Top 10 financial ratios for charities

1. Surplus or profit margin  

net income
----------------------------------- x 100
total income

A business would call this profitability and would usually express it as a percentage. For example, a net income of £18,000 out of total income of £300,000 i.e. 18,000/300,000 x 100 is a profit margin of 0.06 X 100 = 6%. A charity exists to deliver public benefit, not profit; generating a surplus allows a charity to invest in the improvement/expansion of charitable activities. 

If the surplus margin overall is positive, you have made a surplus and your reserves will be boosted. A margin of zero means breaking even and if it is negative, you have made a deficit and you are eating into your reserves and your charity may not be financially sustainable. Your aim will usually be to at least “cover your costs” (break-even) and make a full cost recovery on your projects and services so that the revenue earned meets all the costs relating to the service, including an apportionment of overheads.

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This ratio can be calculated for each major activity, project or contract, and/or it can be used for the charity as a whole, month on month or year to date, and compared to prior periods. It’s useful to know the surplus or profit margin on each activity so that you understand the contribution each activity makes in its own right. An activity creates a surplus if it covers its direct costs and contributes positively (i.e. beyond break-even) to overheads. This can help you decide whether to continue an activity.  You don’t have to exit an unprofitable activity—if it is core to what you deliver as a charity, you can choose to raise additional funds to support the activity, and work on managing the costs as well as you can. 

Ensure that your finance staff understand the arithmetic here—as the cost recovery rate is usually a percentage of costs (not income). A product that sells for 100 and costs 80 makes a profit/contribution of 20. The margin is 20% (20/100), but the mark-up (full cost recovery and surplus) is 25% (20/80). Mark-up is always greater than margin; beware of mixing apples and pears. 

Your charity shouldn’t always be judged negatively on making a deficit in any given year, as this may have been planned per the annual budget in certain circumstances. If this is the case, make sure you justify the deficit in the financial review section of your Trustees’ Annual Report. However, consecutive years of making a deficit with no plan to turn around the charity’s financial performance are generally a cause for concern.

2. Fundraising efficiency  

fundraising revenue
----------------------------------
fundraising expenditure

Also known as the “fundraising multiplier”, this is a measure of the effectiveness of fundraising and can be calculated overall or by event / activity. It calculates the “return on investment” or “ROI” of the various fundraising activities carried out, and the higher the number above 1, the more successful the fundraising activity. 

For example, if you raise funds of £33,000 with fundraising expenditure of £12,000 your “fundraising multiplier” is 2.75. 

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The aim is to increase that number so that the funds raised cover the cost of raising funds many times over. You may find examples of other charities’ funding multiplier on their websites, particularly where they talk about their impact. 

Charities will not always make their decisions based on the ROI alone as some activities generate non-monetary value in areas such as profile raising in the community, recruitment of volunteers and outreach to the beneficiaries the charity aims to support in its mission. 

The Charities SORP (para 8.10-12) allows you to classify educational fundraising costs as charitable activity expenditure rather than fundraising expenditure, which will increase this ratio. 

3. Earned income

earned income
----------------------------------
unearned income

Another useful ratio for donors and funders is the ratio of earned to unearned income. For example, a charity may have £150,000 of earned income and £200,000 of unearned income and a target ratio of 1:1 i.e. equal parts earned and unearned income. Currently, the ratio sits at 150:200 or 0.75:1. 

If in future earned income is £250,000 and unearned remains £200,000 the ratio will be 1.25:1, and has exceeded the target ratio. This ratio generally applies to a mature charity that has developed diversified income as it has evolved.

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A charity that has a healthy proportion of well-diversified earned income (via trading, running events, investment income, performance-related grants and contracting for services) compared to unearned (non-performance-related grants from funders and donations from individuals) is likely to be more sustainable and more able to weather income downturns. 

Earned income can be considered steadier and more controllable than unearned income, although some forms of earned income, e.g. shops and cafes, were hard hit by the pandemic.  

4. Programme expense ratio

total programme expenditure
----------------------------------                  x 100
total expenditure

This ratio compares total programme or project expenses (direct costs of charitable activities) to total expenses, and is expressed as a percentage. This ratio demonstrates how efficient your charity is in fulfilling its mission by providing information on how much of a charity’s expenses are being spent on programmes (charitable activities) versus supporting services, such as management, general or fundraising expenses. 

You can deduct fundraising expenditure from total expenditure if you want to keep it separate. This ratio is internal only and is best derived from management accounts, where there is a clear demarcation between direct costs and overheads, rather than the filed financial statements.

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You will need to agree a good benchmark ratio for your charity – too high a ratio i.e. high programme costs compared to total costs can indicate that the charity has not invested enough in its infrastructure to sustain its quality of service, now and in the future. It may be that new charities will spend less relatively on their programmes than more established ones because of the administrative and fundraising efforts involved in launching the charity [at1] , however, expenses can be skewed because new charities rely heavily on volunteers rather than paid staff. It’s hard to estimate an acceptable range of programme expenditure to total expenditure, but generally this can fall between 60—70, although there are nearly as many working models as there are charities in reality! 

Individual donors to charities are often put off by high levels of expenditure that do not go directly to the cause, but you need to educate your donors about the costs of running a robust charity that will be around to continue to support its beneficiaries into the future.  

5. Employment cost ratio

total employment cost
----------------------------------   x 100
total expenditure

Employment cost is expressed as a percentage of total expenditure, and should include any roles that are outsourced. For example, £530,000 of staff costs (salaries, employment costs and outsourced fees) as a percentage of total expenditure of £930,000 for the year is .569 x 100 = 56.9%. The higher the ratio, the more important it is to keep on top of it! You may be able to compare this overall to similar charities in your sector, but you always need to bear in mind your own charity’s unique circumstances, and the important thing is to identify changes in your ratio from one month to the next and act accordingly.

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The reason for some charities’ financial woes is that they have allowed employment costs to drift higher than other charities in their sector. The cost of employing staff must be sustainable and met by the contribution generated by the activities of the charity. To meet increasing staff costs, charities need to look at ways to generate or raise additional funds, or reduce other operational costs.

6. Unit cost and full cost recovery

programme / project cost
----------------------------------
number of units delivered

Charities who provide a service need to understand what their unit cost is i.e. the financial cost to the charity of working with one beneficiary or case, or delivering one activity. Costs are made up of direct and indirect costs and “full cost recovery” means ensuring that all costs involved in running a service are recovered, including the relevant proportion or “allocation” of indirect costs or “overheads”. 

For example: 

Direct costs of a service for a project:
Staff (2 employees) £10,000 + Materials £5,000 = TOTAL £15,000

Indirect costs of the charity in the period for allocation:
Rent £24,000 + Utilities £8,000 + Admin £4,000 = TOTAL £36,000

Allocation of indirect costs to the project by headcount:
There are 10 employees at the charity therefore the project needs to bear 2/10 of overheads i.e. 2/10 * £36,000 = £7,200 

Total project cost: £15,000 + £7,200 = £22,500 

If the service is expected to be delivered to 100 beneficiaries, then the unit cost on a full cost recovery basis is £22,500/100 = £225. The volume forecast should be as accurate as possible.

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It’s worth noting that a significant variation can arise when actual output is more or less than planned output – if you deliver more than 100 units, the overheads will be spread over more units, resulting in a lower unit cost, and if you deliver less than 100 units, overheads will be spread over fewer and the result will be a higher unit cost. 

It’s not easy to compare unit costs of one charity with another as the services can vary, and you will generally not know what another charity’s unit cost is – this is a calculation done with mostly internal financial information. In putting together a funding application or bid, you may also be told what costs or percentage of costs to include. But having your own measure of your unit costs and full cost recovery is essential as it allows you to understand the costs that need to be covered as a minimum in order to price cost a service correctly and make a surplus on it, if you need to, or recover costs in full under a full cost recovery model. For wholly or part grant-funded activities, the funder may well not agree to fund all the overheads—let alone a contribution to reserves. If so, then to remain sustainable, the charity should consider other options—revenue and/or spend.

7. Current ratio

current assets
-------------------
current liabilities

The aim is to keep the current ratio above 1.5 i.e. to show that your current assets (those assets on your balance sheet readily convertible into cash) exceed your current liabilities, indicating that your charity can meet its short-term financial obligations. If the ratio is less than 1.5, it would be wise to question your charity’s ability to meet its payment commitments. 

An increasing ratio month on month (or quarter on quarter, if you only produce a balance sheet quarterly) shows an increasing margin of safety. Whatever the reporting period, monthly budget and cashflow review is always a good idea which allows for a timely response to, or pre-emption of, arising issues.

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You also need to consider whether certain assets classed as “current” are readily convertible into cash at this time – for example, the stock in a charity shop. If necessary, use the “quick ratio”, also known as the “acid test” ratio, which excludes stock and prepaid expenses from the current assets. Your quick ratio should be not less than 1. 

Note that you should exclude any restricted funds from this calculation and consider those restricted activities separately. Restricted income and assets are available only for operations the restriction applies to. The greater the restricted element of income or assets in your charity, the more important it is to track the current and quick ratios, as margins are likely to be tighter.

8. Debtor and creditor days

Debtor days ratio

debtors
-------------------                     X  365
annual billed revenue

If you bill any of your work, the “debtor days” ratio tells you how many days on average your customers or clients who owe you money take to pay you. For example, say you have debtors of £43,000 and your annual earned income is £170,000. Your debtor days are 0.253 * 365 = 92, which means that it takes on average approximately 3 months for your clients to pay you! You need to bring this average down by chasing overdue amounts. Remember, “Cash is King”, and you need to ensure that amounts due to you are in your bank account as soon as possible! 

Charities preparing annual receipts and payments accounts may not have the same depth of debtor and creditor information, but the same concept applies. Regular (ideally monthly) review and update of the cash flow forecast is probably the minimum requirement.

Creditor days ratio

trade creditors
-------------------                       X 365
annual purchases 

The “creditor days” ratio measures how many days on average your charity is taking to pay its bills. Obviously, the longer you can hold onto your cash the better, but try to remain within reasonable limits with your suppliers to maintain a good relationship and retain good credit terms. Taking a long time to pay can be a sign of a failing charity, and may impact your reputation. And always make sure you pay tax authorities on time as paying tax late incurs penalties and interest.

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Debtor days ratio

Ensure that you have sent the correct invoice to the correct client at the correct address to avoid delays in getting your invoice into their payment process. Call the client and make sure you know when the best time is to send your invoice to them—larger organisations have a scheduled pay run often only once a month and you need to make sure you get your invoice authorised for payment in good time to be included. 

Include an aged debtor report in your management accounts pack, detailing invoices due <30 days, 30-60 days and 60-90 days, by client, number, date and amount, and chase invoices proactively before they are due—these are called “credit control” procedures and will also help you to identify late paying clients for future reference.

Creditor days ratios

If the debtor days figure is significantly higher than the creditor days figure, the charity is better at paying its invoices than it is at collecting debts. So it may be worth comparing the two ratios periodically to focus your effort on collecting money owing to the charity and stretching credit terms with suppliers where possible, if cash flow is an issue. 

9. Reserves

Total funds of the charity, less restricted funds, fixed assets and designated funds

It’s not enough to calculate your “reserves target” or policy as a flat rate 3 months’ worth of annual operating expenditure, this is merely a guideline for how much cash you should keep on hand to survive should there be a fall in income. A reserves calculation needs to ensure you have sufficient reserves for your charity’s needs, and this will depend on your future plans. Such funds are described as “free reserves” as they need to be in unrestricted assets and readily available for you to use to support your charity without having to borrow externally.

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The SORPs basis for a reserves calculation is balance sheet total less functional fixed assets, restricted funds and designated funds. Designated funds are funds set aside by the charity for a specific purpose. The charity can change its mind and free up these funds if needed elsewhere, unlike restricted funds which are restricted by a funder or donor outside of the charity, and could even be clawed back by funders where services can’t be delivered as planned. 

Charities preparing annual receipts and payments accounts can start the reserves calculation from total cash funds; ignore fixed assets, but adjust for any significant difference between debtors and creditors (shown in the Statement of Assets and Liabilities).

Reserves should be calculated regularly, both with reference to current year core costs, but also looking forward if costs are expected to increase, or there are specific plans in place, for example to move premises, expand or scale up activities. Whether reserves keep up with expectations is a good indicator of going concern and when to issue warnings to the Board. A good going concern indicator is a satisfactory cash flow forecast that shows adequate reserves for the duration of the going concern period; for a last-minute filing non-company charity, the period will be 22 months (e.g. for the year ending 31 March 2022, the period runs from 1 April 2022 to the filing deadline + 12 months i.e. 31 January 2024—the earlier the filing, the shorter the period). The calculation should include “winding up” costs if the charity faces financial difficulties, e.g. costs of staff redundancy, contract penalties and disposal costs.

10. Liquidity cover  

current cash on hand
----------------------------
average monthly expenditure 

This ratio is a useful measure to show how many months of average operations you can afford with the current cash on hand from your unrestricted reserves if there was a sudden loss of income. Your monthly operational costs comprise payroll, rent and other overheads that are usually significant and not easily avoided. For example, if your current cash balance is £15,000 and your monthly expenditure is £6,500, your liquidity cover is approximately 2.3 – i.e. you have 2.3 months’ worth of funds on hand. 

This ratio should go hand-in-hand with a monthly review and update of the cash flow forecast.

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Consider also how quickly you can access funds should you need to make them available – you don’t want to be scrabbling around for signatories to an offline deposit account you can only access once a month if your liquidity cover falls dramatically – think about your liquidity “lead times” (see also “current” and “quick” ratios above).