7 Important Financial Ratios Every Charity Leader Should Know
It is clear that charity organizations are obliged to manage their funds responsibly. Essentially financial ratios come in handy as a valuable tool that helps charities to assess their financial health.
Charity leaders are required to know how to assess the financial performance of their organizations using financial ratios. If these ratios are used effectively, they should help leaders to identify strengths and weaknesses within the organizations.
Financial ratios can be used to evaluate three key areas:
- Charity programs
- Financial stability
- Planning operations
It’s important to point out that the use of financial ratios varies from one charity organization to another. The financial ratios mentioned in this blog will not be suitable for every charity organization.
Tweet this: The current ratio measures the organization’s ability to pay short-term liabilities.
1. Debt equity ratio
Debt-to-Equity Ratio = Total Liabilities / Total Shareholder Equity
Total liabilities and total donations equity appear on the balance sheet. This ratio measures the correlation between borrowed funds and the money donated to the organization. Obviously, any charity organization with a lot of debt will struggle to continue operating.
Debt consists of organization’s current liabilities which appear in the following accounts:
- accounts payable
- and accruals.
A debt equity ratio of greater than 100% tells you that your organization has more debt than assets. As we all do, charities should strive to keep debts as low as possible.
2. Current ratio
Current Ratio = Current Assets / Current Liabilities
The current ratio measures the organization’s ability to pay short-term liabilities. Charities should try to keep their current ratios above 1.0 as anything less than 1.0 indicates that the assets are vulnerable.
One drawback of using a current ratio only is that it includes current assets like second-hand clothing which cannot be readily converted into cash.
3. The asset turnover ratio
Asset Turnover ratio = donations/average total assets
This ratio measures revenue generated from assets. It reveals the organization’s efficiency in spending funds. Usually, this ratio shows the charity leader how responsible the organization has been.
4. Viability ratio
Net assets/long-term debt = Viability
As the name implies, this ratio measures the viability of the organization, i.e a higher viability ratio enables organizations:
- to cover long-term debt.,
- raise more funds and
- increase its revenue.
5. The inventory turnover ratio
Inventory turnover = cost of goods sold/Average inventory
This ratio measures the efficiency of converting stock into cash. To calculate this, divide the cost of goods by the units of inventory held during a specific period. When your organization keeps stock that is sold, those sales are convertible into cash.
Generally, a high inventory ratio indicates that your organization is successful in increasing its funds through selling inventory.
6. Savings ratio
(Total Revenue – Total Expenses) ÷ Total Expenses
This ratio shows the rate of the charity’s total revenue minus expenses relative to annual savings divided by total expenses. A high ratio indicates excessive savings.
Organizations using efficient PO systems like Procurementexpress.com have a greater chance of reporting a high ratio because:
- Procurementexpress.com helps charity organizations to spend within budget
- Procurementexpress.com protects charity organizations against wasted spend
7. Program ratio
Program expenses / Total expenses
The program ratio helps charity leaders assess the correlation between program expenses and the organization’s total expenses.
A higher program ratio indicates that the organization requires higher overhead costs to complete its programs. This information comes in handy when drafting a new fundraising plan. Charity leaders will know how much it costs to raise funds for a specific charity program.
Need more info on financial ratios? Read more here.