Measuring an organization’s performance goes far beyond the debits and credits and the two-dimensional numbers reflected on a financial statement. Especially for nonprofit organizations. While, it is essential for continuing operations to be profitable, the real goal is to find a way to tie profit and purpose to be able to both effectively fulfill your mission, while developing the resources necessary for organizational stability and growth. The question is, how do you know if your organization is healthy?
There are many factors that go into an organization’s health including financial reserves, liquidity, cash flows, expendable net assets, and operational effectiveness. Too often we have seen organizations with robust financial statement net assets, but when you look behind the numbers you realize the organization has plenty of illiquid assets, so it can’t pay its bills.
Looking at trends in numbers (sales over the last 5 years), benchmarking your organization against other organizations (what is your labor cost as compared to other organization’s labor costs), and looking at the interrelationship of numbers (days in cash vs days in receivable to determine if adequate cash flow levels exist), are all important in understanding how your organization is functioning. These provide a lot of insight into operational effectiveness and provide an organization with an understanding of potential risks and inefficiencies.
Certain analyticals that you should be reviewing monthly, in addition to understanding deviations from your established budget, are:
- Days in cash: Days in cash is an analysis that divides your cash balance by your daily cash expenditures (total expenditures less depreciation, bad debt, and in-kind expenses). The resultant is how many days of operations that an organization has on hand. This is useful in analyzing cash flow. A low days in cash could indicate: a need for a line of credit or other financing; that your staff is incurring significant time in cash management and vendor relations; or that you have a problem with receivables collection or lack of discretionary resources.
- Liquidity: This looks at the bankability of your organization. It divides current assets by current liabilities and it effectively measures how liquid you are … do you have the current resources available to pay your current obligations. Most banks want to see a current ratio of 1.35 to 1.5 to 1, in order to extend credit to your organization. That doesn’t mean that they won’t fund you if you are below these thresholds, it just means more effort, explanation, and potentially higher interest rates will be needed.
- Expendable Net Assets: The level of unrestricted net assets that are not tied up in long-term investment (e.g. property and equipment, intangibles, security deposits, etc.). Many organizations only focus on their net assets, but you can’t pay your bills with bricks. By understanding what portion of your net assets are expendable you can better understand the level of resources you have to fund operations. This is extremely important for an organization that is losing money, because you can determine how many years of operations you have left to determine how much time you have to effectuate change.
- Profit and Loss by Program: Many organizations review operations on a global basis, but it is important to look at information on a program by program basis. This will help to understand how much each program is contributing to the overall operations and allow management and the Board to assess whether programs should be maintained or closed down.
- Cost of Fundraising: This looks at the effectiveness of your fundraising activities. You divide total contribution revenue by your fundraising costs (direct and non-direct) to understand the multiple you are receiving. Most nonprofit rating organizations require a minimum return of 3 to 4 times your cost.
In addition to the standard analytics, you should also identify the key performance indicators that are the drivers for your organization. Since all organizations are different, and have different missions, it is most likely that each organization’s metrics are going to vary. For instance, a school is going to be interested in number of students enrolled, scholarships provided, and student/teacher ratios while a clinic is interested in such things as payor mix, units of service, and diagnosis. It is important for organizations to understand which factors provide insight into organizational effectiveness, so they can drive positive results or mitigate losses. Indicators can be either external or internal. External indicators would be factors that are out of the organization‘s control, for example, budget cuts for government funded programs. Internal indicators are factors that are controlled by the organization and are in line with their mission. For example, the decreasing trend in donations, the volume, the average dollar amount per donation. Why are donations decreasing? Is there more competition? Or is it because the message is not reaching enough people?
There is no cookie cutter approach that an organization can use to determine which indicators to measure, because all organization operate in different environments, have different funders, and different missions. Leading indicators can provide insight to help drive future performance and, due to changes in the sector, are becoming extremely valuable tools for forward thinking agencies.