Understanding financial ratios for nonprofits

In the nonprofit sector, financial health is paramount to running operations smoothly and fulfilling missions. 

Nonprofit organizations, unlike their for-profit counterparts, operate without the goal of generating profit for shareholders.

Instead, they focus on achieving social goals and community benefits. 

Understanding financial ratios is essential for nonprofits to assess their fiscal stability, operational efficiency, and overall effectiveness in resource use.

Here’s what we’ll cover

What are nonprofit financial ratios?

Financial ratios for nonprofits are quantitative measures that evaluate the organization’s financial performance. 

These ratios help stakeholders, including board members, donors, and management, understand the financial health of your nonprofit. 

They provide insights into liquidity, solvency, efficiency, and profitability, empowering your organization’s leaders to make better decisions.

Why financial ratios are crucial for nonprofits

There are many reasons why financial ratios are essential for nonprofits, including the key factors listed below, which require efficient monitoring and measurement. 

Transparency and accountability

Nonprofits rely on donations, grants, and public funding. 

Financial ratios provide a transparent means to showcase financial health to donors and stakeholders and demonstrate your compliance with nonprofit accounting standards and funding conditions.

Strategic planning

By analyzing financial ratios, nonprofits can identify strengths and weaknesses, allowing for informed strategic planning and resource allocation.

Performance benchmarking

Financial ratios enable nonprofits to compare their performance against industry standards or similar organizations, facilitating continuous improvement.

Risk assessment

Ratios help identify potential financial risks early, allowing your nonprofit to stay ahead of fiscal issues and take proactive measures to mitigate them.

Make sure you understand how your organization is performing across the most relevant ratios at any given time, and leverage this knowledge to make strategic and operational decisions. 

Investing in smart nonprofit accounting software can help by offering real-time insights, tailored data, and customizable reports on your organization’s key performance indicators. 

Key types of financial ratios for nonprofits

While there are many approaches to assessing and managing your nonprofit’s performance, we’ve outlined some of the core financial ratios you should be aware of.

Liquidity ratios for nonprofits

Liquidity ratios assess an organization’s ability to meet its short-term debt and other financial obligations. 

They measure your ratio of liquid assets (such as cash and accounts receivable) in relation to your current liabilities (debt due within a year). 

For nonprofits, maintaining adequate liquidity is vital for operational stability.

Current or working capital ratio

The current ratio, also called the working capital ratio, measures an organization’s ability to cover its short-term liabilities with its short-term assets. 

To calculate this ratio, you simply divide your current assets by your current liabilities. 

Here is the formula:

Current ratio = current assets / current liabilities

A current ratio above 1 indicates that your nonprofit has more current assets than liabilities, which is generally considered healthy.

Cash reserves ratio (defensive interval ratio)

The cash reserves ratio, also known as the defensive interval ratio, indicates how many months of operating expenses can be covered by your cash and liquid reserves. 

This metric ensures your nonprofit has enough available funds to cover expenses in case of emergencies.

Cash reserves ratio = unrestricted cash and liquid investments / average monthly expenses (less noncash expenses like depreciation)

A higher cash reserves ratio signifies stronger financial resilience, with three to six months of coverage often recommended for nonprofits to maintain stability.

Accounts receivable turnover ratio

This ratio measures how effectively a nonprofit collects payments owed to it for goods or services already delivered. 

Essentially, it shows how often you’re able to collect on your average accounts receivable balance within a set period of time. 

To calculate this ratio, divide your total revenue paid via credit by your average accounts receivable.

Accounts receivable turnover = net credit sales / average accounts receivable 

A higher turnover rate generally means your nonprofit efficiently collects its accounts receivable.

Solvency ratios (leverage ratios) for nonprofits

While liquidity ratios focus on shorter-term financials, solvency (or leverage) ratios measure your organization’s ability to meet its long-term obligations and financial wellbeing.

To be considered solvent, an organization needs to have a positive net worth, meaning it owns more than it owes, with a manageable amount of debt. 

Solvency ratios consider a company’s long-term financial wellbeing, and its ability to cover future debt while continuing to operate effectively and stay profitable.

Leverage ratio (debt-to-equity ratio)

This ratio compares total liabilities to net assets to establish your nonprofit’s degree of financial leverage. 

It’s calculated by dividing the organization’s total liabilities by its total assets, and includes both short-term and long-term debt.

Leverage ratio = total liabilities / net assets 

A lower ratio indicates less reliance on debt. 

On the other hand, a rising debt-to-equity ratio means that your nonprofit might be subject to higher interest expenses, which could affect your credit rating and limit your ability to borrow going forward. 

Debt service coverage ratio (DSCR)

The DSCR ratio assesses your nonprofit’s ability to cover its debt obligations with its operating cash flow. 

It’s calculated by dividing your organization’s net earnings before interest, taxes, depreciation, and amortization (EBITDA) by its principal debt obligations and annual interest.

DSCR = EBITDA / (principle + interest)  

A ratio above 1 indicates that your organization can meet its debt obligations.

Cash flow to total debt ratio

This measures cash flow from operations that are available to pay off debt. 

It helps estimate how long your nonprofit would need to repay its debt based on the cash flow that could, in theory, be put toward these obligations. 

It’s calculated by dividing your cash flow by your debt.

Cash flow to debt ratio = cash flow from operations / total debt 

A higher value indicates a stronger ability to manage debt, and effective cash flow management software can help you stay on top of this ratio.

Government reliance ratio

This ratio shows how much of your nonprofit’s total funding comes from government sources. 

It’s calculated by dividing government funding by your total revenue. 

Government reliance ratio = government revenue / total revenue 

The higher the score, the more your nonprofit relies on government funding, which could cause issues if this source of revenue decreases or comes to a halt. 

In many cases, it’s going to be beneficial to explore other potential revenue sources.

Savings indicator ratio

The savings indicator ratio shows how much of your organization’s total income can be saved for future needs once your expenses are covered. 

It can help you understand whether you’re using or saving extra funds. 

It’s calculated by subtracting your expenses from your revenue and then dividing by your expenses. 

Savings indicator ratio = (total revenue – total expenses) / total expenses

A higher percentage indicates a better ability to add to your net assets and stronger financial health. 

Efficiency ratios for nonprofits

Nonprofit efficiency ratios assess how well an organization uses its resources to achieve its mission. 

In this section, we’ve outlined some of the most useful efficiency ratios to keep tabs on.

Program expense ratio

This ratio measures the percentage of total expenses dedicated to program activities. 

It’s calculated by dividing the cost of your nonprofit’s program services by your total expenses.

Program expense ratio = program service expenses / total expenses

A higher ratio indicates a greater focus on mission-related activities, which will likely be especially important to your donors.

Administrative expense ratio

This ratio assesses how much of the total expenses are allocated to administrative costs by dividing your admin costs by your overall expenses. 

Administrative expense ratio = admin expenses / total expenses 

Ideally, you’d want this to be of relatively low value, as a lower ratio indicates that your organization is allocating resources efficiently. 

Personnel expense ratio

This measures the percentage of total expenses spent on staff salaries, wages, and benefits. 

You calculate it by dividing these types of staff spend by your total expenses. 

Personnel expense ratio = personnel expenses / total expenses

Understanding this ratio can help you assess staffing efficiency and identify if actions are needed to manage this more effectively.

Fundraising efficiency ratio (fundraising expense ratio)

The fundraising efficiency ratio, also known as the fundraising expense ratio, evaluates how much it costs your organization to raise a dollar in donations. 

It gives you a simple way to establish whether your nonprofit’s fundraising is efficient.  

Fundraising efficiency ratio = total donations and contributions / total fundraising expenses 

A lower ratio is desirable, as it indicates effective fundraising efforts.

Nonprofit burn rate

The burn rate measures how quickly a nonprofit uses its financial resources, highlighting monthly negative cash flows. 

It’s an important metric to monitor so your organization doesn’t deplete its financial reserves too quickly.

It’s calculated by subtracting the ending balance of your reporting period from your opening balance, then dividing that amount by the number of months in the period you’re reviewing. 

Nonprofit burn rate = (starting balance – ending balance) / number of months

Monitoring the burn rate is crucial for ensuring sustainability, especially as revenue generation for nonprofits can often be seasonal and/or irregular, meaning there may be periods of time when you have to rely on your savings.

Profitability ratios (surplus ratios) for nonprofits

Profitability ratios measure the ability of a nonprofit to generate surplus revenue, looking at the remaining profit after certain types of expenses.

Operating margin (surplus margin or net margin ratio)

This ratio indicates the percentage of revenue that remains after covering your operating expenses. 

Essentially, it measures your nonprofit’s ability to generate a financial surplus. 

It’s calculated by subtracting your total expenses from your total revenue and then dividing that amount by your revenue. 

Nonprofit operating margin ratio = (total revenue – total expenses) / total revenue

While making a profit isn’t the primary aim of your organization, it’s still important to manage your finances effectively. 

Making a surplus will allow you to reinvest resources in your services and programs, so a positive margin is crucial for sustainability.

Return on assets (ROA)

ROA measures how effectively a nonprofit uses its assets to generate surplus. 

This ratio is typically calculated by dividing a nonprofit’s net income by its total assets to establish a percentage value. 

Return on assets = net income / total assets

The higher the ROA value, the more effectively your organization manages its balance sheet and assets.

Nonprofit financial analysis: using ratios to assess health

Using the above ratios collectively will give your nonprofit a comprehensive view of its financial health. 

For instance, a nonprofit with strong liquidity ratios but weak efficiency ratios may need to reevaluate its expense management to ensure it remains sustainable. 

Regular nonprofit financial analysis can help organizations stay on track with their mission while maintaining fiscal responsibility.

Benchmarking nonprofit financial ratios

Benchmarking involves comparing financial ratios with established industry standards, helping nonprofits identify areas for improvement. 

Many organizations and platforms, such as Charity Navigator and the Better Business Bureau’s Wise Giving Alliance, publish sector benchmarks, allowing nonprofits to assess their performance against peers.

Practical examples of financial ratios in action

To illustrate how financial ratios work and what they can tell you about your nonprofit, consider a fictional organization, “Helping Hands.”

Ratio	Financials	Calculation	Conclusion
Current ratio	Helping Hands has current assets of $500,000 and current liabilities of $300,000.	500,000 / 300,000    = 1.67	This indicates a strong liquidity position.
Program expense ratio	Out of total expenses of $1 million, $800,000 is allocated to programs.	800,000 /  1,000, 000    = 0.8	This shows that an impressive 80% of expenses are directed toward the mission.
Fundraising efficiency ratio	Helping Hands spends $100,000 on fundraising and raises $500,000.	100,000 / 500,000   = 0.2	This indicates it costs $0.20 to raise $1.00, which is a healthy ratio.

Best practices for improving key financial ratios

• Enhancing revenue diversification: Seek new funding sources to reduce reliance on any single source and help improve solvency ratios.

• Optimizing expenses: Regularly review operational expenses to reduce administrative costs and increase your program expense ratios.

• Improving fundraising strategies: Leverage efficient fundraising methods to enhance the fundraising efficiency ratios.

• Building cash reserves: Aim for a cash reserves ratio that allows for several months of operating expenses, ensuring liquidity.

• Regular financial review: Conduct quarterly and annual reviews of financial ratios to identify trends and implement necessary changes.

Final thoughts

Financial ratios serve as essential tools for nonprofits to understand their fiscal health, assess operational efficiency, and inform strategic decision-making. 

By leveraging these ratios effectively, nonprofits can ensure sustainability and continue to make a meaningful impact in their communities.

Financial ratios for nonprofits FAQs

What are the most important financial ratios for nonprofits?

The most critical ratios vary from organization to organization, but they would generally include the current ratio for liquidity, program expense ratio for mission focus, and fundraising efficiency ratio for evaluating fundraising effectiveness.

How often should nonprofit financial ratios be calculated?

Nonprofits should calculate their financial and efficiency ratios quarterly and annually to monitor financial health.

This will help your organization identify any areas where action is needed and make informed decisions about how to improve your fiscal management.

What is a good fundraising efficiency ratio?

A fundraising efficiency ratio of 0.20 or lower (i.e., $0.20 spent to raise $1.00) is generally considered good in the nonprofit sector. 

This can vary from one nonprofit to another, though, and some types of fundraising activities (like in-person events) will cost more than others (for example, an email campaign) but might still be highly beneficial to the organization, both financially and for other reasons (such as donor engagement). 

How can a nonprofit improve its operating reserve ratio?

To improve the operating reserve ratio, your nonprofit should focus on increasing cash reserves through effective budgeting, strategic fundraising, and controlled spending.