Nonprofit organizations are one of the highly regulated forms of business organizations due to the nature of the form.
The primary purpose of nonprofit organizations is not to make a profit but to provide services and work for social causes. For nonprofit organizations, the statement of financial position is prepared instead of a balance sheet.
Like all the profit entities, one needs to also take care of the financial indicators and ratio analysis. The major part of the analysis of nonprofits is to compute and analyze efficiency ratios.
There are two types of efficiency ratios i.e. program efficiency and fundraising efficiency.
Operating reliance ratio has recently come as a solution to measure the reliance of operating expenses that the efficiency ratios cannot measure.
#1 Fundraising Efficiency Ratio
The fundraising efficiency ratio computes how much an organization is efficient at raising funds for the objectives of the organization.
This measures how much fundraising activities are based on the expenses to raise contributions and revenues for the event. This is computed by dividing contribution or revenue by fundraising expenses.
If the nonprofit organization depends on contributions and grants, the relation between the total contributions and expenses need to be understood for fundraising.
It would help to check the cost of expenses or debt raised and would help to devise strategies for fundraising. This further strengthens the application of future contributions of any fundraising that is going to happen.
The industry acceptance fundraising ratio is 4.0. An organization should strive for a fundraising efficiency that is greater than one, however, the best ratios are around 4.0.
4 Importance of fundraising efficiency ratio
- Analyzing the efficiency ratio, the organization can determine if they need to improve their fundraising efforts.
- If the ratio is below one, this certainly indicates that the organization is spending more on fundraising than they are gaining. This can mean that future donations can be more due to efforts being made in the current period.
- By tracking and computing an organization’s fundraising efficiency ratio, management can gauge whether or not the fundraising efforts are becoming more or less efficient.
- the fundraising efficiency ratio provides valuable information that management can use in order to improve its fundraising capabilities.
#2 Program efficiency ratio: Key Ratios and Their Important
It is computed by dividing the program service expenses by total expenses. It helps to measure how much the organization is spending on primary mission rather than administrative costs.
This is an important metric for donors to measure program costs vs operational expenses. The program expense ratio provides what magnitude of organization expense is incurred on services vs services as management or general expenses.
Program expenses are closely related to achieving the objective and mission of organization. It helps to compare financials to administrative costs.
The program expense ratio shall be further segregated into committed and non-committed expenses. The accepted program expense ratio is 66%.
Anything above this ratio is considered the gold standard and the management shall be applauded for the same.
4 Importance of program efficiency ratio
- It helps to know the percentage of money spent on programs relative to operating expenses.
- Comparison with the predefined standard set in the initial set of benchmarks
- It helps to keep expenses constantly in check and in line with industry standards.
- Whenever the expenditure goes beyond the essential borderline, the checks and controls can be ensued upon as such.
#3 Operating reliance ratio
This ratio does not measure any sort of efficiency but can be used as quasi-efficiency ratio. It is computed by dividing unrestricted program revenue by total expenses.
When the operating reliance ratio is greater than 1, it is considered good and is said that organization would be able to sustain itself and management is efficient with the expenses and cash flows of the organization.
But the management cannot solely rely on this operating reliance ratio due to inherent nature of restricted revenues from such restricted assets.
It is important for a nonprofit’s unrestricted program revenues that is the amount that can be spent at the discretion of the nonprofit to cover its total expenses.
However, the organization must still determine whether expenses can be covered by program revenues alone. The key performance to measure such a scenario is the operating reliance ratio.
The operating reliance ratio is computed by taking the organization’s unrestricted program revenues and dividing it by the total expenses of the organization.
If a nonprofit entity has a lower operating reliance ratio, it could indicate that the organization is either not able to meet its expenses or that it is relying on restricted funds in order to do so. If an entity relies on restricted funds, it is an indication of a poorly managed program.