Four Components of Meaningful Internal Financial Statements for NonprofitsFebruary 2, 2018
By Matthew Estersohn, CPA, Senior Manager, Nonprofit, Government & Healthcare Group
At many nonprofits, audited financial statements draw a lot of attention. These are often made publicly available and are scrutinized by management, external auditors, Boards and public stakeholders – such as funding agencies and donors.
As important as audited financial statements are, they are not always the optimal tool for an organization’s internal decision-making process. One challenge presented by financial statements is timing: completing an audit takes time and audited financial statements are often not available until months after year-end. A second is projecting cash flow, as an example – under generally accepted accounting principles in the United States (“U.S. GAAP”), capital purchases and principal payments on debt are not expenses, but still require cash payments.
To facilitate meaningful operational decisions, management and Boards need timely and relevant financial information in the form of interim financial statements. Here is a list of four important elements that should be considered for inclusion within these reports.
1. Comparison to Budget:
A comparison of actual revenue and expense to the approved budget is the most basic way of communicating an organization’s performance against expectations. Given its importance, most nonprofits present this in some form throughout the year.
To be most meaningful, this financial report should be segregated between programs or divisions so that each manager with budgetary authority can track their own progress. Administrative expenses should also be allocated to programs to provide a comprehensive view of each program’s sustainability.
2. Non-Operating Activity:
Management has flexibility when considering which activities are relevant. Some transactions are considered outside of the organization’s control and are often excluded from internal operating results. Investment return on endowment funds is a common example.
One caveat is that the decision to remove any items from an operating measure should always be transparent and non-operating results should be disclosed to the extent known. Consider an organization that is funding operating losses by selling endowment investments. If the internal financial statements show the transfer of the funds into operations, but not the activity within the endowment, the true financial picture is misleading.
3. Nonfinancial Information:
Many nonprofits only include financial information in their periodic reporting. This is understandable considering that the accounting staff is generally most comfortable with the numbers, and volunteers who serve on Finance or Audit Committees often have financial backgrounds.
However, financial reports alone are not useful without nonfinancial data to put the numbers in context. Adding information on the nonprofit’s mission and program activities can both explain differences in account balances, and give the organization a chance to publicize its achievements to internal stakeholders.
Larger organizations may already have sophisticated dashboard reporting on program results, but data-driven information does not have to be difficult to pull together and often already exists within program departments. One simple example is an organization that earns revenue based on the number of people they serve. Such as a museum who would report the number of visitors, a university that would report the total number of students and a health clinic that would report the total number of patients. These metrics can easily be tailored to focus on areas of concern. The museum may want to measure the number of visitors that go to a specific exhibit; the university may be concerned about application rates and student yield; and the clinic may want to see the number of new patients during the period.
Advocacy and civic organizations may not have data that ties directly into financial performance, but can still provide useful information on the use of funds. For example, management can report on a trend analysis of legislation influenced or legal cases defended. These metrics will vary greatly based on industry and organization size. Trade associations and other industry groups may publish data that can be a useful comparison point. Nonprofits with similar missions may also publish statistics in annual reports that can be used for benchmarking.
While there aren’t many substitutes for data-driven information, management can also include a narrative overview of the period, known as an MDA (Management’s Discussion and Analysis) is already used for profit and government entities, with some highlights that may explain variances or unusual results, and speak to projections and future plans.
4. Liquidity Information and Cash Flow Projections:
All internal financial statements should include a balance sheet. However, one of the lessons learned from the high-profile 2015 FEGS bankruptcy is that even organizations with solvent balance sheets may have liquidity issues. The organization should consider reporting liquidity measures – such as working capital balances; current ratios; unrestricted net assets; net of property and equipment; and related debt.
Similarly, the organization should include a projection of cash flow and cash needs. As previously mentioned, capital purchases and debt payments do not impact the bottom line, but are significant drivers of cash needs throughout the year.
The items above are just samples or examples of additional financial information that should be included as part of interim financial reporting. However, organizations should periodically look at their internal reporting and ensure that the information they are providing is helping the Board and senior management make informed, timely and meaningful decisions.