According to the Urban Institute, non-profit organizations play a critical role in the nation’s economy, accounting for 5 percent of gross domestic product (GDP) of the U.S. economy, 8 percent of wages and salaries, and nearly 10 percent of employment.
However, the recession has already had major impact on the sector, challenging organizations to adjust to reduced funding, increased operating expenses, and a heightened demand for services. With many economists predicting several years until full recovery, it is even more essential to gain a real understanding of your organization’s financial situation.
You want to know with as much certainty as possible where you are now and where you plan to be in the years to come.
Keeping an Eye on the Bottom Line
Glossary of Terms
As part of the recent TSNE workshop “Financial Analysis in Turbulent Times,” facilitators Stephanie O’Leary and Rebeka Mazzone discussed how a nonprofit’s budget, cash flow, income statement and balance sheet can be used more proactively assess its current financial state and prepare for the future.
The workshop leaders, staff at Accounting Management Solutions, provided educational information and suggested practices to over 40 participants from local nonprofit organizations. The session was the second in the Third Sector New England’s Better Nonprofit Management Training Series, designed to help nonprofit managers navigate the economic downturn.
The Budget – Your Strategic Plan in Action
O’Leary and Mazzone reminded participants that a budget reflects the financial realities and future expectations associated with a non-profit organization’s programs and other mission-based activities. Budgets are used to guide day-to-day activities and measure performance over time.
The budget also encompasses contingency planning, e.g., 5 percent cuts in funding, 10 percent cuts in funding and likely, an additional “worst-case” scenario. Budgets can also include estimates for pending capital expenses and long-term investments, a planning tactic that is often overlooked. Only half of all participants in this training included capital expenses in the budget.
The budget is a concise communications tool, used to provide information to and from an organization’s board, staff and other stakeholders. Relatedly, O’Leary and Mazzone recommend that the responsibility to update and manage the budget run throughout an organization’s structure and not sit exclusively with those in the accounting or finance department. This type of broad-based “ownership” ensures a more accurate and timely understanding of how resources are being allocated.
Quick tip: With increased economic volatility, organizations should review financial statements as frequently as needed to reflect the speed of change: quarterly, monthly or even weekly if appropriate.
Monitoring Access to Cash: The Cash Flow Statement
Cash flow statements follow the cash coming into and flowing out of an organization. These statements are essential for understanding how organizations are billing and receiving collections. Cash flow statements also monitor contributions to reserve funds.
In general, organizations should aim to have 3 to 6 months of operating expenses held in a reserve fund. In these times, non-profit organizations may want to increase the level of savings to reflect heightened risks of delayed or decreased funding. During the training, roughly 20 percent of participants indicated that their organizations were currently building reserve funds.
Quick tip: A line of credit can provide stability to nonprofits experiencing delays in cash flow with temporary and timely access to credit.
Tracking Financial Health: The Income Statement and Balance Sheet
Income statements track an organization’s revenues and expenses over time. The balance sheet reports an organization’s allocation of assets, liabilities and equity at year end. O’Leary and Mazzone had several suggestions for using these crucial financial reports.
The income statement can be used to link revenues and expenses to programmatic impact. This is because the income statement reveals how the largest expenses are incurred by various programs. In tracking expenses and their resulting impact over time, organizations get a sense of whether a program’s efficiency is increasing or decreasing – and an indication of the financial factors involved.
Market volatility sharply impacts financial indicators reported on the balance sheet. Changes in the market cause changes in how assets, liabilities and equity are valued. Nonprofits must be aware of changes in valuation to communicate accurate information with funders and other stakeholders and also to meet the obligations of current or potential lenders.
Quick tip: Supplement income statements used for internal review with additional statistics, descriptions or other specific points that explicitly link financial indicators to programming and mission-based activities.
Developing Key Indicators
Using all financial statements, O’Leary and Mazzone suggest that organizations develop key financial indicators and limits for those indicators. This will help you watch out for significant changes that signal a need for response. Organizations are also encouraged to compare performance and resource allocation with peers by reviewing publicly available Form 990s and obtaining annual reports.
Under any circumstances, non-profit organizations use timely and accurate financial statements to understand what’s going on and prepare for the future. But in our current times, this need for awareness and preparation is amplified. By being more proactive in using financial statements, organizations have the opportunity to better understand the indicators of financial health now and in the future.