One way that your organisation's board can help keep track of the organisation's financial risks is to use some indicators of financial performance. There are many indicators and ratios that could be used, but we have listed those that we think are most appropriate for Australian not-for-profit organisations.
These include core funding, liquidity, and your D-day (survival) calculation.
The ratios should be calculated from your financial records at the date they were generated.
The results also need to be viewed in the context of your organisation's overall circumstances, including its strategy and financial history.
It's important to take note of ratio trends over time. Significant changes in your organisation's circumstances need to be uncovered and questioned.
Remember, your fundraising and financial sustainability should be a standing agenda item.
Core funding reliance ratio
This ratio highlights your organisation's ability to meet its commitments by looking at how much of your budget relies on your largest funding sources, your core funders.
That ratio compares the largest one or two funding sources or revenue streams to your total revenues. Divide your core funding by total revenue to deduce that fraction. .
Now look at your biggest funder. What proportion are they of the total?
- A third (1:3)? That’s probably fine.
- A half? (1:2) It’s not optimum.
- Is it two-thirds? (2:3) It’s a possible concern.
Now consider your top two funders. What do they cover together? Are they completely independent funders, or could problems be linked across both? If you’re being funded by two government departments, for example, a change of the party in power could knock them both out together.
The bottom line is that you want to avoid relying on too few funding sources, because the people behind that funding can change their minds without notice. Ideally, it’s better to spread (or diversify) the risk across a variety of funding sources. That’s easy to say, of course, but if you can’t do it, then you have to factor in the risk that you’ll suddenly be cut off at the ankles.
As with all ratios, they’re guidelines, not firm prescriptions. That’s why we’ve expressed them here as fractions, because percentages can look much too precise. Ratios should be interpreted in their full context. Having said that, these ratios can be useful in assessing where your vulnerabilities may lie.
Consider too whether having too many fundraising streams – where the funds obtained are relatively small – might create an unnecessary administrative burden.
Current ratio (liquidity ratio)
Current assets (assets that can be converted to cash easily) : Current liabilities (what your organisation owes others)
This ratio highlights your organisation's ability to meet its commitments. In a normal business a ratio of less than 1.5:1 is cause for action. If it falls below 1:1 then you have serious issues and you need to consider seeking advice (it could indicate solvency issues).
If, on the other hand, you have a very high ratio (e.g. 2.5:1) you might be able to find more efficient ways of using that cash (e.g. investment).
As a board set where you think your risk on this might sit. Do you want to adopt a conservative approach and set it between 2:1 and 2.5:1 or do you want to sail closer to the wind at 1.5:1?
Survival (D-Day) calculation
Assume all your income stops today and you can only draw on your reserves. Here's the basic calculation:
(Reserves - forward commitments = how long you can last)
This indicator is used to demonstrate to the board how long you could last in a cash crisis (e.g. all of your funding stops). However unlikely this situation is, it gives the board an indication of how long they have to source new income.
As a board set where you think your risk on this might sit. Do you want to adopt a conservative approach and ensure you commit 12 months of cover into reserves or do you want to sail closer to the wind at three months?
Some typical revenue risks:
- Stability of revenue from primary sources
- Predictability of pledges/bequests
- Reliability of government grants and contracts
- Level of dependence on one or two major donors
- Funders policies/actions on overheads and annual support
- Economic health of the community
- Timing of funding commitments to agencies (advance or arrears?)
- Publicity that could adversely affect current or future revenues
- Regulatory/Policy changes
Some typical spending risks:
- The extent to which economic downturns or other types of events may effect demand for services, either up or down
- The extent of funding commitments made for longer than one year
- Amount of unsecured debt you carry (what's your debtor policy?)
- Long‐term leases (get out clauses?)
- Level of dependency of programs on stable, individual funding streams
- Ability to downsize operations quickly and meet employee commitments