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Board of Directors’ Use of Financial Ratios

By: Shawn Williams, CPA, FHFMA, Audit Senior Manager

As a current board member for several not-for-profit organizations, my fellow board members and executives seek my advice when reviewing and dissecting financial reports. CPAs are highly preferred during annual board recruitment due to their knowledge of finances, taxes, and accounting standards; however, the non-finance volunteers serving on the board of directors can apply financial ratios in order to summarize reporting into logical, measurable data.

Take for instance the Days Cash on Hand Ratio:

This ratio calculates the number of days in expenses or asks the question, “If business was to stop today, how many days could operations continue without running out of cash?” The general target is 180 days or 6 months, but the size of the organization (or company) and industry served also has an impact on the measurement. Shooting for 90 days for a not-for-profit is a great first step to building a stronger reserve to weather the bad times. Corporations that have reserves in excess of 360 days, such as Apple, can become more strategic where innovation and acquisitions can be very prosperous.

For shareholders or board members of not-for-profits, the Return on Net Assets (equity) can be a reflection of the amount of return on $1 of net assets or better yet, “What did $1 of net assets earn for the fiscal or calendar year?”

The net income will include both operating and non-operating revenues and can be severely impacted, either positively or negatively, if there are any assets invested in the financial markets. Obviously, the desired return is positive, but to keep pace with inflation and the market, the desired position is at least 5%. Remember, this ratio uses the net income (or bottom line) for all operating and non-operating activities. To that end, the last ratio in this set of analyses and one that may be considered as most imperative is the Operating Margin.

This key standard measures the return on operations and may be broken down even further to analyze operations by department or service line. In order to fund operations and the expenses incurred, a 3% margin will allow necessary coverage with room to build additional reserves. Organizations have an even more challenging time in the wake of healthcare reform and changes in health insurance, reimbursement reductions, and sequestration.

When calculating the above ratios, benchmark your organization against others in the industry and competitors while ensuring that your organization’s trend is of utmost importance. These metrics will guide the board in developing strategies around which revenue sources to continue building or discontinue, where expense control is needed, and possible financing alternatives while staying focused on serving the organization’s mission.

 

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