Metrics Based Financial Management

By Paul Konigstein, AMS Senior Consultant

Program activities in most nonprofit sectors are becoming evidence based as nonprofits develop metrics to measure program effectiveness. While funders, boards, and nonprofit managers are gradually perceiving the value of program metrics, they have been slower to recognize the value of financial metrics. Hidden within the financial statements is important data which indicates the financial sustainability of your nonprofit. Unlocking that data with financial metrics provides critical guidance for financial and programmatic decisions.

The most important metric is the current ratio, which is defined as current assets divided by current liabilities. Both these numbers should be on your Statement of Financial Position (also known as the balance sheet). If your statement does not separate assets and liabilities into current and non-current, ask whoever prepares your financial reports to do so. If you want use accounting lingo, tell her you want a Classified Balance Sheet. This does not mean that your balance sheet is top secret, but rather that assets and liabilities are classified into current and non-current portions.

Current means one year or less in the future. A current asset is cash or anything that you could reasonably be able to convert to cash in less than one year. Examples of current assets include money promised you by donors and program service fees owed you by clients. Long-term assets are those which usually take longer than one year to convert to cash to meet your obligations. These include buildings, furniture, and equipment.

A current liability is money you will have to pay out in less than one year. Examples include money owed to vendors, office lease payments for the next year, and the balance on your line of credit. A long-term liability is money you will have to pay out in more than one year. Examples include a balloon payment at the end of a mortgage or money owed in more than a year on a copier lease.

The current ratio is designed to measure your nonprofit’s ability to meet its financial obligations. If your current ratio is greater than or equal to one, your organization has enough assets to meet its obligations during the coming year. The greater the number, the more financially sustainable is the nonprofit. If your current ratio is less than one, you are probably experiencing cash flow problems and may be borrowing or delaying some payments to make ends meet.

If your current ratio is less than one, develop a plan to increase revenues or reduce expenses to increase your cash on hand. Postpone activities which require a significant cash outlay such as opening a new site, developing a new program, or moving to a new office until your current ratio improves.

How far below one your current ratio can go without triggering a crisis depends on the characteristics of your nonprofit. Sectors such as social services where revenue typically comes from reimbursement contracts and clients who may have difficulty paying typically have a lower current ratio than sectors such as international public health where revenue typically comes from grants paid in advance of program delivery. Generally speaking, if your current ratio is less than ½, take immediate action to reduce expenses.

Other metrics can be derived from financial statements, but the current ratio is ideal for developing familiarity with financial metrics since it addresses the most fundamental aspect of a nonprofit: sustainability.