You get the packet every year and see the same cluttered spreadsheets accompanied by blocks of text with phrases like “all material respects” and “accounting principles generally accepted in the United States of America.” But did you know the information in your hands is one of the most powerful tools your organization has? When used correctly, financial statements can help you generate more revenue and give donors confidence that their gift counts.
Unfortunately, few people besides curious accountants ever read through a non-profit organization’s financial statements for fun. They’re tough to read and interpret, even if you understand the words on the page. Since no one’s ever recommended a book they couldn’t read, it’s important to know both the big picture and the line items in your organization’s financial statements.
Each section contains information for a specific purpose. Knowing what to look for and what it means will help you communicate your not-for-profit’s financial health and goals to the people and organizations who matter most.
The first page in the packet typically reads like a letter. This is the auditing firm’s opinion on the material presented in the financial statements. There are several headings in this document that describe the auditor’s responsibilities and the management’s responsibilities, and how they’re different.
The most important line in the auditor’s opinion is the opinion itself. It is usually phrased along the lines of “the financial statements present fairly, in all material respects, the financial position. . . .” This is an unmodified opinion; it’s the best report for a not-for-profit organization. The rest of the opinion contains helpful background information but nothing vital to your current year.
Statement of Financial Position
In the for-profit world, this section is called the Balance Sheet, and it’s divided into three areas: Assets, Liabilities, and Net Assets. You may have guessed that Assets are what the organization owns, Liabilities are what it owes, and Net Assets is the difference between the two.
Each of these pages is organized according to liquidity, or how quickly the items can be converted to cash/how soon the bills are due.
Most people want to see a positive value for Net Assets. This means the organization is in a healthy position for long-term sustainability.
Statement of Activities
Like the previous section, the Statement of Activities is split into three tables: Revenue, Expenses, and Change in Net Assets. This report is the equivalent of for-profit organizations’ Income Statement.
- Revenue – Sources of the organization’s income, in any order. Non-profits that rely heavily on a single stream of revenue may be at a higher risk than those with balanced sources of income.
- Expenses – Items the organization has spent money on during the given fiscal year. This includes total amounts from Program, Management and General, and Fundraising expenses. A more detailed schedule of expenses is included in the Statement of Functional Expenses.
- Change In Net Assets – Revenue minus Expenses. Healthy organizations will have a positive value here, indicating they made more money than they spent.
Though it’s not the end of the world, a negative Change in Net Assets reveals that a not-for-profit organization is using up its reserves to continue operating. Without intervention, the organization may run out of money over time.
Statement of Functional Expenses
This page breaks out non-profits’ expenses according to three functional categories: Program, Management and General, and Fundraising. This statement is becoming more critical as donors, grantors, and the general public look more carefully at expense ratios before making a contribution.
In general, people like to see the majority of expenses in Programs, since it means their dollars are put more directly toward serving the organization’s mission. However, no organization can survive without management and fundraising, which means you must balance being mission-minded with also being fiscally responsible.
Statement of Cash Flows
Perhaps the most confusing page in a not-for-profit financial statement packet, the Statement of Cash Flows combines elements from Financial Position and Activities into one schedule. If you know how to read this page, you will see a clear picture of this chapter in the organization’s financial story.
This page begins by restating the Change in Net Assets for the year and then describing the movement of cash through the organization until arriving at the actual cash amount at the end of the year, whether positive or negative.
Look for big purchases (large negative numbers) that may explain why the end-of-year cash amount seems low, or for large positive numbers that boost the cash amount much higher than normal.
For more information about how these numbers were generated and what they mean for your non-profit, give us a call or contact your auditor.
Notes to the Financial Statements
Commonly called “footnotes,” the accompanying notes to non-profits’ financial statements hold a wealth of information, including explanations for unexpected changes, details of the organization’s structure and mission, and descriptions of the mortgage or other ongoing payments.
Note 1 provides biographical information about the organization reported on. We see this as a critical piece of information, as it provides context for the financial information presented elsewhere. This tells people who you are by listing your mission statement, major programs, fundraising strategies, and vision.
This note is typically the longest footnote, and contains the following items:
- Basis of accounting (usually accrual)
- Estimates made between fiscal year-end and actual date of financial statement issue.
- Fixed Assets and their measurement/depreciation
- Net Assets
Note 2 may also include other sections, depending on the complexity of the not-for-profit organization.
The remaining notes also depend on the specific circumstances of the organization. They include details about investments, mortgage payable, leases, retirement plans, and concentrations of revenue from other organizations.
Things to watch out for in the notes are changes that occur year-over-year (the addition or removal of paragraphs within a note), entries detailing use of donor-restricted funds, and any concentrations in revenue, which may indicate risk.
2018 Financial Statement Changes
Starting in 2018, financial statements will be a little easier for donors, board members, and other readers to understand, thanks to a few (mostly superficial) reporting changes.
The biggest change coming from the Financial Accounting Standards Board (FASB) concerns Net Assets: Instead of three classifications, there will now only be net assets with donor restrictions and net assets without donor restrictions.
We’re always available if you need any guidance or suggestions on how to adopt these new standards.
Putting It All Together
There are many pieces that comprise a non-profit organization’s financial statements, all of which reveal a different perspective on the financial story — as if it were being told from many different characters’ points of view.
Though it takes time and practice to understand and utilize this information to your organization’s benefit, it’s well worth the investment. Donors and grantors feel more confident contributing to organizations that can speak openly and clearly about their financial story, whether promising or challenging.