As nonprofits diversify both their programs and income, careful financial analysis becomes even more crucial to short and long term success.  There are a series of analyses which should be performed by top management and reviewed by the board.

1.  Ratio of income to expense.

An overall analysis of income to expenses will show whether or not the organization is on sound financial footing.  Generally speaking, the income to expense ratio should be at least even (1.0).  Each monthly report should show income, expenses, percent to budget in each category, and overall ratio. If the income to expense ratio appears to be headed in a negative direction for more than a few months (other than times in the calendar year where there are expected shortfalls), there need to be immediate adjustments.  Expenses should be cut and the revenue expanded.

As an organization grows, its expenses often outweigh the income, even during times when the income is growing.  This often requires raising more capital than initially expected to handle the growth.  Organizations may need to slow the growth rate to meet the rate of income growth.

2.  Ratio of income to expense by program.

An organization should analyze the financial ratios by program area at least twice a year.  As the funding streams change, many executives will find that funding for certain programs is cut, and these programs are continued without management and board realizing the extent to which the organization is underwriting the program from its general revenues. If funding replacements are not found within a year, underfunded programs can become a serious cash drain on the organization.  If a program is central to the mission, organizations may decide to carry that program even with steep cuts.  However, the challenge will be implementing a plan to develop new resources and, cutting from other less mission essential areas.

Each organization has its own method for designating program-based income and expense.  We recommend that you differentiate program-specific income from the program’s fair allocation of the undesignated budget.

For example, one mission essential program that uses 20% of the staff and 15% of administrative overhead has a program budget of $185,000.  It receives 60% of that income from designated grants, restricted donor gifts and special appeals.  The other 40%  comes from the general operating budget allocation.   This program will remain a revenue center for the organization as long as it retains its high level of designated gifts.  Even though 20% of the staff are dedicated to this program, the program does not cost the organization 20% of its overall undesignated budget.

Another program might use the same staff and administrative resources, yet receive only 40% of its funding from two major sources.  One is a private foundation grant and another is a $40,000 government fee-for-service contract.  The government contract is cut.  Although the organization may have enough overall budget to carry the program without the fee-for-service contract, it will probably create a serious financial strain if new revenues are not developed.  If the program is not central to the mission, executives often find themselves changing or downsizing the program to reduce the financial drain of long-term subsidies on the rest of the organizational budget.

3.  Ratio of income reserves to deferred expenses.

Organizations with property, equipment and other expenses need to plan for the replacement of these items which are usually considered capital expenditures.  Since organizational cash reserves are, in general, much less than they were ten years ago, many organizations will be hard-pressed to cover either emergencies or planned capital expenditures. An analysis of the last five years’ of capital expenditures, current depreciation schedules, and short-term capital improvements should provide you with sufficient information to plan for replacement costs over the next ten years.

You may find that the costs for building repairs, painting and replacement of computer equipment could run hundreds of thousands to millions over the next decade.   You may find that you need to increase your reserve fund, cut costs on deferred expenses, or conduct a capital campaign. It is because of the high cost of building and maintaining that many organizations build in special capital campaigns to cover these expenses.  However, the sheer number of capital campaigns in most cities today creates greater competition for the dollars, and may provide a warning to organizations to build in additional safeguards in the event a capital campaign brings in less than budgeted.

4.  Donor to budget ratios.

There are a number of important donor ratios which can be performed to help the organization assess its financial strength.  The first is a simple comparison of donated to other income.   Your ratio of donated to overall income should continue to grow over time.

Another ratio is the number of donors to donated income, which provides you with the average gift size.  Also of importance is the ratio of new donors added to the house file; the donor renewal rate; and ratio of new donors to expires.  You should have net increases in both number and income amounts, as well as growth in the average gift size.

For example, one organization had 15% of its $1.2 million budget ($180,000) in donated income three years ago. Today, it has donated income totalling $250,000.  This represents a substantial number of new donors and increases in the average gift size.  However, since the organization’s  overall budget is now $1.4 million, there is no substantial growth in donated giving as a percent of budget.  The donor base would need continued development in order to support the organization’s ongoing budget growth.

Other ratios which indicate financial health include the ratio of the number and total of major gifts to total giving, and the number of planned gifts developed per year.  Your attrition rate, age profiles, and percentage of bequests from older donors will provide strong indices of your future financial strength.

Published by New Ventures Consulting, Copyright 1996, Anne Hays Egan. Revised 7/21/2005. Updaed 2009.