Assessment of Risk Using Financial Ratios in Non-Profit Organisations

Abstract

Financial ratios have been widely used and regarded as a useful tool in predicting business failure, detecting fraud and evaluating performance. In the current study, financial ratios are used to assess risk of financial vulnerability. This study examines to what extent Non-Profit Organisations (NPOs) are exposed to risk of financial vulnerability. This study extends the work by Tuckman and Chang (1991) who developed financial vulnerability prediction model by using financial ratios as four financial indicators of financial vulnerability- Administrative cost ratio, Debt ratio, Revenue Concentration Index and Surplus margin. To provide a more meaningful investigation, the current study uses eight financial indicators -Debt ratio, Cash ratio, Revenue concentration index, Reliance ration ratio, Administrative ratio, Management cost rate ratio, Net Operating Margin and Primary Reserve Ratio. The financial data to compute the ratios were derived from annual reports of 134 NPOs registered under Companies Commission of Malaysia (CCM) for the financial period of 2011. This study finds that 14% of the samples NPOs are classified under high risk of financial vulnerability. Majority of NPOs (69%) are at moderate risk. The study indicates that NPOs are at risk because their revenues are not well diversified, revenues earned are highly depending on the major source of income, low administrative cost, and do not have any surpluses during financial shock. Overall, this financial vulnerability model provide useful device for NPOs to assess their level of risk and the regulators to enhance their monitoring system.

Keywords: assessment of risk, financial ratios, financial vulnerability, non-profit organisations