OVERVIEW OF RATIO ANALYSIS

for

Community Development Corporations

From EaSy User Manual, a publication of Organizational Development Initiative of Local Initiatives Support Corporation

EaSy is a tool that facilitates the analysis of the financial health, status and trends of your Community Development Corporation quickly, accurately, and efficiently. Using your data to generate user-friendly graphs and tables, EaSy is an instrument for high performing CDC boards and staff to strengthen organizational financial management. To order a copy of EaSy, send an email to odi@liscnet.org or fax your request to 212-986-1857. You can also contact your local LISC office to obtain this software.

Overview of Ratio Analysis for Community Development Corporations

atios are used to analyze financial statements and to explain relationships between individual amounts in the financial statements (i.e., revenues and expenses; assets and liabilities; revenue to assets; and expenses to liabilities). A ratio in isolation is typically of little value. Ratios become more meaningful when they are compared to: Organizations past performance. Organizations of similar size. Standards by charitable watchdog organizations (i.e., National Charities Information Bureau, Better Business Bureau).

We have grouped ratios for discussion by their application in measuring liquidity, efficiency, leverage and profitability.

From EaSy User Manual, a publication of Organizational Development Initiative of LISC

Overview of Ratio Analysis for Community Development Corporations

I. Liquidity Ratios
Liquidity ratios, also referred to as solvency ratios, show the ability of a CDC to meet financial obligations over the short-term. These ratios help you assess the organizations ability to meet such near-term obligations as accounts payable, or to maintain regular operations, with current assets that will become available in the near future (typically within one year). These ratios give information on the adequacy of unrestricted cash for seeding new community development projects, bridging cash shortfalls, and providing collateral for loans.

Current Ratio - This ratio compares assets expected to be available as cash within the next year (i.e., cash, investments, accounts receivable, etc.) with current liabilities, or those liabilities that will become due within the same 12 month period (i.e., accounts payable, current portion of debt, etc.). The current ratio is calculated as follows: Current Ratio = Current Assets Current Liabilities

As a general guide, the current ratio should be 1.2:1 or higher. In the for-profit and government sectors, a current ratio of 2:1 is considered an indicator of reasonable financial strength. A ratio of less than 1.0 indicate that the organization does not have sufficient current assets to meet current payment obligations. Charting the current ratio over time provides useful information concerning trends in the CDCs financial status. An analysis of the CDCs current ratio requires some judgement. If the CDC has carried a receivable from an affiliated entity on its books (for example, a housing development limited partnership) for several years, in the same amount, this is most likely not collectible within a one year period. A more conservative approach in determining the current ratio would require deducting the amount of questionable receivables from total receivables reported. Cash Ratio - This is a more conservative estimate than the current ratio since assets other than cash and cash equivalents are excluded from this ratio. The cash ratio relates current liabilities to an organizations most liquid current assets. In essence, some assets are quickly convertible into cash. A CDCs most liquid current assets exclude accounts receivable from this calculation, as these are frequently not immediately collectable. This ratio is an important measure of the organizations liquidity. Cash Ratio = Cash + Cash Equivalents Current Liabilities

This ratio should be at least .5 to .75, and clearly, the higher the better.

From EaSy User Manual, a publication of Organizational Development Initiative of LISC

Overview of Ratio Analysis for Community Development Corporations

Days Cash This is the number of days that the organization can pay its obligations without any cash inflows. This can be a very enlightening number and in some cases shocking. Days Cash is expressed in number of days, and is calculated as follows: Days Cash = (Cash + Cash Equivalents) X 365 Operating Expenses - Depreciation

As a general guide, an organization should have at least 90 days (three months) of cash at its disposal.

Working Capital This is the difference between current assets and current liabilities. It represents the pool of resources available to management to conduct daily operations, and is a significant indicator of the resources available to your CDC for equity investments in development projects. Working Capital is expressed as a dollar amount (not as a ratio) and is calculated as follows: Working Capital = Current Assets - Current Liabilities

From EaSy User Manual, a publication of Organizational Development Initiative of LISC

Overview of Ratio Analysis for Community Development Corporations

II. Efficiency Ratios

Efficiency ratios measure how successful the organization is in using the assets and capital at its disposal in order to maximize cash flow. Receivable Turnover - The receivable turnover ratio and the average receivable collection period provide information on the ability to collect receivables by examining how often they turn over (or are collected) per year and the number of days (on average) it takes to collect accounts receivable. The intent is to determine the liquidity of accounts receivable. The organizations receivable turnover rate, stated in times per year, is computed as follows: Receivable turnover = Annual Revenue/Support* Average Receivables**
*Revenue and support amounts are located in the Statement of Activities. **The Average Receivables is calculated by adding the prior years accounts receivable and the current year accounts receivable from the Statement of Financial Position and dividing the total by two.

Once the receivable turnover rate is determined, the average collection period (in days) is calculated as follows: Average Collection Period = 365 Receivable Turnover Because many CDCs have a number of revenue and support sources (i.e., government grants, private grants, rental/developer revenue, etc.) it is appropriate to separately calculate the receivable turnover ratios and the average collection period for the major different sources of revenue/support. For example, you might want to look at the average collection period for government grants, if these grants are a major element of your CDCs revenue. You would calculate your Grants Receivable Turnover (annual grants receivable/average grants receivable), and then divide 365 by that amount. If its taking the organization an extended period of time, lets say more than 3 months, to collect the major source of revenue, perhaps the organization needs to explore diversifying its sources. Receivable turnover and the average collection period are meaningful statistics since they show how long it takes for an organization to convert its accounts receivable to cash. Comparing these to ratios to the Days Cash provides a powerful snapshot of a CDCs efficiency and liquidity. A CDC with only 30

From EaSy User Manual, a publication of Organizational Development Initiative of LISC

Overview of Ratio Analysis for Community Development Corporations

Days Cash, and a 90 day Average Collection Period, could be facing short-term problems. A reasonable time period to collect is 30 days for accounts receivable and 90 days for grants. A longer time period is indicative of billing or collection problems.

Management & General Expenses as % of Total Expenses - This ratio measures what percentage of total expenses the organization is spending on management and general expenses (sometimes referred to as administration and overhead). This ratio is generally of great interest to the funders, as it is a reflection of the CDCs proficiency in the use of funds for programmatic purposes. Charitable watchdog organizations set a standard for this ratio in the range of 20% - 25% of total expenses. This ratio is calculated as follows: Management & General Expenses Total Expenses

Program Expenses As % Of Total Expenses - This ratio indicates what percentage of total expenses are devoted to program activities. Charitable watchdog organizations look for this ratio to be 60% or greater. This ratio is calculated as follows: Program Expenses Total Expenses

From EaSy User Manual, a publication of Organizational Development Initiative of LISC

Overview of Ratio Analysis for Community Development Corporations

III. Leverage Ratios

Leverage ratios measure the difference between funds generated by the CDCs activities (i.e., fees, developers profit, and unrestricted grants) as compared to funds supplied by outside lenders in the form of debt. Outside lenders are interested in seeing a high proportion of organizational equity to debt, to insure the CDCs ability to fulfill payment obligations, as well as its ability to weather unexpected financial reverses.

Debt To Net Assets Ratio - This ratio measures to what extent the organizations operations are funded by debt. The principal amount of the CDCs long term debt is the amount included in the computation. Commercial lenders frequently look at this ratio to determine their risk when they are considering lending to a new borrower. An excessive debt to net asset ratio may suggest that the CDC is over-leveraged. In the community development industry, a ratio above 5-to-1 is cause for concern. Younger CDCs, in particular, need to be very conservative in acquiring debt, until they have established stable and adequate revenue streams. In calculating this ratio it is important to consider: Whether the organization has an explicit policy on what ratio is acceptable and where you stand in relation to this ratio. The quality of the net assets, with an analysis of its composition (i.e., what portions of the net assets are unrestricted or questionable receivables. The ability to service debt, or the net cash flow during the year. The reliability and consistency of the sources of support and revenue. How the CDC uses debt. Long-term debt to finance real estate investments is an acceptable use while long-term debt to finance organizational operations is cause for concern. This ratio is calculated as follows: Debt-to-Net Assets Ratio = Long-term Debt Net Assets

From EaSy User Manual, a publication of Organizational Development Initiative of LISC

Overview of Ratio Analysis for Community Development Corporations

IV. Profitability Ratios

Ratios concerned with profitability may, at first consideration, not be relevant to the CDC industry. CDCs are nonprofit organizations with a charitable purpose; profit would seem to be antithetical to our work and purpose. At the same time, a CDC cannot afford to remain static, or stagnant, nor can it afford a long-term decline. An organization, which chronically runs deficits, is a poor candidate for outside investment or program expansion. For better or worse, a funders confidence in the effectiveness of the organizations management will be determined and influenced by the results of these ratio calculations.

Operating Ratio - This ratio can be used as an index of efficiency as well as profitability. It is frequently calculated as part of the underwriting of real estate projects, but also can be used as a measurement of how well the CDC can control operating costs. A CDC with a low operating ratio (and therefore a high level of revenues) is generally considered stable, and well managed. Trending this ratio is a useful analytic exercise. If the ratio is increasing over time, it may, for example, indicate that the organizations net revenues are shrinking through the loss of an important source of funding. This ratio is calculated as follows: Operating Ratio = Total Operating Expenses Revenues + Support Return On Net Assets - This ratio is frequently referred to in the field of financial analysis, and is also known as Return on Equity. In nonprofit terms it compares the amount of change in net assets (or net revenue) to the net assets (or equity) of the CDC. The composition of the CDCs net assets is an important consideration when analyzing this ratio. The net assets of many CDCs consist of real estate, which is fixed in value. Real property which has been designated for a particular use, or a restricted income group, will not necessarily generate a profit or return. On the other hand, a CDC whose net assets are substantially liquid may generate a high rate of return on its funds. Watching the trend of this ratio provides useful information to a CDCs financial managers. This ratio is calculated as follows: Return on Net Assets = Change in Net Assets Net Assets

From EaSy User Manual, a publication of Organizational Development Initiative of LISC