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CHAPTER FORTY-ONE

Financial Statement Analysis: Key Financial Ratios and Metrics for Nonprofits

Financial statement analysis reveals how well a nonprofit organization (NPO) has done in meeting its targets. Interrelated ratios reveal the financial standing and areas of financial trouble. Each ratio should be compared over the years for a trend, to an industry norm (e.g., healthcare standard ratio), and to comparable NPOs to obtain a relative standing. Ratios vary depending on the service provided, complexity of operations, funding sources, and donor restrictions. A cost-benefit analysis should be undertaken for new programs. Risk-return analysis is also essential.

When evaluating the service efforts of an NPO, look to see how much of every dollar goes to the primary mission as opposed to the fundraiser’s commissions and the executive director’s salary. Carefully monitor the relationship of supporting services to program services expenses.

Financial statement analysis is undertaken by those working within the NPO, such as managers, and outsiders evaluating the NPO’s financial statements. Financial statement users are provided with red flags as to impending financial problems that need to be identified and corrected. Areas of strength are also identified and taken further advantage of. Financial statement users include resource providers, such as contributors and grantors. They want to know how well their funds are being spent for the purposes solicited. Financial statements reveal this fiduciary trust. Further, donors do not want to pour money into a sinking ship. Suppliers and loan officers analyze the financial statements to determine whether to give credit and, if so, how much and for what time period. Companies and government (federal and local) agencies awarding contracts appraise financial statements as to whether contractual provisions are being adhered to. Government regulators (watchdogs) evaluate the financial statements to ascertain if compliance is being made to prescribed regulations and limitations. An NPO serves the public, so concerned citizens may want to analyze its financial statements to determine if service goals are being met.

This chapter has two primary objectives. First, it focuses on ways NPOs can assess the progress and health of their businesses. It takes readers through step-by-step procedures in performing financial statement analysis. The procedure involves:

• Appraising the balance sheet for financial position and flexibility
• Analyzing the statement of activities for operating performance
• Evaluating the statement of cash flows for cash position
• Referring to footnote information
• Evaluating the auditor’s opinion
• Reviewing internal documents related to financial health
• Reviewing budgets to determine if plans are practical and for future directions

Second, the chapter discusses some key financial ratios that are critical for assessing the financial health of NPOs. It also introduces some key financial metrics for NPOs.

As a giver or donor, you need know how to distinguish among NPOs in the same field. You want to address this question: How do you figure out who does the most with the contributions and who spends inordinate sums, however well intentioned, on raising the money and excessive overhead? Several indexes are helpful to answer those questions: charity commitment, fundraising efficiency, and donor dependency.

A case study, presented at the end of the chapter, analyzes a nonprofit organization using including trend analysis, ratio computations, and analytical evaluation.

TREND ANALYSIS

Trend (horizontal) analysis is a time-series analysis of financial statements of the NPO covering more than one accounting period. It looks at the percentage change in an account or category over time. The percentage change equals the change over the prior year. For example, if salaries expense increased from $140,000 to $165,000 from 2X11 to 2X12, the percentage increase is 18 percent ($25,000/$140,000). The reason (or reasons) for such an increase should be determined. Does the increase indicate more staff was needed because operations improved, or does it indicate a lack of cost control, or is there some other cause? Is the situation an unfavorable one requiring management attention? By evaluating the magnitude of direction of a financial statement item over the years, the analyst can appraise its reasonableness.

ANALYSIS OF THE BALANCE SHEET

Evaluation of the balance sheet considers the NPO’s liquidity, asset utilization, solvency, financial flexibility, and capital structure. Assets, liabilities, and net assets (fund balance) must be scrutinized.

LIQUIDITY ANALYSIS

Accounting Standards Codification (ASC) 958-205, Not-for-Profit Entities: Presentation of Financial Statements (FAS-117, Financial Statements of Not-for-Profit Organizations) requires NPOs to present information about their liquidity. Liquidity is the ability of the NPO to pay current debt as it comes due. It indicates how fast the NPO’s assets turn into cash. A liquid asset has less risk than an illiquid one. In evaluating liquidity, exclude restricted funds because they are unavailable for use.

Liquidity considers the seasonality of cash flows. Wide fluctuations in cash flows may result in a liquidity problem. Liquidity ratios are explained next.

Working Capital

The higher the working capital amount, the better the liquidity.

Current Ratio

The current ratio is a measure of liquidity equal to:

Current assets are those assets to be converted to cash within one year or the normal operating cycle of the NPO, whichever is greater. Current liabilities are due within one year.

In general, the current ratio should be a minimum of 2:1. A low ratio means poor liquidity. An excessively high ratio may also be a negative sign because it may indicate too much money is being tied up in current assets rather than invested in noncurrent assets for a higher return.

A limitation of the current ratio is that not all current assets have the same degree of liquidity. For example, accounts receivable is more liquid than inventories of suppliers. Prepaid expenses are not redeemable for cash but rather a prepayment for future benefits (e.g., prepaid advertising).

Current unrestricted assets include cash and cash equivalents (marketable securities), accounts receivable, investment income receivable, inventories of supplies, and prepaid expenses. Current unrestricted liabilities include accounts payable, prepaid services, and the current portion of mortgage payable.

Temporarily Restricted Assets

Temporarily restricted assets should also be considered. An example is pledges receivable arising from gifts to finance operating activities. However, another type of pledges receivable exists, namely unconditional and unrestricted pledges receivable. Another temporarily restricted asset is grants receivable.

With respect to temporarily restricted net assets, determine when the resources will be available. For example, if temporarily restricted net assets include term endowments and annuities, it may be best to consider them permanently restricted. The current ratio for unrestricted and temporarily restricted assets is calculated as:

A determination should be made as to the nature of the restrictions on pledges receivable.

Acid-Test (Quick) Ratio

The quick unrestricted assets are the most liquid assets. Excluded are inventories of supplies and prepaid expenses. The quick unrestricted assets include cash and cash equivalents, accounts receivable, and investment income receivable.

A higher ratio is better. It should be at least 1:1.

Accounts Receivable Ratios

Turnover and the collection period are useful ratios.

The ratio shows the number of times average net accounts receivable turn over relative to fees generated. The more turnover, the better.

The ratio indicates the amounts owed the NPO as well as its accounts receivable management success. A lower ratio is better because it takes fewer days to collect on receivables. Cash received earlier can be reinvested for a return. A high ratio is bad because money is being tied up in receivables that could be invested elsewhere. Further, the longer days receivables are held, the greater is the chance of uncollectability. Perhaps billing is deficient. Receivables must be kept under control.

In looking at the collection period, consider terms of sale, account profile, service mix, collection policies, and the collection period of comparable NPOs.

An aging of receivable balances should be prepared broken down by current, past due (0 to 30 days), past due (3 l days to 60 days), past due (61 days to 90 days), and past due (91 days to 120 days). The aging listing should be in both alphabetical order and by magnitude of receivable balances outstanding. The older the receivables are, the less the chance of collection. A determination should be made of both time distribution and size distribution. How many billing periods has a particular account been unpaid?

A determination should be made of what percent receivables are to total assets equal to:

A high ratio is a problem, especially if most of the accounts receivable are from a few sources.

Pledges Receivable Turnover

The turnover ratio for pledges receivable is similar to that of accounts receivable.

A lower turnover for pledges receivables means a longer collection period.

Is the collection period for pledges less than expected? If so, is it because of inadequate collection efforts? Compare to industry averages. Determine the reasonableness of the provision for uncollectible pledges. Analyze pledges receivable in terms of time and size diversification.

The turnover and age of grants receivable should be determined in a similar way.

Inventory

Inventory may have a low turnover because items are too costly, poor quality, or lack appeal.

Days in Cash

The days in cash is the number of days the NPO can continue in operation if cash inflow stops. It is the number of days of average cash payments the NPO can manage without cash inflow. The higher the number, the better. The days in cash ratio equals:

Cash Flow to Total Debt

The ratio of cash flow to total debt equals:

The ratio indicates how much of internally generated cash is available to pay debt. A higher ratio is better because there is better liquidity, in that cash flow from operations is being generated.

Days Purchases Unpaid

The ratio of days purchases unpaid equals:

where Daily purchases = Purchases/360

The ratio is used to evaluate trade credit. It shows how long (how many days) trade credit remains unpaid.

If the suppliers’ payment terms are 30 days and the NPO pays in 90 days, on average it may mean there are liquidity problems.

Current Liability Coverage

The ratio equals:

The ratio reveals how much of current liabilities can be paid from cash and short-term investments if cash inflows cease.

Financial Flexibility

The greater the amount of unrestricted net assets, the greater the amount of financial flexibility. NPOs with huge permanently restricted endowments and minimal unrestricted net assets may not enjoy much flexibility. Can the NPO respond and adapt to financial adversity and unexpected needs and opportunities? Which resources are available when needed?

Asset Utilization

Asset utilization applies to the efficiency with which the assets are used in the operating activities of the NPO. For example, a higher ratio of revenue to assets indicates more efficiency of assets in generating profit. What assets are excessive relative to the optimal level?

The efficiency usage of supplies may be determined as:

A low turnover is a negative sign because it means supplies are excessive and are not being used efficiently.

What is the rate of supplies’ usage? How fast would the current usage level deplete supplies inventory?

The ratio shows how often supplies are used such as in a particular program.

Analysis of Fixed Assets

In the long run, buying assets is cheaper than renting. NPOs also have more control by buying because they do not have to concern themselves with lessors unexpectedly raising rental rates or demanding certain prohibitions of using the property.

The average accounting age of equipment (e.g., computers) can be determined as:

The ratio reveals how old the equipment is. It shows the rate equipment is being used and replaced. A lower ratio is better.

The ratio is of particular interest to hospitals because they must buy expensive up-to-date technological medical equipment and keep facilities in good working order for the best patient care.

A low depreciation charge may indicate that the NPO is making significant use of rentals. Does a reduction in fixed assets mean there is less capacity and utilization?

Analysis of Liabilities

Short-term borrowing can be used to fill the gap resulting from the temporary shortfall in contributions or other sources of cash inflow.

If long-term debt is used to finance fixed assets, the NPO has greater financial leverage risk. The NPO must be able to pay principal and interest.

Analyze the long-term indebtedness of the NPO including:

• Interest rate being charged.
• Excessiveness of debt.
• Reason for borrowings. How is the money to be used?
• Maturity dates of debt. Are debt payments staggered? Can the debt be repaid?
• Lines of credit.
• Loan restrictions such as collateral requirements. Are such restrictions tying the hands of the manager?
• Understated liabilities, such as the liability for severance payments or for earned but unused vacation time

APPRAISAL OF SOLVENCY, CAPITAL STRUCTURE, AND NET ASSETS (FUND BALANCE)

A healthy capital structure will help ensure the NPO’s ability to engage in its daily activities. High leverage (debt to net assets or fund balance) means risk. The debt ratio will increase if the NPO must finance fixed asset expansion with borrowed funds.

The ratio of long-term debt to total unrestricted net assets (fund balance) reveals the NPO’s long-term commitments to its ability to pay the debt. This ratio relates borrowed funds to owned funds. A ratio over 1 may indicate a problem in handling additional debt. Can the NPO pay existing interest and principal payments?

Analysis of the net assets (fund balance) depends on the facts and circumstances. A surplus indicates better financial health than a deficit. An increasing trend in the surplus is a favorable sign. Surpluses provide savings for financing the future and the ability to pay off debt.

EVALUATION OF THE STATEMENT OF ACTIVITIES

An NPO should communicate to the users of the financial statements which specific revenues and expenses are included as the operating revenues and expenses. If the NPO’s use of the term “operating” is not clear from the details on the face of the statement, ASC 958-205 requires a footnote describing the nature of the measure of operating performance. The financial analyst should carefully review the NPO’s definition of the operating measure and compare it with that used by similar NPOs; the definition should be consistently applied. Generally, the operating income measure is a subtotal in arriving at the net change in unrestricted net assets.

In analyzing the statement of activities, determine:

• Whether the entity is self-sustaining and operating well
• If service efforts are being successful
• Whether management has discharged its stewardship responsibilities

In the long run, if an NPO does not spend all of its revenues, it is not funding as much services as possible to the public. However, if it keeps spending more than its revenues, it will go bankrupt.

In analyzing an NPO, consider operating capital maintenance, a concept that refers to whether the NPO is maintaining its capital by having its revenues at least equal to its expenses. Why did a surplus or deficit occur?

An NPO should not report a profit consistently each year. If it always shows a profit, the NPO may not be accomplishing its objective of providing as much service as possible with available resources. It should either provide more service and thereby increase its costs or reduce prices it charges for services. The objective of an NPO’s financial policy should be to break even.

An NPO (such as a membership organization) may have a policy of having an operating excess one year but a deficit in another year, which balances out. For example, member dues may be increased only once each three years. In the year of the dues increase, an operating surplus may arise. In the second year, there may be a break-even point, and in the third year a deficit may exist. Dues are then increased again.

In a similar vein, an NPO may want an operating excess one year to eliminate a deficit from the previous year.

An operating surplus may also be desired to have adequate funding for expansion, to subsidize programs, or as a result of a lawsuit. A surplus may be desired as a contingency for unexpected problems and to replace assets.

An NPO may want to operate at a deficit in one year to reduce an accumulated surplus or to meet a special need.

In conclusion, an NPO does not have to break even each year. It may have a surplus in one year(s) and a deficit in another year(s) to meet its unique circumstances as long as it balances out over a number of years.

Revenue

The revenue base should be diversified to reduce risk. For example, overdependence on one revenue source (e.g., grants) may be dangerous.

A decline in revenue may indicate ineffectiveness. For example, a decline in college tuition may mean problems in attracting students at a college. How does actual revenue compare to expected revenue?

Total revenue needed daily on average equals:

Costs

Expenses should be analyzed in terms of program and object of expense. Variances between actual and budgeted expenses should be investigated.

Determine the reason for a sizable increase or decrease in an expense. For example, a significant increase to a specific expense may not be due to a change in organizational plan but may reflect contributed services instead.

Determine the cost per unit of service. A lower rate means better cost containment. When costs need to be reduced, the first thing to cut is lower-priority programs that least accomplish the NPO’s goals. However, consider how changes in program activities would affect donor contributions and volunteer support. Identify controllable and uncontrollable costs. Ask these questions:

• Can costs be reduced by replacing obsolete and/or inactive equipment?
• Can costs be reduced by improved technology?
• Will an improved repairs and maintenance program lower costs?
• Can staff improvements be made to lower costs?
• Can energy costs be reduced through improved traffic management?
• Can productivity be improved?

Ratios include:

A lower ratio indicates better cost control.

The ratio evaluates the effectiveness of fundraising efforts. Is fundraising cost excessive for funds obtained?

U.S. GAAP requires a statement of functional expenses from voluntary and health organizations. The statement is helpful to the financial analyst because it provides a detailed breakdown of expenses by program. It is analogous to segment reporting in business enterprises.

Profitability

NPOs trying to expand and enter new areas need to be profitable. Profitability measures include:

A higher ratio shows better operational performance (profit).

Operating revenue excludes nonoperating sources, such as fundraising revenue, dividends, and extraordinary items. The operating profit is derived solely from operating activities without having to rely on contributors. A higher ratio is better.

The ratio shows how efficiently the net assets (fund balance) have created the year’s profit.

Ratios of investment performance include:

Higher ratios indicate better returns on investments.

Disclosures

In examining footnote disclosures, identify contingencies, including positive and negative developments affecting the NPO. Disclosure of possible future funding problems is a red light. An example is changing political policies directed toward reducing government funding.

A lawsuit against the NPO is a negative sign, particularly if it is reasonably possible that the NPO will lose.

PERFORMANCE METRICS

We have to examine the quality of the services and programs offered by the NPO, not just look at dollars. The NPO’s objective is to render an amount and quality of services. For example, measures of performance (or metrics) for a college include number of enrollments, number of courses, and ratio of faculty to students. Some general performance measures to keep in mind include:

• Capital per unit of service
• Number of patients treated daily by a doctor
• Number of welfare cases handled by a social worker
• Input/output relationships, such as the cost and time of performing a service and the quality and quantity of service provided
• Number of complaints

How do you figure out who does the most with the contributions and who spends inordinate sums, however well intentioned, on raising the money and excessive overhead? Several indexes, including charity commitment, fundraising efficiency, and donor dependency, would be helpful to answer those questions.

Charity Commitment

Charity commitment percentage =

Essentially, the resulting figure excludes such overhead as management and fundraising.

Fundraising Efficiency

Fundraising efficiency measures how much of the money raised from private sources remains after accounting for fundraising. It is computed by taking the total funds raised from the public through direct contributions, indirect contributions (such as from United Way), and proceeds from one-time special events, subtracting fundraising costs, then expressing the result as a percentage of the total amount from the public (private support).

Donor Dependency

Donor dependency tries to assess how badly a charity needs contributions—as opposed to money raised from selling products or tickets or reaping investment gains—to fund its current operations. It is figured by subtracting a charity’s annual surplus (excess of revenue over expenses) from public donations (private support), then dividing this figure by the public donations (private support). A percentage at or above 100 percent means that the nonprofit is totally dependent on donations and is not salting away funds for a rainy day. A negative index number means that surpluses exceed all donations for the reporting year.

Exhibit 41.1 presents these indexes for a selected charity organization.

Exhibit 41.1 Charitable Commitment, Fundraising Efficiency, and Donor Dependency

Fundraising Ability

Creditors evaluate an NPO’s fundraising ability as a major source of debt repayment for non–revenue-generating projects. Donated funds are important to consider when appraising the NPO’s creditworthiness. Refunding is issuing new debt to replace existing debt and may occur if (1) market interest rates have decreased, (2) excessive restrictions exist in current debt, or (3) there is a desire to lengthen debt maturity.

Analysis of Pledges

In appraising pledges, consider these questions:

• Are pledges decreasing among a particular category of donors or all donors?
• Does poor economic activity result in fewer pledges?
• Have new tax laws made gift giving less advisable?
• Do donors feel the objectives of the NPO no longer match with their views?

Creditors may not assign a value to pledges receivable when analyzing the NPO because donors are not legally bound to honor their dollar pledge or time promised. For example, if the donor goes bankrupt, although unlikely, the promise will not be kept. The donor may change his or her mind in giving because of a change in circumstances. However, the creditor should examine who the donors are, their past history of giving, their current financial status, and their reliability. If the donor’s profile indicates a high probability of giving the amount promised, creditors will give loans based on security or the pledges receivable. For example, pledges may be used to secure debt service or construction loans.

The analyst considers pledges due within one year of higher quality than pledges due in five years. Thus, the shorter the time period associated with the pledge, the less risk involved.

Analysis of Contributions

A potential cash problem is indicated when actual contributions fall significantly short of expectations. Restricted contributions are unavailable for operating purposes and to pay short-term debt. How much funds are available and when? What are the restrictions (e.g., scholarship fund, building fund)? Are the restrictions very specific or excessive? It is better to have a higher ratio of unrestricted contributions to total contributions because unrestricted contributions are available to be used by the NPO in its regular activities. Restricted contributions do little to improve the NPO’s liquidity unless the donor’s terms allow for the transfer of funds for operating purposes.

NPOs with substantial contributed services need special attention. The footnote on contributed services should be closely read because it describes the program or activities that use volunteer services, the nature and extent of contributed services in monetary and nonmonetary terms, and the amount of contributed services recognized as revenue for the year.

Looking at Endowments

An endowment represents long-term investments. Investment income from the endowment may be unrestricted and available to finance operating activities or restricted as to use. Donors want financial feedback as to whether the NPO has expended resources received, if expenditures are in accord with promises made, if services and activities provided are of high quality, and the remaining balance of resources. Constraints and commitments made to donors regarding fund use are disclosed in the financial statements. For example, are legal requirements being met?

A decrease in endowments is a negative sign because it may indicate less interest or dissatisfaction with the NPO. However, poor economic conditions may be the reason.

Answer these questions about the portfolio in which endowment funds are invested:

• How much fluctuation exists in the securities portfolio?
• Is diversification of the portfolio adequate?
• Are the securities negatively or positively correlated?

Total return on endowment investments may be estimated by computing it as a percentage of the average balance of endowment investments.

The return on the endowment investment should be higher as the risk of the investment increases.

Evaluation of Grants

In analyzing grants, answer these questions:

• Has there been a sufficient attempt to obtain public and private grants?
• Was reference made to suitable sources, such as The Foundation Directory?
• Does the foundation’s objective match the grant proposal?
• Are matching funds required to receive the grant?
• Was the proposal completely done (e.g., detailed information, clear discussion of how funds will be used)?
• Were due date filings met?

Perform a risk-return analysis. Is the return sufficient to justify the risk? The greater the risk, the greater should be the return. Risk means the probability of an activity accomplishing its objective. For example, there may be a high degree of risk associated with a new specialized academic program in a university or a new medical procedure at a hospital. There is always risk in allocating human and financial resources to new programs.

To control or reduce risk:

• Use agents and representatives, including volunteers.
• Carry adequate insurance protection. For example, insurance should be sufficient relative to the value of the insured property.
• Carefully hire qualified staff to avoid damages and injuries to others.
• Have written policies and communicate them carefully through the organization.
• Have proper supervision over new hires.
• Have protective provisions in contracts to limit the NPO’s liability for contractor malfeasance.
• Have proper security over assets to guard against theft or destruction.
• Diversify operations.
• Avoid dealings with selected groups that may result in legal liability problems, such as young children when dealing with hazardous items.

Audit Reliability

Many state and local governments require audits to be conducted of NPOs. Have the NPO’s financial statements been subject to an audit, review, or compilation? A big difference exists between these processes in terms of the reliability of the NPO’s financial statements. An audit provides the highest level of reliability and testing. No testing is performed in a review; rather, a determination is made as to whether the financial statements make sense. A compilation, the least reliable type of assessment, involves just collecting and reformatting financial records.

In looking at the audit opinion, an “except for” qualification or a disclaimer may indicate a problem. An unqualified opinion is best.

Software

Software exists to analyze NPOs. For example, the Functional Cost Analysis Program develops credit union income and cost information along functional lines and compares data among credit unions and banks.

SPOTTING POTENTIAL BANKRUPTCY AND AVOIDING FINANCIAL PROBLEMS

Negative net assets (fund balance) indicate a worrisome deficit position that is an indicator of potential bankruptcy. Cash forecasts showing expected cash outflows exceed expected cash inflows may point to financial distress. If cash is a problem, timely steps may be needed to improve cash flow and solve problems. How long will the current cash position last if all cash inflows were to cease?

A balanced budget, using conservative revenue estimates, is its own way to avoid financial ruin. A balanced budget requires difficult choices, such as curtailment or elimination in certain services or programs.

Answer these questions to gauge the NPO’s probability of potential failure:

• Is there adequate insurance?
• Does excessive legal exposure exist? What is the nature of pending lawsuits? Is the NPO abreast of all current laws and regulations affecting it?
• What government adjustments are expected regarding rate charges and reimbursements?
• Is there inadequate control over expenditures?
• Is there deferred maintenance that can no longer be postponed?
• Are loan restrictions excessive?
• What effect will contractual violations have?
• Are costs skyrocketing? Why?
• Are bills past due?
• Is debt excessive?
• Are debt repayment schedules staggered?
• Should maturity dates be extended?
• Is the public or government criticizing the NPO?
• Is there a decreasing trend in donor interest?
• To what extent are donor contributions restricted? Restricted donations cannot be used to pay current expenses unless the restriction is satisfied or lifted.
• Is there less community interest in the NPO (e.g., fewer members, patients)?
• Are fewer volunteers available?
• Are more grant applications being rejected?
• Is there a cash shortage?
• Is the NPO anticipating future trends (e.g., social, political, technological)?
• Does the NPO have sufficient expertise in the areas it is involved in?
• Is there a buildup in assets (e.g., receivables)?
• Is a hedging approach used to finance assets by matching the maturity dates of liabilities against them?
• Are long-term fixed-fee contracts hurting the NPO?
• Is there a sharp increase in the number of employees per unit of service?
• Are there open lines of credit?
• Does a lack of communication exist?

Ways to avoid financial problems include:

• Merging with another financially stronger similar NPO. Will a merger aid in financing, lower overall operating costs, synergy and efficiency, and program expansion?
• Restructuring the organization.
• Selling off unproductive assets.
• Deferring the payment of bills.
• Discarding programs and activities no longer financially viable.
• Implementing a cost reduction program, including layoffs and attrition. But will doing so eliminate programs that will be hard to start up again? Are you getting rid of scarce talent? Such cuts are referred to as irreversible reductions, which in the long run may not be wise.
• Increasing service fees.
• Increasing fundraising efforts and contributions.
• Applying for grants.
• Stimulating contracts.

CASE STUDY IN FINANCIAL STATEMENT ANALYSIS

Family Service Agency of Utopia

This case study is based on a sample NPO provided by the Internal Revenue Service in Form 990. A sample tax return is prepared for illustrative purposes and presented at the end of this chapter.

An analysis of the trends from 2009 to 2010 reveals:

• The cash position declined having a negative effect on liquidity.
• Pledges and grants receivable have both significantly increased, reflecting success in obtaining pledges and grants to the NPO, which is a favorable sign. However, it may be that there is a problem in collecting the pledges and grants due to higher receivable balances.
• The buildup in inventories may mean greater realization risk.
• Fixed assets were fairly constant.
• The increase in total assets is a favorable indicator.
• Total liabilities were about the same.
• While the balance in current unrestricted funds increased, a favorable sign, there was a decline in the current restricted fund. However, the dollar amount of the decline is small even though it is a higher percentage.
• More funds are available for fixed asset expansion.
• The NPO has been successful in having more endowment funds.
• The increase in total net assets (fund balances of about 6 percent) is a positive sign.
• Contributions, gifts, grants, and similar items decreased about 5 percent. The reasons for the decrease should be determined. Is there less interest in the NPO among donors? If so, why?
• The membership revenue almost doubled, reflecting greater interest in the NPO’s policies as indicated by more enrollments or an increase in per member fees. Perhaps there was a successful membership drive.

Liquidity Analysis

Each $1 of total assets is comprised of $0.33 of current assets.

The high ratio means good liquidity.

The high ratio further indicates good liquidity.

Because the quick ratio (2.87) exceeds the norm of 1.0, good liquidity is evident.

Receivables turn over 1.5 times per year relative to fees generated. The low turnover rate indicates less liquidity. Perhaps there is risk in collecting.

It takes 243 days to collect on receivables, indicating a possible collection problem.

The very low ratio means receivables are insignificant relative to total assets.

The high turnover rate means faster collection on pledges, which is a favorable liquidity indicator.

It takes about 41 days to collect on pledges. This is favorable.

This computation indicates that $0.47 of internally generated cash is available to pay $1 of debt.

For each $1 in current liabilities, there is $2.20 of cash and short-term investments available to pay it.

Current debt is a high proportion of total liabilities. This is an unfavorable liquidity indicator.

Analysis of Solvency

There is $8.60 in assets for each $1 in liabilities, indicating a good solvency position.

The low ratio of debt to net assets/fund balance is a favorable indicator of the ability of the NPO to meet its obligations. It indicates less risk.

This ratio is a further indication of a solid solvency position. The NPO is able to fulfill its long-term debt commitments.

Analysis of the Statement of Activities

a Given from year 2009.

The declining revenue per day from 2009 to 2010 is a negative sign for operating performance.

Total expenses are a high percentage of total revenue, cuttings into surplus.

Fundraising costs as a percentage of contributions is reasonable, indicating an effective fundraising campaign.

The profit margin should be compared to other similar NPOs. If it is lower, it indicates less operational performance.

a ($964,800 + $916,000)/2 = $940,400

This ratio reflects reasonable efficiency of the net assets/fund balance in generating yearly surplus for the year.

The rate of return earned on the investment portfolio is low.

Exhibit 41.2 summarizes financial statement analysis covered throughout the chapter.

Exhibit 41.2 Financial Ratio Analysis

	12/31/2009	12/31/2010
Assets
Total Cash (Lines 45 and 46)	$248,700	$228,500
Accounts Receivable (Line 47c)	1,800	1,600
Pledges Receivable (Line 48c)	46,000	58,900
Grants Receivable (Line 49)	4,600	5,800
Other Receivables (Line 50)	—	—
Other Notes and Loans Receivable (Line 51c)	—	—
Inventories (Line 52)	6,100	7,000
Prepaid Expenses and Deferred Charges (Line 53)	9,600	13,800
Total Current Assets (Line 45 through Line 53)	316,800	315,600
Investments—Securities (Line 54)	430,700	474,400
Investments—Land, Buildings (Line 55c)	—	—
Fixed Assets (Line 57c)	168,500	174,800
Other Fixed Assets (Line 58)	—	—
Total Assets (Line 59)	$916,000	$964,800
Liabilities
Accounts Payable and Accrued Expenses (Line 60)	$46,000	$39,300
Grants Payable (Line 61)	—	—
Support and Revenue Designed for Future Periods (Line 62)	61,600	59,600
Loans from Officers (Line 63)	—	—
Total Current Liabilities (Line 60 through Line 63)	107,600	98,900
Tax-Exempt Bond (Line 64a)	—	—
Mortgages (Line 64b)	3,600	3,200
Other Liabilities (Line 65)	—	10,200
Total Liabilities (Line 66)	$111,200	$112,300
Net Assets or Fund Balances
Current Unrestricted Fund (Line 67a)	$446,300	$485,100
Current Restricted Fund (Line 67b)	10,000	6,400
Land, Buildings, and Equipment (Line 68)	156,800	166,200
Endowment Fund (Line 69)	191,700	194,800
Other Funds (Line 70)	—	—
Capital Stock (Line 71)	—	—
Paid-in Capital (Line 72)	—	—
Retained Earnings (Line 73)	—	—
Total Net Assets (Fund Balances) (Line 74)	804,800	852,500
Total Liabilities and Fund Balances (Line 75 = Line 66 + Line 74)	$916,000	$964,800
	For the Year Ended
	2009	2010
Program Service Revenue (Line 2)		$2,600
Dividends and Interest from Securities (Line 5)		16,400
Total Revenue (Line 12)	$800,600a	760,300
Fund Raising Costs (Line 15)		65,400
Total Expenses (Line 17)		712,600
Excess or (Deficit) (Line 18)		47,700
Depreciation (Line 42)		$5,200
Liquidity Analysis
(1) Total Current Assets/Total Assets		0.33
(2) Current Ratio = Current Assets/Current Liabilities		3.2
(3) Accounts Receivable Turnover = Program Service Revenue/Accounts Receivable		1.5
(4) Days to Collect on Receivables =365 days/Accounts Receivable Turnover		239
(5) Total Accounts Receivable/Total Assets		0.2%
(6) Cash Flow to Total Debt = (Net Income + Depreciation)/Total Liabilities		0.47
(7) Total Current Liabilities/Total Liabilities		0.88
Analysis of Solvency
(8) Total Assets/Total Liabilities		8.6
(9) Total Liabilities/Total Fund Balance (Net Assets)		0.13
(10) Long-Term Debt/Total Unrestricted Fund Balance		2.8%
Analysis of the Statement of Activities
(11) Daily Revenue = Total Revenue/365 days	2,193	2,083
(12) Total Expenses/Total Revenue		93.7%
(13) Profit Margin =Excess of Revenue over Expenses/Total Revenue		6.3%
(14) Return on Net Assets (Fund Balances) = Excess of Revenue over Expenses/Net Assets		5.1%
(15) Dividends and Interest from Securities/Investments		3.5%
a Given from the previous year.

Conclusion

The NPO’s liquidity is favorable, meaning it is able to pay its short-term obligations. Its solvency is also favorable, meaning it can satisfy its long-term debt when due. The NPO is having difficulty in its operating performance, as indicated by declining daily revenue, high expenses to revenue, and low investment return. However, fundraising costs are being controlled, resulting in successful fundraising efforts. Profit margin and return on net assets or fund balance appear reasonable. There is more interest in the NPO, as indicated by the increasing membership base.