Assessing Your Nonprofit's Financial Health
Nonprofits’ goals differ from those of a for-profit business. However, both nonprofits and businesses need to understand their finances equally well to maintain their financial health. Otherwise, nonprofits that overlook the importance of their financial health will often find themselves unable to fulfill their mission effectively.
Below are three important areas to evaluate so you can better understand your organization’s financial health:
1) Profitability and Savings – Is your nonprofit saving money? Designation as a nonprofit is a tax status and not a business model; there should be a consistent surplus of unrestricted assets at the end of the year to cover full costs. In fact, it is even more crucial for nonprofits to make a ‘profit’ each year than it is for businesses considering they usually have a more unreliable revenue stream.
Revenue Sources – How reliable is your revenue? It is crucial to look at the risk of your revenue sources; look at the percentage of ‘risky revenue’ or the percentage you are unsure you will receive next year and whether you have done anything to mitigate that risk. Make sure to look at the level of diversification; the more diversified your revenues, the less risk you have.
Expense Sources – How do your expenses trend with respect to your revenue? Look to where your nonprofit has been spending money and the fluctuation of expenses over the years. Evaluate the nature of your expenses as to whether they are fixed or variable. If your revenue decreased in a certain year, would your expenses decrease too? If the answer is no, you are likely exposed to a higher risk.
2) Liquidity – Does your nonprofit have assets quickly convertible to cash in case any problems arise? Has your nonprofit budgeted a reserve fund? Liquidity can be assessed by looking at your nonprofits cash flow statement and the current assets and liabilities on your balance sheet. When a nonprofit is illiquid, it is subject to higher risk of not meeting short-term obligations when an unexpected event occurs (i.e. economic downturn or loss of major revenue source). One way to think about it is to make sure your nonprofit’s cash flow is greater than its risk; this ensures that your nonprofit will have the cash necessary when any of your potential risks are realized.
3) Financial Flexibility – Is your nonprofit’s financial structure such that it can adjust cash flows in the case of unexpected needs, opportunities, and threats? This is usually an issue when a nonprofit takes on too much debt; if this is the case, it may have more difficultly (and less flexibility) in raising debt in bad times to continue to fulfill its mission. To assess your nonprofits financial flexibility, you should first look at the amount of long-term obligations on the balance sheet.
Have questions about your nonprofits financial health? Contact SOURCE@cmc.edu! We have Consultants with the financial background necessary to assist you.