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Wednesday, March 21, 2012

Back to the Future: Rely on Financial Statements to Make Decisions for the Future


Financial statements regularly slide over your desk and pass through board members’ hands, providing a wealth of financial data on your nonprofit’s most recent month, quarter or year. The big question is whether your organization is analyzing the RIGHT timely data to make business decisions and plan for the organization’s future?

Looking for Insights
Think of the audited financial statements as a family album, providing a history of your nonprofit’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 springboard your organization to making better-informed decisions.

Understanding Basic Financials
Being able to use the information in basic financial statements to strategize for your organization starts with understanding the statements’ purpose and components. Remember that the majority of your board, audit and finance committee members are volunteers and come with a background in for-profit industries and you may need to emphasize key differences  between nonprofit and for-profit accounting, specifically restrictions, revenue recognition on contributions and endowment.

Statement of financial position. This report lists your nonprofit’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 your nonprofit’s financial health on a given date — usually the end of a month, quarter or year.

Be sure to evaluate your organization’s overall liquidity and assets held in support of your organization’s endowment.  Every board, finance and audit committee member always has lots of questions about endowment.  Be sure to spend lots of time educating them on its definition and how it’s used and managed by your organization.

Statement of activities. This statement provides details about the revenue and support your organization is bringing in and the expenses it’s incurring for a time period ending on a specific date: for example, “the year ending Dec. 31, 2011.” This is also the date of the statement of financial position. The statement of activities typically summarizes funds coming in 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.

You should spend some time explaining whether operating results are in line with budgeted expectations or are unplanned variances. Also, communicate if unplanned variances are consistent within your industry or just something that affected your organization more than the average organization. 

Lastly, just because your organization is nonprofit does not mean you do not need to earn a profit. To the contrary, it is of the utmost importance that your organization be ran like a business,  meaning positive changes in net assets.  This will help to ensure the fiscal viability of your organization for many years and lets potential donors know that your organization has staying power and they should donate!

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 — group each expense into the function that received the benefit of the expense.

Statement of cash flows. This report presents the impact of the nonprofit’s activities on cash for the same period as the statements of activities and functional expenses. It segments cash coming in and going out into operating, investing and financing categories. This is a big item of focus for you and your committee members. Ask, is your organization able to generate positive cash flows from operations?

Notes to the financial statements. These remarks explain the nonprofit’s accounting policies and information about certain entries presented in the statements. Details on the activity in endowment funds and information on temporarily restricted net assets are, for example, given in the footnotes. They also include details about line items, such as the allowance or discount included in long-term pledges receivable, debt and related party activity.

Using Financials to Investigate
It’s critical that your nonprofit perform monthly comparisons of the organization’s financial results to its corresponding budget. Most financial software programs allow the budget to be entered per month and produce statements that compare actual results to what was budgeted.

Make it a policy to investigate any variances greater than a certain dollar amount or percentage. 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 allows you to properly oversee and assess operations in a timely way, and evaluate the performance of individual programs and departments.

Using Figures to Forecast
Planning for the near future is critical in today’s lean 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 and cut back 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 nonprofits with cyclical cash needs during the year. The projection can help you plan properly and make good investment 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
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 you’re accomplishing specific goals.

If your current year’s objective is to increase membership from 1,500 to 1,800, 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 statement of activities to monitor pledges and develop a detailed listing of pledges receivable to monitor donor payments.

What are your Financials Saying About your Organization?
As management and the board evaluate risk and make strategic decisions, your nonprofit’s financial information will serve as a critical tool. Have the statements available to the decision makers in a timely fashion and present them in a format that’s easy to understand.

If your organization has an annual financial statement audit, the accounting firm conducting the audit should make a presentation of this information to the board. Also have the financial statements available to donors, potential donors and grantors so they can see how their support is being used. Financial facts affect most decisions, so take advantage of this important resource.

BENCHMARK IT!
Comparing your annual results with other nonprofits in your industry — or benchmarking against industry statistics — can help identify your organization’s strengths or weaknesses. And this can lead to spotting growth opportunities or reallocating resources. Apply these same ratios over several years and you’ll 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.

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