Financial Statements for nonprofits
Starting and running a nonprofit organization is a rewarding journey, but it comes with its unique set of challenges, especially when it comes to managing finances. Financial statements for nonprofits, while often perceived as daunting, are actually your organization’s financial pulse. In this guide, we’ll simplify the concepts and draw analogies to help nonprofit leaders, especially those new to the world of finance, understand these essential tools.
Balance Sheet: Your Organizational Net Worth
Think of your nonprofit’s balance sheet as its organizational net worth statement. Just as you assess your personal financial health by considering assets (like your home, savings, and investments) and liabilities (such as mortgages and loans), a balance sheet does the same for your nonprofit. It reveals the value of what your organization owns (assets) and what it owes (liabilities). The difference between these two, known as your organization’s equity, is akin to its net worth.
Much like an annual checkup for your health, a healthy balance sheet displays increasing in net assets (the equivalent of equity) over time or, at the very least, stability in this line. A declining net assets line, left unaddressed, can lead to a depletion of net worth. A negative net assets balance may indicate heavy reliance on external funding sources or financial instability.
Profit and Loss (P&L) Statement: Your Monthly Income and Expenses
The P&L statement is akin to your nonprofit’s monthly income statement. Just as you track your personal income and expenses monthly to gauge your financial performance, the P&L does this for your nonprofit. It outlines your revenues (income) and costs (expenses), resulting in net surplus (if positive) or a deficit (if negative). It assesses your financial performance over a specific period, typically a month, a quarter, or a year. If your balance sheet reflects your annual health report, the P&L statement reveals the organization’s financial lifestyle during the past year.
While the “bottom-line” (net surplus or deficit) is often emphasized, focusing on the “topline” (revenues) and the “middle line” (gross margin) can be equally, if not more, important. Effectively managing these two areas can have a profound impact on the organization’s overall financial health.
Cash Flow Statement: Your Organizational Cash on Hand
The cash flow statement details the inflows and outflows of money within your organization. While the P&L shows your financial performance, the cash flow statement informs you whether your nonprofit has enough cash to meet its financial obligations. It considers factors like donor contributions, expenses, and investments, providing a clear picture of your liquidity.
The cash flow statement typically comprises three main sections:
- Operating Activities: This section focuses on the cash flows generated from your nonprofit’s core activities, such as program services and fundraising. Positive cash flow from operations is generally a sign of a financially sustainable nonprofit.
- Investing Activities: In this section, cash flows related to investments in assets, securities, or capital improvements are outlined.
- Financing Activities: This section details cash flows related to fundraising, grants, and other sources of capital. It also includes repayments of debt and distributions to stakeholders.
In my opinion, the cash flow statement is your go-to financial report, as cash is the lifeblood of any nonprofit. I’ve witnessed nonprofits with significant deficits successfully coming back to life around by effectively managing their cash flow.
The Importance of Supplementary Reports for Nonprofits
While the basic financial statements are vital, it’s crucial to remember that they shouldn’t be read in isolation. To gain a comprehensive view of your nonprofit’s financial health, consider additional reports and analysis:
- A/R Aging Report: This report shows the outstanding amounts owed to your organization by donors or partners. This report is key to managing your receivables effectively and ensuring timely collection to maintain healthy cash flow.
- A/P Aging Report: This report reveals the outstanding amounts your nonprofit owes to vendors and suppliers. It’s a valuable tool for prioritizing payments and negotiating favorable terms with your suppliers.
- Budget-to-Actual Statement: Comparing budgeted figures to actual financial performance can help identify variances, enabling better financial management. Emphasize positive variances and take corrective actions to address negative ones to continuously improve your nonprofit’s financial model.
- Year-Over-Year Comparison: Analyzing financial data from one year to the next can help you spot trends and make informed decisions for the future.
- Ratio Analysis: This is a complex topic, so we will discuss it in a separate article but to illustrate its significance, I will cite a simple example like the current ration. This ratio it can reveal a lot about relationship between current assets and current liabilities. If the ratio exceeds the normal level, this indicates that resources may be underutilized, but if it falls below the acceptable range, it highlights the liquidity problem facing the organization.
- Statement Functional Expenses: this is a crucial element within the supplementary reports of any organization’s financial documentation. It serves to break down the allocation of expenses into functional categories, demonstrating how funds are used to support the nonprofit’s core activities, administrative functions, and fundraising efforts.
The importance of a functional statement as an integral part of the financial statements for nonprofits aiming to attract more donations cannot be overstated. Donors want to know that their contributions are being put to good use, and a well-structured functional statement provides transparency and accountability. It allows potential donors studying the financial statements for nonprofits to see the percentage of their donations that directly support the nonprofit’s mission and programs, rather than being absorbed by overhead or fundraising costs. This transparency builds trust and confidence in the organization’s financial stewardship, making it more attractive to individuals and entities looking to invest in the nonprofit’s mission and impact.
Understanding your financial statements is crucial for making informed decisions as a leader. Consider them as invaluable tools to assess your organization’s financial health. But remember, to get a complete picture, supplementary reports and careful analysis are equally important. By demystifying financial statements and embracing them as valuable tools, you’ll be better equipped to navigate the financial aspects of your nonprofit with confidence, ensuring that you can continue to make a positive impact in your community.
By Ryan Osman, CPA, MBA https://www.linkedin.com/in/raafat-osman-cpa-mba-b0991423/
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FAQ:
Q: Can Renancial Consulting help preparing the financial statements for nonprofits if the organization is not located in Texas?
A: Our motto is “local roots, national reach!”
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