It’s a myth that all stakeholders need to be experts in every aspect of nonprofit finances. Even on nonprofit financial committees, some members may be skilled in accounting, others in banking, and others in investing or financial analysis.
Yet all nonprofit leaders, including board members, directors, and finance committee members, should have at least a basic understanding of nonprofit finances.
But if you bring zero experience in accounting or financial management to your organization, that’s okay. Because the basics of nonprofit finances are easy to grasp.
In this article, we’ll walk you through the elements of nonprofit finance that every executive director, CFO, and accountant should know.
Step #1: Money In / Money Out
You can see how much revenue comes into an organization and how they spend that money by looking at the Statement of Activities (also called the Income Statement) or an updated Budget report (also referred to as the Budget vs. Actual report).
But you won’t understand a nonprofit’s finances based on financial statements alone. To start grasping a nonprofit’s finances, you should have in-depth conversations with staff to understand the various programs and major fundraising initiatives.
Money In: Revenue
Start by investigating how the organization earns money and who pays them.
For example, is the organization dependent upon special event fundraising? Or is it heavily funded by complex government grant funding? And are there seasonal trends in funding, like a school with revenue during the school year but zero income during the summer? Or a big once-per-year fundraising event?
Understanding the sources and seasonal flow of revenue into the organization will help you anticipate needs and set realistic expectations.
Money Out: Expenses
Once you understand the revenue side, familiarize yourself with how, why, and when the organization is spending its money.
Close to 60% of expenses go to staffing pay and benefits in most nonprofits. Is that the case here? If not, where is the money going instead? And what makes up the balance of expenses? Are they going toward occupancy costs? Does the organization make grants to other nonprofits? Or does it spend a lot of money on supplies needed to execute its programs?
Once you understand money in and money out, take a look at the assets the nonprofit owns and the liabilities that it owes to others to get a grasp of their financial health.
Step #2: What do they own? And what do they owe?
You can find a nonprofit’s assets and liabilities on the Statement of Financial Position (also called the Balance Sheet), which gives you a quick snapshot of the long-term position of the organization.
But, as with revenues and expenses, you can only learn so much from the reports. You’ll learn a lot more from intentional conversations with people inside the organization who can help you understand what those numbers mean. For instance…
- Does the nonprofit have enough cash to fund its programs and meet payroll?
- Are there complex investments or endowments restricted to specific purposes?
- Has the nonprofit taken on significant debt or been slow to pay its creditors?
If a nonprofit has had long-term effective financial oversight, it should have enough cash, smart investments, and plenty of assets.
Well-managed nonprofits should also be collecting on pledges or accounts receivable on a timely basis. Similarly, healthy nonprofits should carry minimal debt and pay their vendors on time. On the other hand, a poorly managed nonprofit will have little money in the bank, few other assets, an accumulation of debt with no clear plan to repay it, and a ballooning accounts payable balance.
Step #3: Understand compliance
To fully grasp your nonprofit finances, you need to start to understand the major compliance requirements that impact your organization.
In most cases, these include an annual audit and federal tax return. While reviewing the audit or the tax return might seem overwhelming at first, sitting down with the finance committee while the auditors present the audit and 990 is a great way to accelerate your learning curve. The audit team will identify any deficiencies in the accounting, review the various reports and explain what they mean, and discuss major details of the financials.
By actively inserting yourself in this process and asking questions, you’ll quickly start to grasp financial concepts you thought were beyond your reach.
Step #4: Never stop learning
Understanding nonprofit finances is a core responsibility of board members and executives.
And in most organizations, others on your finance committee or accounting team are glad to help. So lean on them, ask questions, and be inquisitive. Plus, there are numerous free resources specific to nonprofit accounting and governance. Resources may include white papers, articles or blogs, and even online courses.
If you’d like to learn more, check out our free online course on nonprofit finances and financial reporting here: www.thecharitycfouniversity.com
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