Understanding Financial Ratios

Make Your Board Finance Report Sparkle!

The finance report is often the most daunting part of any board meeting. It's the moment when financial documents like the balance sheet and statement of activities are presented, leaving board members with a plethora of questions. As an Executive Director, understanding these documents is crucial to telling the story of an organization's financial health.

The balance sheet is a fundamental financial statement that provides a snapshot of an organization's assets, liabilities, and equity at a specific point in time. It's dynamic, changing with every financial transaction. For instance, if an organization purchases new equipment, its assets increase, while if it takes on a loan, its liabilities also rise. This document is essential for understanding the organization's current financial position.

The statement of activities, known as the profit and loss statement in the for-profit sector, details where funds come from and how they are used. It resets at the beginning of each fiscal year and evolves throughout the year as income and expenses are recorded. This statement helps track whether an organization is running a surplus or deficit.

Financial ratios are powerful tools that synthesize information from these statements to tell a story about an organization's financial health. One of the most important ratios is the "days of cash on hand," which indicates how many days an organization can operate using its current cash reserves. This ratio is calculated by dividing the cash available by the average daily expenses.

To illustrate this, consider a small non-profit at the midpoint of its fiscal year. If it has spent $42,300 and its average daily expenditure is $235, it can determine its cash reserves by dividing its available cash by this daily average. For example, with $15,000 in cash, the non-profit has approximately 63.8 days of operation. This figure is useful for assessing financial stability, as organizations with consistent cash flow typically have lower days of cash on hand, while those reliant on large grants may see this figure fluctuate significantly.

Generally, non-profits aim to have between 90 and 180 days of cash on hand, indicating a solid financial position. Anything above 270 days might suggest excess cash that could be invested or used to establish an endowment fund. Monitoring this ratio over time provides valuable insights into an organization's financial trajectory. If the days of cash on hand are decreasing, it may indicate financial challenges, while an increase suggests improving stability.

Using financial ratios like this can transform the finance report from a dry presentation into a compelling narrative about an organization's financial journey. By analyzing trends over time, boards can make informed decisions about resource allocation and strategic planning, ensuring the organization remains financially healthy and sustainable.