One of the most important responsibilities of a not-for-profit board is financial oversight. But for board members who do not have an accounting background, financial statements can sometimes feel like a collection of numbers without much explanation. The good news is that you do not have to become an accounting expert to be able to learn meaningful information from your organization's financial reports. The two primary reports to review are the Balance Sheet, also called the Statement of Financial Position, and the Income Statement or Statement of Activities. The primary goal when reviewing these reports is not to determine if the numbers look right, but to understand the organization's current financial position, identify potential concerns, and determine whether actual results are consistent with the budget the board approved at the beginning of the year.
Balance Sheet
The balance sheet provides a brief overview of the organization's financial position at a particular point in time. For a nonprofit, it generally shows assets, liabilities, and fund balances. Instead of focusing on each line item, pay particular attention to a few areas that can tell you a lot about the organization's overall financial health.
Cash Reserves
Start by looking at the organization's cash balance. How much cash does the organization have available? More importantly, how does that amount compare to what the organization normally needs to operate? Having cash in the bank does not necessarily mean that all of it is available for operations. Some of the cash may be restricted or designated for specific purposes, or is needed to cover invoices due for payment in the current month. Board members should consider whether the organization has sufficient cash reserves to handle the normal ups and downs of income and expenses.
Accounts Receivable
If the organization issues invoices for its program services, you should review accounts receivable reported on the balance sheet. Accounts receivable represents amounts owed to the organization but not yet collected. Depending on the organization, this might include unpaid tuition, program fees, pledges, or other amounts. A growing accounts receivable balance could indicate a collection problem that needs to be addressed by the board. The board should ask whether any balances are significantly past due and if the management has developed a reasonable plan for collection.
Liabilities
Look for current liabilities, particularly accounts payable and other amounts owed by the organization. A balance in accounts payable is not necessarily a problem; organizations routinely have bills that have been received but not yet paid. However, you should pay attention to unusually large balances. Are there significant bills that have been outstanding for an extended period? Is the organization delaying payments because cash is tight? These questions can help the board identify concerns that may not be evident by simply looking at the cash balances.
Designated Funds
Another important area to review is the designated funds. The balance and activity in these funds should be included within the organization's fund balances. Board members should ask whether there are significant unexpended balances and whether those funds are being tracked properly. If donors have designated contributions for a particular purpose, the organization needs to be able to identify those resources and show they are being used appropriately. Proper tracking of designated funds helps the board understand how much of the organization's resources are actually available for general operations.
Income Statement
The Income Statement, or the Statement of Activities, shows the organization's income and expenses over a period of time. A helpful format for reviewing the income statement is to include three primary columns: the first column shows the actual income and expenses year-to-date, the second column shows the annual budgeted amounts, and the third shows the percentage of the budget used year-to-date. (See sample statement below). The percentage column can be a very helpful reference point while reviewing the rest of the report, as it can help identify points of concern that require more attention. For example, if an expense is already at 90% of its annual budget halfway through the year, the board needs to ask why. There are a few possibilities that could explain the percentages, such as an unexpected expense, the original budget underestimated the cost, or the timing of expenses throughout the year.
Organization of the Report
The first thing to consider is whether income and expenses are organized into clear, reasonable categories. The board should be able to look at the report and quickly understand where the organization’s money is coming from and how these funds are being used. When expenses are grouped into overly broad categories, it can be difficult to identify potential areas of concern or understand where money is actually being spent. Clear and meaningful categories also make it easier to track expenses over time and develop a more accurate and useful budget.
Review Budget to Actual
Next, compare the actual year-to-date to what the organization expected. Are any of the income or expense accounts significantly higher than anticipated? A difference does not necessarily mean something is wrong. Budgets are estimated, and circumstances may change throughout the year, but significant differences may cause some questions. Understanding the reason behind the difference can be more important than the actual difference.
Compensation Levels
For many not-for-profits, employee compensation is one of the organization's largest expenses. Board members should consider whether compensation levels for the executive director, administrator, or other key employees are reasonable and adequate. Insufficient pay can make it difficult to hire and retain qualified employees and may ultimately create additional costs for the organization.
Closing Caution: Before reviewing financial reports, the board should understand the accounting method used to prepare them, since it can affect what information the reports provide. For example, if a school prepares its financial statements on the cash basis, the balance sheet will not show amounts owed by student families. As a result, the board may not realize that the school is having difficulty collecting tuition or other receivables. Similarly, accounts payable may not appear on the balance sheet, even if the organization is falling behind on paying its bills.
Balance Sheet (statement of financial position)
income statement (Statement of Activities), including budget
What to notice on the balance sheet:
- cash reserves
- accounts receivable if any
- current liabilities such as accounts payable
- are there any large payables that were outside the budget
- any designated funds
- unexpended designated balances
- are all designated properly recorded (anything missing?)
What to notice on the income statement:
- Income and expenses in reasonable categories
- are any accounts higher than anticipated
- compensation levels for director and other employees
- is it reasonable
- is it adequate
- Preferred layout of a budget to actual report
- first column: actual expenses
- second column: budgeted expenses
- Forecasted income
- Approved expenditures
- third column: % ytd of budget
- evaluate the percentage to determine is any adjustments need to be made or what unexpected expenditures occurred.
Reference sample statements - mostly the income statement, balance sheet probably not needed
Closing caution: The accounting method used to prepare the reports has some influence on the board review process and what information can be learned from the reports. For example, if a school prepares reports in cash basis, the balance sheet will not show current receivable from student families. This statement would fail to disclose if the school is experiencing collection problems.
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