit margin is too low or even negative it may indicate the opposite.
There may be times when an organization plans to have a negative margin, due to investing in new programs which have lead times before revenue outpaces expense. Planned negative margins are also seen when there may be a need to correct reserve balances. However, running consistent negative profit margins is a warning sign that the organization may be headed into financial trouble.
It’s important to remember that ratios alone are not the silver bullet to predicting or evaluating an organization’s financial health. They are part of a broader set of financial best practices that include budgeting, forecasting, and financial statement review and analysis. And—as in the story of Goldilocks—getting it “just right” is ultimately unique to each organization.
