Spotlight on Monitoring the Financial Health of Your Organization – Part 1 : Statement of Financial Position
by Sara Kirk, Audit Manager
Posted on October 17, 2014
Does your organization have the ability to weather unexpected financial challenges? This can be critical to those analyzing your financial statements both internally and externally. The amounts reported within the Statement of Financial Position can provide valuable information regarding the liquidity and financial flexibility of an organization.
The Statement of Financial Position focuses on the organization as a whole, and reports total assets, liabilities and net assets. The statement provides a cumulative picture of an organization at a single point in time.
Liquidity is defined as the ability or ease with which assets can be converted into cash. There are two key ratios that are used to measure liquidity. The first liquidity ratio is the current ratio, which is calculated by dividing total current assets by total current liabilities. The current ratio is a simple way to assess an organization’s ability to pay immediate obligations. A healthy current ratio would be 2, an indicator that even if current assets were to be reduced by half; the organization’s creditors would still be paid in full.
The quick ratio takes the concept of the current ratio one step further. It is a more conservative approach to assessing whether an organization can pay liabilities as they become due. The quick ratio is calculated by dividing cash and equivalents + marketable securities + accounts receivable by total current liabilities. Current assets such as inventories that generally take time to be converted into cash are excluded from the calculation. As with the current ratio; organizations with a higher amount generated from the quick ratio calculation are considered to be financially stronger than those with lower calculated amounts.
Many organizations experienced a decrease in contributions and donations in recent years due to economic factors. In times of declining revenue and support, having more liquid assets is extremely important to demonstrate an organization will continue to pay debts as they become due. The debt to total assets ratio is a leverage ratio that provides creditors with some idea of an organization’s ability to withstand fluctuations in revenues without impairing the interest of creditors. The ratio is calculated by dividing total debt by total assets. A ratio of less than 1 is an indicator that most assets are financed by equity, meaning the assets are owned outright. A ratio of greater than 1 is an indicator that most assets are financed by debt.
Evaluating and monitoring liquidity and leverage ratios internally can assist management and the board of directors in making key decisions and with benchmarking organizational performance. These financial indicators can also provide important insight into how those outside your organization may be evaluating your financial condition.