By educating volunteers on how to read an audit report and financial statement, you can help them contribute meaningfully to the decision-making process.
While many of your organization’s board and committee members are passionate about nonprofits and eager to serve, many do not have a strong financial background. This can make it challenging for them to understand an audit report and limit their ability to contribute meaningfully to important decision-making conversations.
You can help your board and committee volunteers get a better grasp on nonprofit financial statements by offering them this glossary of key terms. It is not a comprehensive list of the items on a financial statement, but it does include the most important elements for making informed decisions about the use and allocation of resources.
Current ratio measures the ability to pay off short-term obligations
To calculate the current ratio, divide current assets by current liabilities. It is always good to be in the positive, but a truly good ratio is 2-to-1, which means that you have twice as much in current assets as current obligations (liabilities). This figure is more important than the basic cash figure because it shows what you have on hand after accounting for all liabilities.
Months of cash represents “survival time”
Committees often need to know if your organization has enough cash to cover expenses over a certain period of time. The months of cash figure gives a quick snapshot of your organization’s “survival time,” were it to lose future funding or become unable to generate short-term revenue.
Months of cash is calculated in two steps: first, by figuring your total expenses by month (total expenses divided by 12), then dividing your total cash by that monthly figure. Ideally, you should have three to six months of cash on hand, meaning you could operate that long in a funding crisis. If your organization is heavy on investments, you might consider including them in this analysis, because tapping into your investments could potentially help cover expenses if it became necessary.
Debt service coverage ratio tells how you’re handling your finances
This ratio is particularly important if you have debt or are considering taking on more. Bankers and some donors might look at this ratio to see how dependent your institution is on debt. It gives them a sense of how you are handling your finances.
To calculate this ratio, you need to know your unrestricted earnings before interest, tax, deductions, and amortization (EBITDA) expenses, plus unrealized gains and losses. Then you need to know your debt service, which is sum of all interest expense, principal payments on debt, and any capital leases.
Once you have your unrestricted EBITDA figure, you divide it by your debt service figure. This gives you your debt service coverage ratio. You want this to be about 1.10-to-1. However, some banks and other institutions might have their own way of calculating this ratio based on the nature of debt they are issuing. But for purposes of discussion at your monthly committee or board meetings, this basic calculation serves well.
Revenue sources can indicate opportunities
When reviewing your statement of activities (called an income statement by for-profit entities), you should also review your organization’s sources of revenue. If you’re like most organizations, your revenue comes mainly from program services. But plenty of other sources are in the mix, including investment income and contributions. A keen awareness of all revenue sources can help you vet new revenue opportunities or discontinue certain programs and activities based on their contributions to your organization’s financial health and mission.
Functional expense allocation required by FASB ASU 2016-14
With the release of the Financial Accounting Standards Board’s (FASB) Accounting Standards Update (ASU) 2016-14, most nonprofits are required to present a statement of functional expenses on their financial statements for fiscal years starting December 15, 2017. There are generally three categories of expenses under this statement: program, management and general, and fundraising.
Nonprofits must now track how much of every dollar is spent in each of these three categories. For a board member, the functional expense allocation is always something to look at year-over-year. Any significant swings in the allocation should be questioned. It is imperative that your expenses are correctly allocated among these three categories. Most donors are encouraged by a nonprofit’s financial prudence when the statement of functional expenses shows that the majority of each contributed dollar is spent on programs and mission rather than administration.
How we can help
Our nonprofit sector professionals are available to further educate your board members on how to use financial data for effective decision-making. We can use technology tools and personal experience to help you calculate and analyze these and other ratios, and work with you to employ them as you plan for an impactful and sustainable future.