Five Minutes for Finance - Financial Analysis
8 Steps to Analyzing a Nonprofit’s Financial Statements
So you’ve produced financial statements - now what? Let’s explore how to use the financial statements to evaluate your organization’s health and sustainability so that it is positioned to deliver on its mission for the long haul. Here’s a step-by-step guide to make the process easier.
✅ Step 1: Review the Statement of Financial Position (Balance Sheet)
Check if assets comfortably exceed liabilities.
Look at cash and receivables—are they enough to cover short-term obligations?
Review net assets (unrestricted vs. restricted) to see how much flexibility your nonprofit has with its resources.
✅ Step 2: Look at the Statement of Activities (Income Statement)
Compare revenues and expenses—is your nonprofit running a surplus, deficit, or break-even?
See where money comes from: are funding sources diverse or dependent on just one stream?
Check if spending aligns with the mission—most expenses should support programs, not just administration or fundraising.
✅ Step 3: Don’t Skip the Statement of Cash Flows
Focus on cash from operations—is it positive or negative?
Look at big swings in investing or financing activities that could affect long-term stability.
Remember: an organization can show a surplus but still struggle if cash flow is weak.
Also look at the cash flow forecast (if available) - this may be easier to understand and will show you when cash might be tight in the near future.
✅ Step 4: Use Ratios as a Quick Health Check
Current Ratio (also known as the Working Capital Ratio) = Current Assets ÷ Current Liabilities (Can we pay short-term bills?). The ratio should be at least 1.0.
Months of Cash on Hand = (Average monthly expenses ÷ Total Cash). This metric indicates how many days of expenses your organization can pay for with the available cash. Does it cover at least 2 payroll runs? If not, you may need to consider slowing non-payroll expenses until your cash balances are stronger.
Program Expense Ratio = Program Costs ÷ Total Expenses (Are resources mission-focused?). Traditionally, organizations strive to have at least 85% of the total expenses spent on programs. However, this rule of thumb does not apply to all types of nonprofits. If your organization requires a lot of infrastructure (e.g. complex financial, human resources, or information technology needs), it may be appropriate to spend more on non-program activities in order to keep the organization strong.
Operating Reserves = Unrestricted Net Assets ÷ Annual Expenses (How many months of cushion?).
Fundraising Efficiency Ratio = Total Fundraising Revenue ÷ Fundraising Expense. This shows how much money your nonprofit raises for every dollar it spends on fundraising. It’s a quick way to measure how effective an organization is at turning fundraising expenses into actual contributions. Not all fundraising efforts yield the same results. For example, large gifts from major donors usually involve less expenses than a fundraising event, which involves costs like venue fees, catering, collateral materials, and staff time.
✅ Step 5: Pay Attention to Liquid Unrestricted Net Assets (LUNA)
Not all “net assets” are equally usable. Some may be tied up in buildings, equipment, or board-designated funds that can’t be easily tapped in a crunch. LUNA focuses only on resources a nonprofit can quickly access and spend without restrictions.
Formula: (Unrestricted Net Assets – Net Fixed Assets – Non-Liquid Assets)
Why it matters: It shows the true financial flexibility of the nonprofit.
Benchmark: Many funders look for at least 3 months of LUNA as a sign of stability. To determine how many months’ of LUNA you have, use this formula: Average monthly operating expenses ÷ LUNA.
If LUNA is negative or too low, the nonprofit might struggle to handle unexpected expenses or revenue delays—even if other financial indicators look fine.
✅ Step 6: Analyze Trends and Compare to Peers
One year of data only gives you a snapshot—the real insight comes from looking at changes over time and comparing your results to similar organizations.
Trends to Track:
Revenue growth or decline over several years
Program vs. admin spending ratios over time
Changes in cash reserves or LUNA levels
Fundraising efficiency (cost to raise a dollar)
Peer Comparisons:
Benchmark against nonprofits of similar size, mission area, or geography
Use publicly available Form 990s or sector reports to see how your ratios stack up. Guidestar is a good source for finding 990s.
Ask: Are we in line with our peers, ahead, or falling behind?
✅ Step 7: Review the Budget Variance Report
Financial statements tell you what happened. The budget variance report tells you how actual results compare to what was planned. This is one of the most valuable tools for boards and managers.
Look at variances by line item: Are revenues coming in as expected? Are expenses higher or lower than budgeted?
Ask why variances exist:
A positive variance (spending less than expected) could mean cost savings—or it could mean a program isn’t running at full strength.
A negative variance (spending more than expected) might reflect strategic investments—or an area of overspending.
Pay attention to timing differences: Some grants or expenses hit later in the year, so not every variance signals a problem.
Use it as a management tool: Variance reports should guide mid-year decisions, like adjusting spending, seeking new funding, or delaying projects.
✅ Step 8: Understand the Recognition and Release of Restricted Net Assets
Restricted contributions can make your nonprofit’s financials look stronger than they actually are—unless you know how to read them.
Recognition: When your nonprofit receives a grant or donation with restrictions (time-bound or purpose-bound), it must record the total grant or donation amount as restricted revenue, even if it can’t be spent right away. This often inflates revenue in the year the gift is received.
Release: When your nonprofit spends the funds according to the donor’s restrictions (e.g., on a specific program or after a certain date), the amount is released from restriction and reclassified as unrestricted revenue on the statement of activities. The release of temporarily restricted net assets will increase your unrestricted revenue, but will decrease your restricted revenue, resulting in a net effect of zero on your total revenue (restricted plus unrestricted) per Generally Accepted Accounting Principles (GAAP).
Impact:
Revenue may look unusually high in one year (when the restricted gift is recognized) and lower the next year (when no new gift is received, but spending continues).
Net assets on the balance sheet may look healthy, but much of the money may not be available for day-to-day operations.
Boards should always check the release schedule to see how restricted funds will flow into operations over time.
Key takeaway: Restricted money is valuable, but it can’t always pay the bills. Always separate the story of restricted and unrestricted funds to understand the nonprofit’s real financial health.
Conclusion
This isn’t about perfection—it’s about sustainability. Healthy financial statements, a solid LUNA level, positive trends, a well-understood budget variance report, and careful tracking of restricted net assets all show that your nonprofit is positioned to keep doing its work, attract funding, and serve its community. With this checklist, you’ll be able to spot both strengths and warning signs at a glance.
About this Series
Special Note: This is the last article in this series. If you have any suggestions for additional topics, please add them in the comments section. Thank you!
Here is a list of, with links to, previous articles:
About the Author
For over 30 years, Robert Pascual has been a leader in nonprofit financial management as a CFO, consultant, conference speaker and educator. He holds an MBA from the Haas School of Business at the University of California and is the founder and principal of Robert Pascual, MBA LLC. He has worked with small, mid-size, and large nonprofit organizations spanning the fields of education, workforce development, housing, health, philanthropy, social services, media, fiscal sponsorship, nature, and the environment. Each of these organizations has faced both unique and common challenges, some of which are probably similar to ones that you wrestle with.