Interpreting Financial Reports
At NFP Partners, we’ve dedicated many of our Blog articles to growing nonprofit financial managers’ knowledge in planning for financial growth and avoiding financial uncertainty. This article is another example of such! If you’re here to learn how to effectively monitor the financial success of your nonprofit organization and dig deeper into nonprofit financial reports, you’re in the right place.
Reading and interpreting financial reports can be daunting when you can’t understand the numbers on the page. Let’s break down some of these reports that may help give you confidence and clarity at the end of the month when you are reviewing your organization’s financial progress.
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 some other financial reports, such as 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 amount of cash an organization holds, any outstanding debts, and the Net Asset Section of the report.
The Net Asset Section explained
The Net Asset section of the report is equivalent to the equity section of a for-profits balance sheet. This section gives the reader the picture of “what is the organization worth.” Accounting rules require net assets to be classified as with restriction or without restriction. This means when the organization receives income, the classification must be decided at that time. Grant awards and funding notices from donors are the sources of determining the classification.
If they restrict the funds to a program or time period, then they are restricted funds. 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.
Many nonprofits that are focused on grant funding will tend to have a larger restricted net asset balance. It is important to know that these funds are not allowed for other uses, purposes, or time. If the net asset balance of funds that are without restriction is limited, the organization may want to focus on seeking support for general operations through donations or grants that do not have restrictions.
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. These amounts should match the net asset section on your Statement of Financial Position.
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 unrestricted. Also, as expenses are incurred for any restricted funds, these are tracked in a segment of the accounting software, such as a class, customer, or job, and are “released” from restriction in a month-end entry.
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.
Challenges of nonprofit accounting reports
Accounting rules require the recognition of revenue at the time of the award or the receipt of funds. 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 received.
For example, the nonprofit receives an unrestricted grant of $450,000 and a restricted grant of $500,000. If these grant awards do not have any requirements outside of a periodic report, they will be recorded in total 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 2022, 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.
Considerations for next year’s budgeting
In addition, when it comes to the budget process for the next year, you will be budgeting for those grant 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. You must remember and keep reminding the board and finance committee we are drawing from the net asset balance.