How to Get a Full Understanding of Your Nonprofit’s Financial Health
At the year’s end, when you’ve completed the financial statement for your nonprofit, review the following points, either as a board or within the board’s finance committee. You can ask different questions about the statement of position (or balance sheet) and the statement of activities. The answers arm you with a clear understanding of your organization’s financial health.
Looking at the statement of position, compare some of the numbers, asking:
Do the cash and cash equivalents exceed the accounts payable? If so, the organization has enough cash in the bank to pay its immediate bills to vendors.
Are accounts payable increasing over time? You’ll see fluctuations in amounts owed from month to month and year to year, but if accounts payable are steadily rising, the nonprofit’s bills are getting ahead of its capability to pay them.
Do the total current assets exceed the current liabilities? If they do, the organization has enough money readily at hand to cover all its immediate obligations, such as bills and taxes, employee benefits, and loan payments.
How much of the assets are made up of property, equipment, or other durable goods the organization owns, and what is the nature of those assets? Some organizations appear to be financially healthy because their total assets are high, but they may have trouble covering immediate expenses if all of those assets are things that are hard to sell.
Does the current liabilities section show a high amount of payroll taxes payable? If so, the organization may be delinquent in paying its taxes.
In the liabilities section, do you see an item for a refundable advance or deferred revenue? If you see this item, it means money paying for a service was given to the organization before the organization provided that service (such as subscription income theatergoers pay in advance of attending performances). Make sure the organization has sufficient assets — preferably cash — to provide the services it has promised.
Has the revenue-to-date ratio changed? To see whether income is coming into your organization in a steady and reliable way, divide the current year’s revenue by the prior year’s revenue at the same point in time. If your revenue is steady over time, the ratio figure you’ll compute is close to 1. If the ratio is less than 1, money is coming into your nonprofit at a slower rate.
Are you using temporarily restricted funds for other purposes? Temporary restricted net assets consist of money from foundations, donors, or customers for which the organization must still perform a service. For example, if your nonprofit receives a foundation grant to produce a particular play and subscribers buy advanced tickets to that play, the money you receive from those sources is considered temporarily restricted until you produce the play.
What if you need money immediately to pay the rent? Sometimes organizations borrow from temporarily restricted funds for such a purpose. If you do, restore these funds as quickly as possible. Otherwise, you won’t have the necessary funds to produce the play. To see if temporarily restricted net assets have been spent, divide cash plus accounts receivable by temporarily restricted net assets. The ratio should total 1 or higher.
Has the organization borrowed money? If so, the amount appears in the liabilities section as a loan or line of credit. Compare its total unrestricted net assets to the total amount borrowed. If the numbers are similar, the organization may have cash at hand, but all of it must be repaid to a lender.
The financial statement will be dated, and the answers to the questions you have just asked should give you a good picture of the health of your organization over its entire history leading up to that date. Now it’s time to look at the statement of activities, which illustrates what happened in the past year. Two simple questions summarize that story. Look to the bottom of the page to see:
Is the change in net assets a negative or positive number? If it’s negative, the organization lost money in the previous year. If the loss is a high number, ask why it took place. If it’s a modest amount, ask whether it’s part of a downward trend or something that rarely occurs.
Is the number shown for total net assets a positive number? If so, the organization is in a positive financial position (even if it lost money in the past year). That’s good news!
In accrual accounting, if an organization receives a multi-year grant, the entire amount of that grant is shown as revenue in the first year. If that grant is a major part of the nonprofit’s annual revenues, it may create a high positive net balance in the grant’s first year that is followed by apparent losses in year two and year three.
You may want to footnote this situation in presenting your finances to your board or funders. If your books are audited, you can ask the CPA firm to include a footnote about it in the audit.