Nonprofits, or nonprofit organizations, are entities that serve a specific purpose. Usually, this purpose includes a collective, public or social benefit. Nonprofits do not operate to generate profits from their activities. Any income from those operations is secondary to the nature of these entities. Usually, these entities conform to several rules resulting from the purpose and mission.
The accounting standards and processes differ for nonprofits compared to other businesses. Usually, these entities follow different formats for their financial statements. Based on that feature, their financial reporting process also differs. Furthermore, the ratio analysis for the stakeholders of a nonprofit organization will also consider those differences. However, that does not mean the typical financial ratios will not apply to these entities.
The key performance indicators for nonprofits are significantly dissimilar from other entities. On top of that, the different reporting standards for these entities make it challenging to assess their performance. Nonprofits use functional expense allocation to report their activities. Consequently, they divide those expenses into program, administrative, and fundraising expenses.
What are Program Expenses?
Program expenses refer to any costs incurred to carry out a nonprofit’s mission. In other words, it includes the expense incurred on activities that nonprofits consider primary. Compared to companies, program expenses are the equivalent of the cost of sales.
These expenses are crucial in letting a nonprofit reach its goals and abide by its mission. For most nonprofits, program expenses are the most prominent item in the statement of activities.
Program expenses also differ from one nonprofit to another. Since these expenses relate to the entity’s mission, they will vary. Similarly, these expenses differ from the other primary costs for nonprofits. For example, program expenses are significantly different from administrative or fundraising expenses. However, that does not imply one type of expense is more crucial to a nonprofit’s activities.
Program expenses include the costs necessary to deliver specific programs. As mentioned above, these programs conform to a nonprofit’s mission. The more a nonprofit spends on program expenses, the more investors relate it to efficiency. Similarly, it also links with higher activity levels for the nonprofit. Consequently, it leads to higher achievements and conformance with the underlying mission.
Overall, program expenses are costs incurred in delivering a program based on a mission. These costs are a crucial part of any nonprofit. Usually, program expenses appear as the first item under the expense heading. Similarly, these expenses form the highest portion of the total costs incurred for nonprofits. Program expenses are also a critical part of the program expense ratio.
What is the Program Expense Ratio?
The program expense ratio is the relative measure of program expense to total expense. In other words, this ratio takes a nonprofit’s program expenses and divides them by its total expenses. As mentioned above, program expenses are the highest portion of the total costs incurred by nonprofits. Similarly, investors associate these expenses with the highest efficiency in achieving missions.
Therefore, the program expense ratio determines the percentage of program expenses to the overall expenses. It establishes how much a nonprofit spends on its mission rather than paying it for other activities. Usually, investors and donors prefer this ratio to be high. However, there is no standard or benchmark to how much it should be. Similarly, too high of a program expense ratio can be questionable sometimes.
The program expense ratio calculates the percentage of expenses nonprofits spend on their core activities. Its reciprocal shows the portion spent on non-essential operations. However, the former analysis is more crucial for donors than the latter. Nonetheless, they relate to each other due to the calculation for the program expense ratio. The program expense ratio is similar to a vertical analysis for the income statement.
Overall, the program expense ratio calculates the percentage of program expenses to total spending. It is a critical ratio to determine the amount spent on core activities. In most cases, the higher this ratio is, the better donors will consider it. However, there is no set limit or condition to how much this ratio should be. Practically, donors consider various factors when analyzing the program expense ratio.
How to Calculate the Program Expense Ratio?
The above definition for the program expense ratio also shows how to calculate it. As mentioned above, this ratio considers a nonprofit’s program expenses relative to its total expenses. Therefore, it is straightforward to formulate this ratio. The formula for the program expense ratio is as below.
Program Expense Ratio = Program Expense / Total Expenses x 100
The data for the above program expense ratio formula is available in the statement of activities. Usually, a nonprofit report its expenses as a whole under its revenues. These expenses include three items, program, administrative and fundraising expenses. Therefore, program expenses are the first item that appears on the total expenses reported by nonprofits.
If the total expenses are not available, donors can also calculate them manually. As mentioned, it includes three components. Once donors have that information, they can use the following formula to reach total expenses.
Total Expenses = Program Expenses + Administrative Expenses + Fundraising Expenses
Donors can calculate the program expense ratio through a vertical analysis of the statement of activities. However, instead of using revenues as a base, they must measure it based on total expense. This way, they can also calculate the percentage of other expenses relative to the total amount. However, the program expense ratio is more critical among these.
Example
A nonprofit entity serves disabled people by providing them with necessities. This entity’s mission is to help people with disabilities in their daily living situations. Consequently, it receives donations from many donors and uses them in various programs. During the last year, the nonprofit reported the following expenses.
| Particulars | Amount |
| Program expenses | $750,000 |
| Administrative expenses | $150,000 |
| Fundraising expenses | $100,000 |
Based on the above information, donors can calculate the program expense ratio. However, they must know the total expenses first. Donors can calculate the amount using the following formula.
Total Expenses = Program Expenses + Administrative Expenses + Fundraising Expenses
Total Expenses = $750,000 + $150,000 + $100,000
Total Expenses = $1,000,000
Once donors calculate the total expenses, they can use the following formula for the program expense ratio.
Program Expense Ratio = Program Expense / Total Expenses x 100
Program Expense Ratio = $750,000 / $1,000,000 x 100
Program Expense Ratio = 75%
The above program expense ratio implies that the nonprofit used three-quarters of its spending on program expenses.
What Does the Program Expense Ratio Show?
The program expense ratio shows how much expenses a nonprofit dedicates to its mission. For most nonprofits, these expenses are the highest percentage of total expenses. However, other factors may contribute to it. For newer nonprofits, the program expense ratio will be lower. These nonprofits have higher other expenses initially.
However, as nonprofits become more stable, they can run their operations more efficiently. On top of that, they will also have more programs to operate. Consequently, their program expense ratio will be higher. However, these features don’t need to hold true. Other factors may also dictate how much the program expense ratio will be.
The program expense ratio is crucial in determining a nonprofit’s efficiency in using funds. The higher this ratio is, the more the nonprofit spends on its mission. Similarly, it implies that the other activities use up lesser resources. It sends a positive signal to donors. Consequently, they will be willing to pay more in donations in the future.
Conclusion
Nonprofits use a different set of metrics for financial analysis. These entities report their activities through the statement of activities. Usually, this statement includes revenues and expenses. These expenses further consist of program, administrative, and fundraising activities. Among these, program expenses are the most crucial. Donors can use the program expense ratio to determine how much nonprofit spends on those expenses.