We rely heavily on data when making strategic decisions. This is especially true today with the process of information sharing, in which data is almost always readily available. However, some data can be so voluminous that it may become difficult to separate the crucial information from the noise.
In part 1 of this article series, we distinguish three key performance indicators that can provide valuable insight into an association’s operations. This insight is key in formulating an actionable plan to support an association’s two primary objectives: financial stability and long-term sustainability. Be sure to check back for part 2, in which we will identify two more key performance indicators.
Operating Reserve
The operating reserve is a separate account or fund established by an association to address unpredictable developments that result in significant revenue decline or large unbudgeted expenses. The industry recommendation ranges from 25 to 50 percent of the annual operating expenses. The choice of quotient is guided by the purpose, scope and needs of the association adopting the reserve. It is intended to supplement the organization’s revenue or cash losses over a short-term period. For this reason, it is often referred to as a “rainy day” fund.
Operating reserves are not meant to cover any long-term revenue shortfalls, which is why the recommended range caps at 50 percent. The operating reserve should not be too high, because it could present the risk of unnecessarily preventing funds from getting reinvested back into the association, and thus impede innovation.
In addition to determining the amount of the reserves an association will need, here are a few questions to consider:
- How will the reserve be replenished once used, or how will it be funded initially if a reserve has not been set up? What will the timeline be? Most associations build reserve funds over time, so realistic timelines should be set.
- Where will the funds be kept? The operating reserve needs to be easily accessible.
- How can the funds be used? The reserves are unrestricted funds by definition, so it is important to establish policies detailing specific use of the reserves to ensure the funds are not unnecessarily depleted.
Current Ratio Trend
The current ratio measures the short-term liquidity standing of an association by evaluating its current assets against its current liabilities. It provides a quick assessment on how solvent an association is. An association with a current ratio less than one does not have the working capital to pay its current debt. An association with a current ratio of one or more has the assets available to meet current and future obligations. This being said, a ratio that is too high might indicate that the association may not be utilizing its assets effectively.
The current ratio is a static ratio: it provides the result at a point in time. It must be analyzed together with an examination of the assets and liabilities being used for the calculations, as well as the trend fluctuations over time. Perhaps the association has a large accounts receivable balance that is used to calculate a sufficient working capital; but what if the balance has remained the same for the last six months and is now potentially uncollectible? The working capital may no longer be sufficient. This illustrates one of the drawbacks of the current ratio: the assumption that all current assets can be converted to cash.
The same analysis can be used in evaluating the trend fluctuations of the current ratio. Let’s say the ratio is less than one, but it has been slowly increasing over the course of the term being evaluated. The same goes for ratios greater than one that have decreased. Looking at only the ratio might result in one course of action, but evaluating it with its fluctuations over time might change that course of action. Which scenario might cause more concern?
Revenue mix
The revenue mix is a proportional calculation of each revenue generator of an association to its total revenue. The mix is important because it highlights certain products and services that may be more profitable than others, as well as the dependence of the association on each one. When generating and analyzing the revenue mix, it’s important to consider the context. The context is determined by the profitability of each revenue category and the perceived value of each. For example, though a service or product might not be a big revenue driver, it could be the biggest value generator amongst members. This means removing it could cascade into losses in other revenue categories, such as dues, education or product sales.
The purpose of reviewing the revenue mix is to identify the association’s revenue and value generators, so you can take actions to preserve them and eliminate or replace the unsuccessful ones. This way, the association can free resources to develop new services or products. At Sikich, we motivate associations to constantly think of ways to reinvent themselves. By reinventing, we do not mean a complete overhaul of an association’s activities; but rather, course corrections in meeting the mission goal.
The second goal of the analysis is to determine whether there is significant revenue concentration in one revenue category. The higher the concentration, the higher the risk of revenue losses if there are unexpected internal or external causes that drive it down. As the saying goes, try not to have all your eggs in one basket. A more balanced mix will allow the association to ride such effect, but you should also be conscious of not over-diversifying. This would require more resources to maintain successfully because it would be difficult to focus on each one effectively.
The third goal of the revenue mix analysis is reviewing the mix over time or in comparison to peers to determine if the dependence on certain products and services has shifted over time, and if the association’s revenue profile is significantly different from peers. For a more useful analysis, the recommendation is to generate on the basis of at least three years’ average. This analysis is also referred to as Revenue Trends.
Feel free to check back in when we discuss two additional key performance indicators: Revenue Trends and Intangible Resources. If you have specific questions about how you can apply these indicators to your association, reach out to our not-for-profit experts today.
