In a world where the last two years have produced 90% of all
data ever created (so
says IBM), there is something to be said for avoiding information overload.
This is especially true for nonprofit organizations whose leaders must constantly
balance money and mission, while marshaling ongoing evidence of social and
financial performance. With limited finance staff and multiple sources of
financial information, it’s no wonder these leaders and their supporters often
struggle to tell a clear, compelling financial story that makes sense of all
How can nonprofit executives, funders, and advisors identify
what matters most when examining finances? What are some trends and indicators
that can guide us through an abundance of data and help assess true financial
Not all financial indicators are created equal. Below, I
offer a short list based on NFF’s years of experience lending to and advising
nonprofits. You can find this data on historical-looking documents such as
audited financial statements and Forms 990, as well as on forward-looking
internal budgets and projections.
Strapped for time to do this number crunching yourself? Financial SCAN, a data
platform developed by NFF and GuideStar, can do this analysis for you,
illustrating trends in an organization’s financial performance through
user-friendly dashboards and graphs. You can also use the tool to see how one
organization’s financial metrics and ratios stack up against its peers.
reliability. Rather than overly focusing on the ratio of earned to contributed
revenue, we suggest evaluating revenue reliability – an organization’s track-record
of bringing in recurring dollars, on an unrestricted operating basis, year
after year. Reliable revenue doesn’t always come from the same sources providing
the same amounts of money. However, it does suggest an ability to predict a
level of income with a fair amount of certainty, based on historical
performance and an understanding of market dynamics.
surpluses. A healthy business
model is one characterized by reliable revenue that covers operating
expenses and contributes to surpluses – all in the service of mission.
Nonprofit is a tax status, not a way of operating: Positive operating results (unrestricted
revenue consistently exceeding expenses) are an indicator of strong financial management.
Aiming for breakeven results doesn’t allow for the breathing-room necessary for
when things don’t go according to plan. Nonetheless, since 2008 when NFF began
measuring the percentage of nonprofits reporting a surplus for our annual State of the
Sector Survey, this measure has never surpassed 40%.
coverage. Nonprofit leaders are encouraged to set revenue targets high
enough to cover not just their direct and indirect operating expenses but also
the full costs of doing business. Though
these additional costs aren’t reflected in the income statement, surpluses can
provide the additional dollars needed to address thesedemands over time. These “hidden costs” such as depreciation on
fixed assets and reduction in debt principal reside on the balance sheet and must
also be covered by surpluses. Ideally, surpluses should also contribute to
savings, such as for a future rainy day or a strategic opportunity. Though
covering the full costs of doing business every year is aspirational for most
organizations, doing so ensures longer-term sustainability and vibrancy.
to manage debt. Debt is a critical financial tool that can help
organizations manage the ebbs and flows of cash for operations, facility
purchases and upgrades, and more. But as liabilities bump up against an
organization’s ability to pay off those obligations, they can become a real
problem. Measuring an organization’s liabilities as a percent of total assets
can show how much an organization owes relative to what it owns. As this
percentage creeps up near the 50% mark, it can call into question the
organization’s ability to manage debt, which could jeopardize the delivery of
programs and services.
to steward facilities. If an organization owns property and equipment, it
has a responsibility to maintain and replace these assets over time. We look
for reserves dedicated by the board of directors to facility improvements and
replacements. Absent formal reserves, are there appropriate levels of liquidity
to respond to issues such as replacing the hot water heater or complying with
ADA regulations? Additionally, accumulated depreciation can be a helpful
accounting proxy for evaluating the remaining “usable” life of these fixed
assets, but keep in mind that the accounting value of an asset doesn’t reflect its
market value. An engineer can help identify the true future costs of fixed
asset repairs and replacements.
liquidity. There are a number of ways to measure liquidity, the resources
available to absorb risk and respond to new opportunities. NFF often measures
liquidity in terms of the months of expenses that can be covered with available
unrestricted cash (or access to it). This year’s State of
the Sector Survey results indicated that 56% of respondents expected to
have three months of cash or fewer in 2013. As a general guideline, fewer than
three months of cash is often perilously tight for nonprofits, though the
“right” amount of liquidity depends on several elements, including an
organization’s strategic priorities, funding volatility, facility needs, and
the general economic environment.
When conducting a financial analysis like this one, remember
that numbers tell us a lot about an organization’s finances, but they also have
their limitations. At NFF we strongly believe that no analysis is complete
without an understanding of the context behind the numbers. There is no “right”
business model or balance sheet, other than the one that contributes to an
organization’s ability to manage the unexpected, adapt to changing
circumstances, and pursue mission imperatives.
Still, these indicators are a useful starting point. If you
work at a nonprofit, use them to focus your staff and board on the big picture
story. If you are a nonprofit supporter, consider streamlining your financial
due diligence using these themes as your guide. Examining these key indicators
of financial health can help replace belief with fact – ensuring decisions are
driven by data that will support mission execution today and for years to come.