Since you’ve read all of NFP Partner blog and newsletters, you know how to read financial statements. If you don’t, please read this article to get up to speed.
After reading the article, you should now know the three major financial statements and what to look for. Now, we are going to determine what your nonprofit should do with what you are seeing.
Your nonprofit’s statement of financial position
One of the first statements usually presented is the Statement of Financial Position, also known as the Balance Sheet. This statement presents the nonprofit’s assets, liabilities, and net assets (fund balances). This report details the assets and the liabilities and is used to determine the overall health of a nonprofit.
The asset categories generally include cash, prepaids, receivables, and other assets. When comparing these to current and long-term liabilities, look to see if the assets can cover those liabilities. They can be accounts payable, accrued payroll, or other short and long-term obligations.
If the current ratio (current assets divided by current liabilities) is above 1, it indicates the nonprofit’s assets can cover their short-term liabilities. No further action is necessary. However, if the current ratio is below 1, it indicates the nonprofit may not be able to meet its short-term liabilities. In this case, further research is necessary.
Questions to ask regarding your nonprofit’s current ratios
- How many months has the current ratio been below 1? Is this the first time or is this a consistent problem?
- Does the nonprofit have any short-term debt payments due in the next three months?
- Is the nonprofit meeting its revenue goals? If no, why? Should the budget be revised? Does spending need to be cut-back?
- Does the nonprofit have large outstanding accounts receivable? What’s being done to collect the outstanding invoices?
Another category presented on a Statement of Financial Position is the net assets. The total of the net assets and the liabilities equal the assets. Net assets are divided into two categories, with donor restrictions, and without donor restrictions. These two categories tell us the balances of all of the different funding sources and whether they are unrestricted for any use or restricted for a specific use. A few things should be reviewed regarding net assets.
First, verify the current year to date net income matches the year to date income on the statement of activities. NOTE, if the numbers do not match, stop reviewing the financial statements. They do not balance and an error has been made. Next, compare the beginning net assets plus the year to date net assets which equals the total net assets.
Questions to ask regarding your nonprofit’s net assets
- Has the total net assets increased?
- Is the increase significant, meaning greater than 10%? Is this increase expected? If this is not expected, this could indicate the programs are not spending appropriated money. Additionally, programs could be at risk of not meeting their goals.
- Has the total net assets decreased?
- Is the decrease significant, meaning greater than 10%?
- Is this decrease expected? If this is not expected, this could indicate that the nonprofit is spending ahead of revenue. It could be that revenue is reimbursed after expenses are incurred. Also, it could indicate fundraising goals are not being met.
Your nonprofit’s statement of activities
The second statement which is useful is the Statement of Activities. The purpose of this statement is to lay out all of the revenues and expenses in a column format to show the net income or loss.
If the net income is positive, this means the nonprofit is bringing in more revenue than expenses. If the net income is negative, this means the nonprofit is spending more than it has in revenue. This is not automatically a bad thing. It just means further conversation is needed to determine if this is a real risk that the nonprofit may not be able to meet its expenditure obligations.
Statement of revenue and expense – budget vs. actual
A third and very effective statement for budget tracking purposes is the Budget vs. Actual. This statement tracks current and year-to-date revenue and expenses against projected budgets for all categories. On this report, it’s important to focus on the budget variances.
Questions to ask to understand your nonprofit’s budget variances
- Did the nonprofit have unexpected expenses that are causing a major budget variance? If expenses are tracking lower than expected, does it correlate with lower than expected revenue or vice versa with higher than budgeted expenses?
- What has the highest budget variance?
- Did the nonprofit increase or decrease headcount?
- Did the organization incur higher than expected employee benefits costs?
- Is this category a major category, such as personnel and benefits or professional fees?
- Did the organization need to outsource any tasks? Additionally, will the outsourcing create efficiencies to be realized later?
- Is the variance a positive or a negative?
Just as important as overspending (indicated by a negative variance), underspending could also indicate an issue. If the revenue has been received and a program has outcomes associated with the revenue, the program may be at risk of not meeting expectations. Even more, worst case, your nonprofit could lose funding.
If hiring staff is required to meet the goals, and no one has been hired, the program is at risk. If training is required to meet the goals and none of the training has been performed, the program is at risk. Also, if education or professional development or program supplies are required to meet the goals, and none of the expenses have been obligated, the program is at risk.
The main purpose of financial statements is to provide financial insight to the health of an organization. Learning how to read financial statements is half the battle. But, knowing what to do with the information is how to win the battle.