Interpreting Financial Reports – A Guide to Strong Nonprofit Financial Leadership, Pt. 4
The last several articles of this series have focused on growing your knowledge in planning for financial growth and avoiding financial uncertainty. Now, we will look at how to effectively monitor the financial success of your nonprofit organization.
Reading and interpreting financial reports is difficult. Because of such, we’ve decided to break down some of these reports, in hopes of adding clarity and answering questions you may (or may not) know you have.
Your nonprofit’s statement of financial position
This report is used to provide an overall picture of the nonprofit’s financial performance. This is a financial report that is cumulative from the start of the organization. It is not a snapshot of time like a Revenue and Expense report.
This report is used to show the nonprofit’s cash position, how much debt the organization has, and the net asset position of the organization. Funders will focus on this report when determining if a nonprofit is stable and self-sustaining, making it one they want to invest their funds into. Most attention is focused on the Net Asset Section of the report.
Accounting rules currently require net assets to be classified as unrestricted, temp restricted, and permanently restricted. This means when the organization receives income, the classification must be decided at that time. Grant awards and funding notices from donors are the source of determining the classification.
If they restrict the funds to a program or time period, then they are temporarily restricted. Unrestricted funds are those that are available for general use. Within the unrestricted categories, nonprofits or Boards may also want to set aside funds for specific purposes. These purposes can include building a reserve or establishing funds for the replacement of fixed assets.
The remaining amount is what is called the organization’s Liquid Unrestricted Net Assets (LUNA). These are the funds that are available for operations of the organization and are the only ones that are not committed to any specific purpose.
Your nonprofit’s statement of activities
This report is a revenue and expense report displayed by restriction. It is a YTD report and is standard in an audit package. This report is valuable, as it shows how much is available to fund operations – the unrestricted column.
There also is a reconciliation of net assets. This is a valuable tool to ensure the net surplus (deficit) is correct. Temp Restricted revenue and expenses are recorded in the revenue section. As your nonprofit’s funds are received, they are recorded as revenue. As expenses are incurred they are expensed to unrestricted. They are also tracked using some internal mechanism in the accounting software. This includes class, customer, job, segment by funding source.
Challenges of nonprofit accounting reports
Accounting rules require the recognition of revenue at the time of the receipt. If a nonprofit receives a grant award, (i.e. a multi-year grant award), the full amount of the award must be recorded as revenue in the month the award is effective.
For example, the nonprofit receives an unrestricted grant of $450,000 and a temp restricted grant of $500,000. These grant awards will be recorded in revenue and will result in a significant increase in the ending net assets and net income for the organization.
It’s important to take note of this, and use it as an educational opportunity for your Board or finance committee. If you must record the multi-year grant award in, say February of 2017, but it is a two-year grant, what will happen to the traditional net surplus (deficit) line on your Statement of Activities or Revenue and Expense report for the next 24 months?
Likely, it will show as a deficit because you are now incurring expenses for that grant but no revenue will be recorded in months to come. This makes the understanding and review of ending net asset balances imperative to gathering the financial performance of your nonprofit.
In addition, when it comes to the budget process for the next year, you will be budgeting for those grant’s expenses but there will be no corresponding revenue. When we have nonprofit clients that are in this situation, we will budget for about a 50% net surplus.
This is “set aside” in your nonprofit’s net asset balance. In the following year, we will have those expenses allocated and likely will produce a budget with a net deficit. But, you must remember we are drawing from the net asset balance.
Your nonprofit’s statement of cash flows
This is not a very well understood report in the normal audit presentation of the statement. The report shows how cash was obtained and spent. For example, receivables, payables, investments, or financing (loans).
One word of caution: there is no distinction between unrestricted or restricted cash. A cash flow projection is a necessary tool, especially in multi-year funding situations or reimbursement grant situations.