Financial reporting is the lifeblood of nonprofit organizations. As an oversight-driven sector, nonprofits rely on accurate, timely financial information throughout the year. This information is presented to board members and finance committees and is needed to comply with federal regulations. It also ensures ample cash flow to support program services and long-term financial health.
Financial reports demonstrate your organization’s effectiveness in fulfilling its mission and handling revenue from donors, fundraising efforts, and government grants against associated program expenses.
Nonprofit groups understand the critical role financial reporting plays in communicating information to key constituents. Regular monthly reporting typically includes a statement of financial position (balance sheet), a statement of activities (profit and loss [P&L] and income statements), and other required reports. These reports collectively provide the financial insights your nonprofit needs to thrive.
Real-time information from financial reports arms your organization’s board of directors with the power to make sound business decisions and ensure the nonprofit’s viability and liquidity. Accurate reporting must also be maintained in the event of an audit.
Just like for-profit businesses, complete visibility of financial information at all times is necessary to make informed economic decisions and maintain strong cash inflow. A nonprofit’s purpose is to reinvest profits back into the programs and services they offer.
Three essential items on nonprofit financial statements
Nonprofit accounting and generally accepted accounting principles (GAAP) expert Megan Genest Tarnow, principal at The Mobius Group, deeply understands the nonprofit sector’s reliance on financial reporting. “Nonprofits are unique compared to many for-profit small businesses in that they do review financial statements regularly because of the overall structure of oversight and review,” Genest Tarnow explains. “Boards or finance committees require monthly reporting to review financials and meet the budget-to-actual standard.”
To help simplify financial reporting, Genest Tarnow offers the following top three financial reporting items that nonprofits should review each month.
1. Restricted vs. unrestricted funds
Restricted and unrestricted funds are one of the biggest differentiators between nonprofit organizations and for-profit businesses. It’s important to have a clear understanding of which funds are restricted and which are unrestricted. Restricted funds are based on donor intent. In other words, this money comes from designated giving and can only be used for a specific purpose. Donors can restrict contributions to a designated purpose or period of time (multi-year support or in perpetuity, for example).
According to Genest Tarnow, “Where nonprofits tend to get into trouble is when they don’t have a full understanding of what’s restricted and what’s not. They can’t look at funds as one big pool of money…There needs to be a clear designation between restricted and unrestricted cash so they know what’s available for them to spend.”
Adding to the confusion, this year nonprofits went from three categories of net assets to two. This means that, on top of categorizing restricted assets, nonprofit organizations also have to report on net assets both with and without donor restrictions.
“The takeaway from all this is that nonprofits need to know where their restricted funds are and whether funds are cash or receivable. This lets them know what is actually available for them to spend,” explains Genest Tarnow. “This is why reviewing financial reporting every month is critical.”
Simplifying how to present information is key to helping stakeholders better understand the numbers. Genest Tarnow uses QuickBooks to set up the P&L statement and balance sheet in three easy-to-follow columns: 1.) net assets without donor restrictions; 2.) net assets with donor restrictions; and 3.) the total. “We use the very helpful ’location’ feature in QuickBooks to set this up and simplify reporting for the client,” Genest Tarnow says.
2. Revenue model structure
Typically, a nonprofit’s revenue model is broken down into contributions (or money donated) and earned income. The goal is to ensure that funds are appropriately balanced by tracking where they are coming into the organization. Reviewing the revenue model monthly allows the nonprofit to make adjustments when funding is “out of whack.”
Genest Tarnow explains: “We look at the total earned income, the total contributed income, and then track what percentage of funds are coming from which area. Is it individual donors? Is it a foundation? Is it the government? We want to identify if they have too many eggs in one basket and then decide if we need to diversify income.”
This year, the pandemic amplified the need for many nonprofits to restructure revenue. Consider the following example:
Nonprofit X received the majority of their funding from fee-for-service programming—that is,
the government paid the organization to provide a specific program or service. COVID-19 prevented the nonprofit from providing this service due to social distancing mandates. Because funds were restricted to a designated program, nonprofit X needs to restructure its revenue model and bring in funding from other sources to support daily operations.
3. True program costs
Understanding true program costs is at the heart of longevity and sustainability for nonprofits. Program operations involve many expenses, which means nonprofits need full visibility into their financial information to plan for the future, mitigate risk of cash shortfalls, and report appropriately to the IRS.
“Nonprofits are required by the IRS to report their expenses by function, which is whatever they decide their programs are, plus admin and fundraising. Historically, there have been watchdog organizations that look at admin and fundraising costs as a guide of sorts to measure the efficiency and effectiveness of the organization,” says Genest Tarnow. “More importantly for the nonprofit, by understanding true program costs, it helps to determine if they can support programs on their own or if they need to be subsidized with other contributions.”
Nonprofits are highly regulated and monitored; this is why accurate and detailed records of true program costs are so important. For example, the administrative aspects of running a program can include human resources, insurance, accounting, and board expenses. Fundraising can include anything that relates to marketing the organization and raising contributions, including expenses—office space, postage, copier use, and so on. Every dollar spent on a given program must be calculated to maintain accurate, compliant reporting.
Reviewing true program costs is sometimes an annual exercise. However, for nonprofit groups where cash is tight and decisions about keeping or cutting programs must be made, we recommend monthly reviews.
While not an exhaustive list, this guide provides sound advice and insights about what to look for in your nonprofit organization’s financial reports. Reviewing this key information monthly apprises officers and board members of your organization’s cash flow, net assets, operating expenses, and overall financial health and sustainability.
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