Understanding and Utilizing Financial Statements of Nonprofit Organizations

Financial statements provide a wealth of financial information about a nonprofit organization’s most recent month, quarter or year end. In addition, they also include valuable information to assist in making business decisions and to plan for the organization’s future. This article discusses the purpose and components of different financial statements and how the information can be used to investigate budget variances, plan for the future and evaluate the organization’s effectiveness in meeting its mission.

Reliance on Financial Statements to Make Decisions for the Future
Financial statements are generally prepared on a monthly basis and provided to the members of the board of directors each month. However, do you and the board rely on this valuable information to make business decisions and plan for the organization’s future?

Think of the audited financial statements as a family album, providing a history of your organization’s financial past. Examining that past can help you better manage your organization now and in the months and years ahead.

To glean meaningful insights from these documents, you need to understand what each statement represents. Take it a step further, and you (or the board members) can use the data to create a trend analysis, an industry comparison or a projection of upcoming challenges. Such tools can assist your organization in making better-informed decisions.

Understanding Basic Financial Statements
Being able to use the information in basic financial statements to strategize for your organization starts with understanding the statements’ purpose and components:

Statement of financial position. This statement lists the organization’s assets (what you own), liabilities (what you owe) and net assets (assets the organization has after all liabilities are paid). It’s a snapshot of the financial health of the organization on a given date — usually the end of a month, quarter or year.

Statement of activities. This statement provides details about the revenue and support your organization is receiving and the expenses it is incurring. The statement of activities typically summarizes funds by type of revenue and support, such as fees and service contracts, grants and contributions and investment income. The statement also summarizes expenses — typically under the categories of programs, management and general and fundraising.

Statement of functional expenses. This statement displays a chart of expenses for the same period as the statement of activities, listing expenses in classifications down the page, such as salaries, rent and professional fees. Columns across the page — typically program, management and general, fundraising and total expenses — group each expense into the function that received the benefit of the expense.

Statement of cash flows. This statement presents the impact of the organization’s activities on cash. The statement of cash flows categorizes cash coming in and going out into operating, investing and financing activities.

Notes to the financial statements. The footnotes explain the organization’s significant accounting policies and information about certain amounts presented in the financial statements. Details on the activity in endowment funds and information on temporarily restricted net assets are, for example, provided in the footnotes. They also include details about line items, such as the composition of investments, allowances and discounts included in long-term pledges receivable and future commitments the organization has made.

Using Financial Statements to Investigate Variances
It is useful for the organization to perform monthly comparisons of the organization’s financial results to prior periods and the corresponding budget. Most financial software programs allow the budget to be entered per month and produce financial statements that compare actual results to what was budgeted.

Any variances greater than a certain dollar amount or percentage should be investigated. A smaller organization might, for instance, base the dollar amount on the amount used in its check-signing policy. A percentage of 5% to 10% variance is often used as the rule of thumb. This guideline allows you to properly oversee and assess operations in a timely manner and evaluate the performance of individual programs and departments.

Using Financial Results to Forecast the Future
Planning for the near future is critical in today’s economy. You can compare actual monthly results through the most recent month and add future budgeted monthly amounts to prepare a forecast of the full-year results. This “best guess” of what will happen to the organization in financial terms over a given period of time may indicate the need to find more revenue and support or reduce spending, or you may find just enough resources to buy those new computers. Basically, the comparison will indicate whether you’re on track with your original budget or if it should be revised.

A similar model can be used to prepare a cash-flow projection. This is useful for organizations with cyclical cash needs during the year. The projection can help you properly plan and make informed cash management decisions. If it shows you have excess cash in September, for example, but will need to use the cash in February, invest the cash in such a way that it can be available at the later time.

Finding Other Uses for Financial Statements
Financial information should be used to evaluate the organization’s effectiveness in meeting its mission. Monitoring program information from detailed financial records can help determine whether the organization is accomplishing its specific goals.

If your current year’s objective is to increase membership, for example, examine the total membership fees collected and monitor the progress toward your goal. If you need $2 million to build your new facility, use the monthly financial statements to monitor pledges and maintain a detailed listing of pledges receivable to monitor donor payments.

Benchmarking
Comparing your annual results with other nonprofit organizations in your industry — or benchmarking against industry statistics — can help identify your organization’s strengths or weaknesses. This can also lead to identifying growth opportunities or reallocating resources. By applying these same ratios over several years, you will have the basis for long-range strategic planning and better use of money and resources.

For example, you might notice that another nonprofit in the same industry spends significantly less on its facilities than you do while providing comparable services, or perhaps it raises twice the dollars that your organization does each year. Use these revelations to target areas for improvement.

Your Financial Statements Count
If the organization has an annual financial statement audit, the accounting firm conducting the audit should make a presentation to the audit committee or board of directors. In addition, the financial statements should be available to donors, potential donors and grantors so they can see how their support is being used. Financial position and results of operations affect most decisions that donors make about giving to an organization, so take advantage of this important resource.

As management and the board of directors evaluate risk and make strategic decisions, an organization’s financial statements will serve as a critical tool. The financial statements should be available to the decision makers in a timely fashion and presented in a format that is easy to understand.

If you have any questions on how to best understand and utilize your nonprofit organization’s financial statements, please contact me at (805) 963-7811 or jbritton@bpw.com.