written by Joe Page
Ratio analysis can be used to improve financial decision making and summarize organizational performance. Ratio analysis is thought to be an important part of managing a for-profit business but is often overlooked by not-for-profit entities. While many of the ratios focused on by for profit entities are not relevant to not-for-profits, other ratios can provide valuable insight into the not-for-profit.
For instance, there are ratios specific to not-for-profit entities related to asset turnover, profitability, adequacy of resources or reserves, leverage, revenue sources, and program service expenses to name a few.
In some cases, maintaining certain ratios may be vital to the future of an organization. For instance, lenders often impose covenants that require the maintenance of certain minimum ratios relating to the balance sheet and income statements. Not-for-profit higher education institutions participating in federal student financial aid programs are required to maintain a composite score as defined by the Department of Education. The composite score is a combination of several different ratios. Failure of an organization to maintain these ratios required by such outside sources can ultimately result in the failure of the organization.
Properly done, ratio analysis can help an organization identify negative trends, compare itself to similar organizations and focus its attention on the issues that will determine the organization’s continued success.
Ratio analysis should be an integral part of a not-for-profit entity’s financial management process. Not-for-profit entities should consult with their CPA to determine what ratios are important to the organization and develop systems to monitor and analyze those ratios. Contact us if you have any questions about Ratio Analysis.
Joe is Managing Partner and in charge of audit services for clients in fields such as nonprofit, colleges and universities, manufacturing and distribution, electric utilities and construction.