501 Commons Financial Fitness for Boards 2008 501

What are the key financial issues/questions? § What are our most significant risks? § What areas of our finances do I want to understood better? § What would give me a better sense of the organization’s financial position? § Other questions?

Part 1: Differences Between Nonprofit and Business Accounting

What rules govern nonprofit accounting? § Nonprofits also follow Generally Acceptable Accounting Principles known as “GAAP. ” § The Financial Accounting Standards Board (FASB) determines the accounting standards. § FASB periodically issues new rules that pertain to nonprofit finance. Two of significance to nonprofits are: SFAS 116 : Contributions Made and Received SFAS 117 : Financial Statement Disclosure

Key Issues in Nonprofit Accounting: SFAS 116 and SFAS 117 Handling restricted donations § Donations may be restricted based on timing, purpose, or both. § When recording, posting, and reporting on this donation, the restriction must be noted. § When the funds are spent, the organization must do so in compliance with the donor’s wishes.

SFAS 117: Requirements for Financial Statements Financial Statement under SFAS 117 for NPOs Same forms in for-profit companies Statement of Financial Position or Balance Sheet Statement of Activities Income Statement (or Profit & Loss Statement ) Statement of Cash Flows Statement of Cash flows Note : The titles on the left are used for official external reports. Internally, many NPOs use the titles on the right-side.

Overview of SFAS 117 (continued) § Contributions and net assets must be separated into three categories. Restrictions can only be imposed by the donor, not by the organization or its board. § § § Unrestricted Temporarily restricted Permanently restricted § Expenses are to be reported: § By functional categories (programs, management and general, and fundraising) rather than by natural categories or line items and, § In the unrestricted column or category (even when the source of the funds used to pay for the expense was a restricted donation)

Overview of SFAS 117 (continued) § All capital gains and losses on investments and other assets must be reported in the unrestricted category, unless: § there are explicit donor restrictions, or § provisions of state law require the reporting of gains or losses in a restricted category.

Overview of SFAS 116: Contributions Made and Received § Record contributions when pledges are made, § Even if the contributed income has not yet been received, and § Even if the contribution is restricted. § For example, recognize a $10, 000 grant restricted by the donor for a particular purpose, even if the expenditure that satisfies the restriction will not happen until a future period.

Overview of SFAS 116 (continued) § SFAS 116 placed limitations on the recognition of donated services and material. § Non-cash contributions or gifts in-kind must be measured at Fair Market Value (FMV). For used equipment or furnishings use thrift value of the items. § Donated services are usually not recorded. A volunteer's time can only be recorded if: - the contribution of time results in an asset for the organization, or - the volunteer possesses a professional skill such as an attorney or CPA license, and the nonprofit would have paid for the service had the service not been donated.

Part 2: Financial Tools 1. 2. 3. 4. Budgets Financial Reports Financial Systems Financial Analysis

1. Budgets A budget is a plan for revenues you will raise or earn and a forecast of the expenses you expect to result from your program plan for the year. Preparing a Budget: § What is to be accomplished? § How will be it be accomplished? § When will it happen? § Who will do it? § How will the results be measured?

Types of Budgets 1. 2. 3. 4. Operating Budget Program Budget Capital Budget Cash Budget (Cash Flow)

Budget Responsibilities § Executive Director – Develops the budget. § Board Treasurer, Finance Chair or other Board member(s) review the budget prior to it being presented to the Board. § Full Board – Responsible for authorizing annual operating budget or – If using Policy Governance – responsible for ensuring that the budget reflects the organization’s goals and complies with organizational policy.

Operating Budget Shows planned revenue and expenses for the coming year. § Revenues: – Earned income (program revenue) – Contributed income (corporate, foundation, board, individual) § Expenses: – Salaries and benefits, program costs, fundraising expenses, office supplies, equipment leases, rent, utilities, etc.

Development Plan • A development plan should back up the projection for contributed income. • Show all grant or donation sources and amounts requested in chronological order. • Discount the expected contributed revenues based on experience in previous years. The discounted amount should be used in the budget. • Consider timing issues. When will revenue be received? When will expenses be incurred?

Ask yourself… § Is our plan realistic? § Do we need to change our plan (cut expenses or build revenue)? § Are some sources of revenue so significant that we would need to change our plan if they are not received?

Program Budget § Splits out total revenue and expenses for each major program. § By tracking revenues and expenses for each program you are able to see whether the program is contributing to a surplus or creating a deficit. § Program budgeting allows you to more accurately allocate indirect costs (fundraising, administration) to programs.

Capital Budgets Details expenses for maintaining and replacing major equipment, computers, buildings, automobiles, furniture, etc.

Cash Budget or Cash Flow Projections § Depicts the cash you expect to receive and expenses you expect to pay on a monthly basis. § Update expenses and revenues on a regular basis. § Shows when cash crunches will occur so you can restrict nonessential expenditures.

Financial Tools 1. Budgets 2. Financial Reports 3. Financial Systems 4. Financial Analysis

2. Financial Reports

Financial Reports Tools for financial oversight § Statement of Activities § Statement of Financial Position § Cash Flow Statement Comparative reports: Include actual revenue and expenses compared to budgeted revenue and expenses and prior year amounts.

Statement of Activities § Also called Income Statement § Reports revenues, expenses, and net income § Expenses may be reported by function: program, fundraising, and general and administration. § Shows if you are operating with a surplus or deficit. § Income and expenses are categorized as unrestricted, temporarily restricted, or permanently restricted.

Statement of Activities Contributed and earned income is shown (the "top line") Expenses are taken out leaving… Net Income (the "bottom line") Income Statement Example (P&L) Contribution Support Corporate/Foundation grants Donations Govt. Grants In-kind Earned Revenue Service Interest/Savings Total Revenues Program expense Program Staffing Program Materials Payroll and Benefits Salaries and Wages Benefits/Insurance Non-personal expenses Office Equipment/Supplies Rent/occupancy Other Misc. Expenses Total Expenses Net Income $66, 000 $5, 00 $65, 000 $3, 000 $10, 000 $300 $149, 300 $55, 000 $12, 000 $34, 600 $6, 000 $15, 000 $12, 000 $1, 000 135, 600 13, 700

Statement of Activities Broken down by Temporary, Permanent, and Unrestricted Assets

Statement of Financial Position § Also called the Balance Sheet § Depicts the organization’s financial condition at a given time § Reports § Assets (What the organization owns) § Liabilities (What the organizations owes in unpaid debt) § Net assets (total assets less total liabilities) broken down by: – Unrestricted Funds – Temporarily Restricted Funds – Permanently Restricted Funds

Statement of Financial Position Balance Sheet Example Current Assets Checking Account Savings Accounts Receivable Grants Receivable Total Current Assets Fixed Assets Equipment Accumulated Depreciation Total Fixed Assets Total Assets Current Liabilities Accounts Payable Payroll Liabilities Long Term Liabilities Notes Payable Total Liabilities Fund Balance Total Liabilities and Fund Balance $10, 000 $32, 000 $5, 000 $6, 000 $53, 000 $18, 000 -$1, 500 $16, 500 $69, 500 $25, 000 $7, 000 $15, 000 $47, 000 $22, 500 $69, 500

Relationship between Balance Sheet and Income Statement

Ask yourself… § How does our actual spending compare to our planned spending? § Are variances in revenues or expenses due to seasonal factors or expected to continue?

Statement of Cash Flows § Depicts changes in cash during the year based on actual expenses and when revenue is received. § It converts accrual information to a cash basis. • For example: A promised donation may be recorded in the previous year but actually received this year.

Financial Tools 1. Budgets 2. Financial Reports 3. Financial Systems 4. Financial Analysis

3. Financial Systems Control Environment § Internal Controls – “immune system” – protects the organization against harm § Accounting Policies and Procedures § Investment Policies § Board policies and oversight

What is the role of the board? § Set the tone for good behavior and values. § Establish good policies. § Help establish priorities. § Maintain oversight and sound reporting. § Take appropriate action.

Questions to ask yourself… § Do we have the proper checks and balances to make sure that we run smoothly? § Are we always mindful of the possibility of fraud or mismanagement and the potential for error? § Do we have investment policies? Are we adhering to those objectives? § Are internal controls ensuring that the organization is following its plans, minimizing errors, avoiding employee theft, etc? § Are the financial policies set by the Board being followed?

Financial Tools 1. Budgets 2. Financial Reports 3. Financial Systems 4. Financial Analysis

4. Financial Analysis Tools By themselves, numbers usually don’t mean much. § Ratios clarify the relationship between elements. § Graphs provide a visual aid. § Historical analysis helps identify trends. § Trend analysis helps identify the reason for change.

Examples of financial analysis § Budget to actual: compare planned expenses to the actual expenses to see if your spending is on track. § Current year to previous year § Ratios: – How are our grant writing efforts working? (Total grant requests/ amount received provides a performance ratio for development. ) – What percentage of our budget is devoted to the costs of this program? (Program Expenses/ Total expenses)

Financial Roles Major roles in fiscal activities: – The Executive Director – Finance staff: bookkeeper, Controller The Board of Directors – The Treasurer – The Finance Committee – Each member of the board

Ask yourself… § What roles do we need? § What roles do we already have filled? § Are our roles clearly defined and understood by all? § Is our staff qualified for these roles?

The Role of the Board § Thoroughly review the financial operations of the organization. § Receive and review timely, regular, and in-depth financial reports at each Board meeting. And if the nonprofit is in crisis, the Board may require more frequent reporting. § May want to request descriptions of finances for each program or of affordability for upcoming, major initiatives as well as request information prior to filing taxes. § Board members may serve as Treasurer, on the Finance Committee, the Audit Committee

Ask yourself… § What roles do we need? § What roles do we already have filled? § Are our roles clearly defined and understood by all? § Is our staff qualified for these roles?

Ask yourself § Are we operating according to plan? § Are internal controls ensuring that the organization is following its plans, minimizing likelihood of errors, avoiding employee theft, etc? § Are the financial policies set by the Board being followed?

Warning Indicators § Are major sources of income growing or declining? – If revenues are declining is this a temporary change or likely to continue? – Is the decline related to lower service levels? § Are major expenditures growing or declining? – Is growth related to growth in clients or in per service costs? – Is the growth in the fundraising, administration or program areas? – If the service is supported by fee-for-service revenue, are these revenues keeping pace?

Audits or Financial Reviews § An audit is a comprehensive analysis performed by an outside professional (usually an accounting firm or CPA) of the organization’s financial management procedures and activities, including internal control environment and activities. § All board members should understand the results of the financial audit and be prepared to address any shortcomings or recommendations.

Do you need an audit? § Some funders require an audit § WA State requires an audit for organizations with annual budgets of $3+ million § Organizations with smaller budgets should have an annual financial review conducted by an outside CPA with a full audit every 3 years

Questions or Comments?