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Speed Reading Nonprofit Financial Statements

Speed Reading Nonprofit Financial Statements

By Erin Welch, CPA, Partner, Jacobson Jarvis

What financial statements does your nonprofit Board receive each month? Are they the right reports? Do you understand them? Do you know enough to spot a red flag or ask questions?

One of the most critical requirements of your duty of care is to read and review the financials, and ask questions about the content.

As a board member, your fundamental role is to oversee the implementation of the not-for-profit organization’s mission. This includes exercising your fiduciary duty to ensure that the organization’s financial resources are effectively managed and sufficient to assure the organization’s long-term financial viability.

While you may rely upon the information provided by the organization’s management team and external consultants, including CPAs, that reliance does not release you from the due diligence required by the duty of care. If you do not have a financial background, reviewing the financial information provided and understanding which questions to ask may be a daunting assignment. This article provides some guidance about where to begin.

What reports should my Board be reviewing?

We recommend that the entire Board receive a Balance Sheet and Income Statement for review each month. Ideally these reports should come directly from the organization’s accounting system. If possible, each report fits on one page to make them as approachable as possible for Board members.

Statement of Financial Position (aka Balance Sheet)

The Balance Sheet is a snapshot at a point in time and summarizes the organization’s assets (what you own) and liabilities (what you owe). The net assets section appears where the equity section would be on a for-profit Balance Sheet. Not-for-profit net assets are classified based upon donor restrictions as unrestricted, temporarily restricted, or permanently restricted.

As a board member, you should pay particular attention to these four issues relative to the Balance Sheet:

Liquidity: Liquidity refers to the organization’s ability to access the cash required to pay immediate and routine obligations. This can be monitored by comparing current assets to current liabilities on the Balance Sheet. Your Current Ratio (current assets divided by current liabilities) should be greater than 1.0. Additionally, you should be aware of your financial reserve targets and check to make sure you are meeting these targets. Targets may be required by the bank (loans, long-term asset replacement) or may be internal goals established by your reserve policy.

Trends: One of the first places to check for financial issues involves year-to-year trends. As you compare your current Balance Sheet to that of the previous month or the previous year, you should look for any unusual trends. For example, does the current ratio seem to be decreasing, or have you had a significant growth in restricted assets that may affect your operating budget?

Debt: Many not-for-profits have a lending relationship with a bank or other financial institution. As a Board member, you should be familiar enough with the terms of the loan to understand whether you can access the capital required to cover emergencies. You should also review the Balance Sheet to ensure the loan balances are consistent with expectations. Rapid growth in debt might foretell an impending financial crisis.

Unrestricted Net Assets: Planning for the future is an important Board function. As a part of that planning, you should anticipate the financial demands that could result from a significant economic downturn or an unexpected programmatic opportunity. Assess whether or not your organization has enough liquid unrestricted net assets, and/or access to credit to meet future needs.

Click here for a free Balance Sheet kit with examples and practice exercises.

Statement of Activities (aka Income Statement)

The Income Statement shows the organization’s activity over a specific period of time including support, revenue and expenses. The Income Statement should include both actual and budget (planned) activity and should calculate the variance (difference) from plan. Board members should not be expected to do math in the meeting, so all variances and key ratios should be included.

As a board member, you should pay particular attention to these four issues relative to the Income Statement:

Budget vs. Actual: As you review the Income Statement each month, look for significant variances, especially those that negatively impact the organization, and ask questions so that you better understand both the cause and the effect. If there are large variances, you should understand the reasons for the variances and what management’s plans are for addressing the variances to determine whether you feel confident that management’s plan will be effective.

Concentrations: The Income Statement may not always indicate how dependent the organization is on any one revenue source. Heavy reliance on a single source can be risky. For example, if the organization receives 80% of its funding from a single donor or foundation, the organization could be at significant risk if that funding is decreased or discontinued. Board members should understand management’s contingency plans to address unexpected drops in income. Remember, as a Board member you are responsible for ensuring the long-term viability of the organization, and for ensuring sound operational and financial planning for a crisis situation.

Trends: When reviewing actual expenses, look for expenses that are rising more rapidly than the corresponding revenue or support source. Also, look for longer-term trends in both revenue and expenses. Such trends may signal a need for increased attention to fund development or tighter expense management.

The Bottom Line (aka Net Income/Net Loss): The bottom line is just as important to a not-for-profit as it is to a for-profit organization. As you review the Income Statement, consider whether or not the net change met expectations, both overall and across fund/program/projects, as applicable.

Click here for a free Income Statement kit with examples and practice exercises.

 

Click here for a Financial Statement Review Checklist that includes the Balance Sheet, Income Statement, Statement of Cash Flows, and Audited Financial Statements.

Click here for a free Balance Sheet and Income Statement kit with examples and practice exercises.

The above article is excerpted from Jacobson Jarvis’ booklet What Board Members Need to Know About Not-for-Profit Finance and Accounting and the popular video training series FUN – Finance Unlocked for Nonprofits”. Both of these resources are free and designed to help board members advance their missions as they learn how to make better financial decisions and better protect their assets.

 

Looking for additional training opportunities? Click here.

 

About the author:

Erin Welch, CPA, Partner, has worked as a consultant and nonprofit auditor to not-for-profit organizations for the last 17 years. She helps clients improve their internal controls and processes, conducts financial health assessments, assists clients with board communications, and conducts board trainings.

Erin is: a volunteer trainer for Washington Nonprofits, 501 Commons, and the WSCPA, VP for the Northshore School District Foundation, Treasurer for the CFO Selections Foundation, on the Audit Review Committee of United Way King County, and a member of the Rotary Club of Seattle.

Erin can be contacted at erin@jjco.com or (206) 812-5487

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