Five Key Nonprofit Metrics for Improved Financial Health

Five Key Nonprofit Metrics for Improved Financial Health

Many nonprofits struggle with common issues like cash flow management, fundraising, ensuring their long-term financial survival, unprofitable programs, etc.  This article is designed to help nonprofits with these or similar issues.

I actually found it very hard to choose a title for this article.  I went back and forth between several choices. “Five Metrics for Achieving Nonprofit Sustainability,” or, “Five Key Metrics for Increasing a Nonprofit Organization’s Fundraising Ability” would also have been good titles.  Why?  Because employing these key metrics can help improve the financial health, long-term sustainability, and fundraising ability of any nonprofit.

If your nonprofit is struggling in any one of these areas, or simply wants to improve, please read on.

Before I get into the nitty gritty details of these metrics, I have to give credit where credit is due.  I did not invent these metrics.  While some are well-known metrics, I learned about others at a great seminar called “Strategic Financial Management for Nonprofit Executives.”  The presenter was Scott Schaffer from The Public Interest Management Group, a Seattle based consulting firm that provides strategic consulting services to nonprofits.

In our ongoing quest to deliver more value to our clients, we always keep our ears open for great ideas.  When we find one that will help our clients, we implement it.  Scott has many years’ of experience researching and working in nonprofits and he knows what works, so I felt we had to share his ideas with you.  Some of these metrics would help any business, but some are specific to nonprofits.

Metric #1: Months of Unrestricted Cash

All businesses go through cycles.  Some go through cycles once or twice a year and others only every few years.  Either way it is important to be able to keep things flowing smoothly during the slow times.  Looking at how many months of operating cash your organization has on hand helps you plan in advance to weather the slow times and come out afloat and riding high.  A healthy nonprofit should have a minimum of six months of unrestricted operating cash available for use.

The term “unrestricted” is unique to nonprofits.  When funding sources provide money to nonprofits they may restrict its use by either time or purpose.  Funds restricted by time, also known as “temporarily restricted funds,” may only be spent after a certain time period, or after the accomplishment of some specific goal.  Funds restricted by purpose may only be spent for a pre-determined purpose.

To weather the slow times, a nonprofit needs available unrestricted operating cash.  Restricted cash generally will not suffice as it cannot be spent on just anything and the ongoing bills that must be paid even during the slow times are generally administrative in nature.

Click here to watch our short video on how to determine how many months of unrestricted cash your nonprofit has available.

Metric #2: Structural Budget Surplus

The term, “budget surplus”, refers to the amount by which the revenue a nonprofit receives exceeds its spending for a given time period.  In other words, it means the money left over after all expenses are paid.  A for-profit business would refer to this number as “profit” or “net income”.  A healthy nonprofit should have a consistent 2 to 5% budget surplus over multiple years.  We refer to this budget surplus as “structural” because it should be built in to the long-term functioning of the organization and occur year after year.

If it sounds like I’m advocating for a nonprofit to make a profit, it’s because I am.  While making a profit is not the primary goal of a nonprofit organization, it is necessary for long-term survival.  It is a misunderstanding that nonprofits must budget to break even every year or that a nonprofit must budget to spend all its income each year.  Instead, a nonprofit budget should include a line item for “contribution to operating reserve”.  This should be about 2 to 5% of revenue per year.  Following this policy facilitates the growing of the 6 or more months of unrestricted cash discussed in Metric #1.

Click here to watch our short video on how to calculate your nonprofit’s structural budget surplus.

Metric #3: Current Ratio

The “current ratio” is a common ratio used in analysis of the health of all kinds of businesses.  It is a comparison of current assets to current liabilities.  Current assets and current liabilities can be found on the Balance Sheet, which is known as the Statement of Financial Position for a nonprofit.

Current assets refers to the total of all cash and other assets that can be turned into cash within one year.  Essentially, it is a measurement of liquid assets.  In addition to cash in banks, a typical nonprofit’s current assets might include accounts receivable, short-term deposits, any investments that can be liquidated easily, and inventory.

Current liabilities refers to the total of all of the organization’s debts that are due within one year.  For a typical nonprofit, current liabilities might include payroll taxes payable, sales and income taxes payable, interest payable, accrued payroll, customer deposits that haven’t been earned yet, credit card balances, and other short-term debt payable.

To calculate the current ratio, divide current assets by current liabilities.  This number shows how many times the organization could pay all its short term obligations using its current assets.  For example, if current assets divided by current liabilities equals 2, then in an emergency, the nonprofit could pay all its short term debt off twice using just the current assets.  All other things being equal, this is a sign of financial health.  If the current assets divided by the current liabilities results in an answer less than one, this indicates that the nonprofit does not have the ability to pay off its current debts using its current assets.  In an emergency, it might have to sell a long-term asset such as a building or piece of equipment to pay its short-term debts.  All other things being equal, this is not a good sign.

The current ratio of 2 to 1 is written like this: 2:1.  A nonprofit should target a current ratio of 2:1.

 Click here to watch our short video on how to calculate current ratio for your nonprofit.

Metric #4: Net Profitability Over all Programs

It’s no secret that nonprofits often have one program that does well financially, and one that struggles.  The more profitable program ends up subsidizing the weaker program.  Both programs align with the nonprofit’s mission.  It’s not an ideal situation, but it is common.

Ideally, each program would be profitable on its own, but if that’s not possible, then at least assure that there is net profitability over all programs.

The profitability of each program or activity should be measured separately and discussed regularly.  Questions should be asked:  Is the unprofitable program or activity important enough to the mission that we should keep it?  How could it be altered to increase its profitability?  Is it hurting the long-term sustainability of the organization as a whole? Then, decisions should be made accordingly.

Metric #5: Income Risk Indicator

Nonprofits generally receive their funding from a variety of sources.  Some funding sources are more reliable year after year than others.  It’s important to analyze the risks inherent in each funding source and discuss this regularly.

Nonprofits often receive funding from three common sources:

  1. Grants
  2. Donations
  3. Fee-for-service Income

Which source has the most inherent risk depends on the specific situation.

Grant funding generally comes from the government.  If a nonprofit receives a government grant, it’s important to ask, “what is the likelihood of receiving this grant next year?”.  Government grant funding can be subject to the ups and downs of the economy and political changes.  Generally, it is less risky to receive many small grants than one large one.

Donations are usually less risky than grant funding.  However, if a nonprofit has a few very large donors, if they decide to not to fund the organization again, that could pose a huge problem.  Having many smaller individual donations is generally less risky.

Fee-for-service income, or earned income, is generally the least risky of the three types of funding mentioned here.  This is income earned in exchange for a product or service provided by the nonprofit.  For example, if a nonprofit rents out space in a community center, the rent revenue received is fee-for-service income.  A nonprofit that provides housing and education to adults with developmental disabilities in exchange for a monthly fee from its residents also collects fee-for-service income.

Periodically every nonprofit should analyze its revenue streams and associated risks.  Proactive analysis helps prepare the organization for the unknowns that lie ahead.  I suggest including a pie chart of the different revenue streams on the dashboard of financial metrics that the board uses at board meetings.  The board can use the pie chart as a starting point for discussing the diversification and risk of the organization’s funding sources.

Conclusion:

Paying attention to these five metrics will help any nonprofit monitor and improve its financial situation and move towards long-term sustainability.  Adhering to them will also help increase its fundraising ability.  This is because potential donors, especially corporate donors, venture capitalists, governments, philanthropists, and foundations, assess the financial health of an organization before donating.  They want their money to be put to good use for years to come.

I suggest putting these five metrics into a dashboard for the board to use at board meetings.  Board members often have too much financial information in front of them at board meetings.  This causes them to get stuck in the small details of the financial statements and waste time or micro-manage the executive director.  Other boards don’t have enough financial information.  In either case, their focus shifts away from the strategic role they should be playing in the organization.  Providing the board with a simplified dashboard of key financial metrics helps them do their job and stay on task.

While these metrics are a great start, they are a bit generic.  I encourage any nonprofit to develop its own measureable organization-specific metrics as well.  Examples could be number of clients served per day, rental income generated per month, number of beds filled, meals delivered per week, etc.  They can be used to run day-to-day operations and to guide the board’s strategic planning and decision-making.  A nonprofit that runs by the numbers will be more sustainable, improve its fundraising ability, gain more clarity, and thrive.