Interpreting Nonprofit Financial Statements

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Interpreting Nonprofit Financial Statements

• By James L. White
• Bernard Franks, A Corporation of Certified
  Public Accountants

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Contact Information

• jimwhite_at_bernardfranks-cpa.com
• James L. White
• 4141 Veterans Boulevard
• Suite 313
• Metairie, LA 70002
• [phone]

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Introduction to Nonprofits

• Over one million nonprofits in the US
• For GAAP purposes (ASC 958-10-20)
• Receive contributions (gifts)
• Mission driven
• Absence of ownership interests
• Tax Classifications
• 501(c)(3)-Charitable organizations
• 501(c)(4)-Civic and Social Welfare
• 501(c)(6)-Business Leagues
• 501(c)(7)-Social and Recreational

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Voluntary Health and Welfare Organizations

• Only VHW are required to present a statement of
  functional expenses.
• GAAP definition of VHW
• Contributions from the public (not Government)
• Purpose must be to provide health, welfare, or
  community services.
• Examples of VHW are Salvation Army, Red Cross,
  Goodwill Industries, United Way, Boy Scouts, etc.

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Understanding Differences Between Commercial and
Nonprofit Reporting
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Objectives of Nonprofit Reporting

• Groups that external statements should address
• Funders
• Regulatory agencies
• Governing boards
• Beneficiaries of services
• Employees
• Creditors
• National organization

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Objectives of Nonprofit Reporting

• Communicate the use of resources
• Identify the principal programs and costs
• Communicate ability to carry out fiscal
  objectives
• Other objectives include
• Amount and nature of assets, liabilities and net
  assets
• Inflows and outflows of resources
• Factors that affect liquidity
• Service efforts of the organization

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Other General Financial Reporting Issues

• Comparative financial statements
• Prior years
• Budget
• Fund accounting
• Not required by GAAP

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Significant Differences Between For Profit and
Nonprofit Financials

• Three bucket reporting

Unrestricted
Temporarily Restricted
Unrestricted
Permanently Restricted
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Significant Differences-Three Buckets

• Permanently Restricted-Donor imposed permanent
  restrictions on contributed assets.
• Endowment
• Land committed to be used for programs
• Temporarily Restricted-Donor imposed temporary
  restrictions on contributed assets.
• Time
• Use
• Unrestricted-No donor imposed restrictions.

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Significant Differences-Revenue Recognition

• Contributions-generally are voluntary,
  unconditional transfers of assets (or
  cancellations of liabilities).
• Results in an asset unconditional promises to
  give.
• Can be placed in any of the buckets based on
  donor imposed restrictions.
• Immediate recognition of revenue when conditions
  are met are not required. For example, an
  unconditional pledge is recorded as revenue when
  delivered to nonprofit.
• Must determine if a contribution (gift) or
  exchange transaction.

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Significant Differences-Terminology

• Statement of Financial Position as opposed to
  Balance Sheet.
• Net assets as opposed to retained earnings
• Must be separated by unrestricted, temporarily
  restricted and permanently restricted.
• Statement of Activities as opposed to Income
  Statement
• Increase (decrease) in Net Assets as opposed to
  Net Income.

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Interpreting Nonprofit Statement of Financial
Position
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To Classify or Not to Classify?

• Nonprofit statements are not required to include
  the caption of Current Assets and Current
  Liabilities.
• Classified-Statement can include the
  Classification which allows for current ratio and
  quick ratio analysis.
• Sequenced Statement-Assets and liability are
  sequenced according to their nearness to cash and
  maturity.
• Other-Liquidity information is in no particular
  order. Liquidity is disclosed in the notes.

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Cash

• Focus on restrictions to cash
• Cash available for current unrestricted use does
  not need to be segregated.
• Cash limited to long-term purposes (even if it
  meets the cash equivalency definition) should be
  excluded from cash.
• Examples
• Cash restricted for acquisition of property
• Cash in permanent endowment

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Investments

• Marketable equity securities (equity and debt
  securities) with readily determinable market
  values must be reported at fair value.
• Contributions of investments are recorded at fair
  market value.

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Endowment Investments

• Consider restrictions-Donor requirements may
  produce long-term assets, (e.g. Investments Held
  for Endowment).
• Restrictions can be placed on investment income
• Restrictions can be placed on investment gain
• In the absence of donor restrictions or law,
  donor restrictions on income applies to the
  fund's net appreciation.
• In the absence of restrictions or law,
  restrictions on income applies to the funds net
  losses on investments and reduce appreciation in
  which use restrictions have not been met.
  Remaining losses reduce unrestricted net assets.
  Subsequent gains can restore previous decreases.
• Board designated endowments- gains and income are
  always considered unrestricted net assets.

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Endowment Funds-UPMIFA

• Abandons historic cost as a floor for
  expenditures
• Allows expenditures from endowments during an
  economic downturn.
• The Board must act prudently in good faith
  considering a number of factors in deciding a
  distribution from an endowment.

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Endowments-UMIFA

• Requires the historical dollar amount of an
  endowment must be preserved.
• Absent donor restriction net appreciation
  (realized and unrealized) is spendable.

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Promises to Give

• Promises to Give-(also called pledges) are oral
  of written agreements by donors to contribute
  cash or other assets. Must be recorded
  immediately.
• Pledges must be verifiable
• Pledge card
• Tape recordings
• Contemporaneous registers
• Written follow-up correspondence
• Promises to give must be unconditional.
• Promises to give are recorded at fair value if to
  be collected in more than one year. Amortization
  is charged to contributions not interest.
• Collectability must be considered and allowance
  for doubtful accounts established.

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Inventory Issues

• Purchased inventory is recorded at lower of cost
  (FIFO, LIFO, average) or market.
• Donated inventories are recorded as contributions
  and inventory at the fair market value at date.
• Donated items that have no value should not be
  recognized (e.g. outdated clothing). No value
  if
• Cannot be used internally in programs and
  activities.
• Cannot be sold.

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Collections of Items

• Collections are defined as works of art,
  historical treasures, that are-
• held for public display, education, or for
  research.
• protected, cared for and preserved, and
• subject to a policy that requires sales of
  collectibles to be reinvested into other
  collectibles.
• Acceptable accounting includes
• Capitalization (no depreciation)
• No capitalization
• Capitalize only collection items after adoption
  of SFAS 116

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Interpreting Nonprofit Liabilities
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Deferred Revenues

• Collection of cash received in advance of the
  delivery of goods or performance of services are
  liabilities. Examples include
• Membership dues and fees received in advance.
• Advance ticket sales.
• Advance rental payments.
• Deferred Revenues should be reduced and revenues
  recognized ratably over the period earned (e.g.
  membership dues).
• On classified statements, deferred revenues
  should be segregated between current and
  long-term.

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Refundable Advances

• Refundable advances result from
• Receipt of an advance from third party in which
  the services have not yet been performed
  (exchange transaction).
• Receipt of a contribution subject to donor
  imposed restrictions and the conditions have not
  yet been fulfilled.

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Grants Payable

• The awarding of a unconditional contribution s to
  other organizations should be recorded as a grant
  payable liability.
• This is the reciprocal of the unconditional
  promise to give.

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When Is Receipt of a Contribution a Liability?

• Agency transactions-Voluntary transfers of assets
  to a nonprofit
• Nonprofit has little or no discretion over the
  use of the assets.
• Really acting as an agent for the transfer of
  funds to another nonprofit agency.
• Agency transactions are recorded as liabilities,
  funds are for other Organizations.

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Interpreting Net Assets
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Net Assets

• Net Assets-represent the difference between
  assets and liabilities.
• Must be classified according to
• Unrestricted-not restricted by donors or by law.
• Can be designated by Board action.
• Board can never restrict.
• Temporarily Restricted-Use has been restricted by
  donor-imposed time or use restrictions.
• Permanently Restricted-Restricted by donor or law
  to be maintained for perpetuity.

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Interpreting Statement of Activities
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Revenue Recognition Issues

• Contribution-voluntary , unconditional transfers
  of assets (or payment of liabilities)
• Nonreciprocal-gives something with nothing
  received in exchange.
• Gift out of kindness of heart.
• Recorded as asset and income when conditions are
  fulfilled or amount determinable.
• Exchange Transactions-purchase of goods and
  services from another party.
• Recognized as revenue as services performed or
  goods delivered.
• Agency Transactions-Nonprofit is really an agent.
  
• No revenue recognized.
• Funds are recorded as a liability until delivered
  to other agency.

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Donations of Materials

• Donated materials are recorded at fair market
  value and are considered contributions.
• Donated items used in retail operations should be
  recorded as inventory and contributions. Sales
  and cost of sales are recorded upon sale.
• Free advertising is recorded at fair market
  value.

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Donation of Facilities

• Contribution income (fair value) is recorded for
  the free or below market use of facilities.
• Value cannot exceed the fair market value of the
  asset being used.
• If the contribution is for several years, than
  the contribution is the net present value of the
  fair rental values.
• Contribution is recorded as temporarily
  restricted net asset and released over time.

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Donation of Services

• The fair value of donated services is recorded as
  contribution revenue and expense if
• Create or enhance a nonfinancial asset (e.g.
  non-skilled labor to build a new facility).
• Require specialized skills and would be needed to
  be purchased if they were not donated.

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Membership Fees

• Membership dues might be a combination
  contribution revenues and a portion might be
  exchange transaction.
• Exchange portion of dues would provide benefits
  to members contribution would provide benefits
  to others
• Exchange portion is classified as deferred
  revenues and is earned ratably over the
  membership period.

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Reclassifications

• Reclassifications take place between temporarily
  restricted net assets and unrestricted net assets
• Reclassifications take place when restrictions
  (use or times) are satisfied.
• Reclassifications have no effect on total net
  assets.

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Expenses

• Program Expenses-Direct and indirect costs
  related to providing programs and social
  services.
• Hands on client and program expenses
• Describe the programs-opportunity to market
  services and benefits to the community and
  funders.
• Program services includes allocation indirect
  cost such as facility use (rent , utilities,
  insurance, etc.), telephone, supplies,
  supervision, etc.

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Expenses

• Support expenses-Activities not directly related
  to the mission of the nonprofit.
• Management and General-Includes accounting, board
  expenses, business management, finance, budgeting
  expenses.
• Includes Executive Director and their staff,
  except for the time spent supervising program,
  fundraising.
• Fundraising-Includes all expenses related to the
  appeal for funds.
• Payments to Affiliated Organizations-Allocated
  between program and administrative services when
  possible. If the allocation cannot be
  determined, then the costs is GA.

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Expenses

• All expenses must be reported in the Unrestricted
  Net Asset bucket.
• Netting of expenses against revenues is not
  allowed (except for investments).
• Depreciation is required.

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Allocations
Important for nonprofit to have an allocation
plan. A general plan would be as follows

• Account

• Allocation Method

• Salaries and wages
• Employee benefits
• Office rent
• Utilities
• Building supplies
• Telephone

• Time sheets
• Based on salaries and wages
• Square footage
• Square footage
• Square footage
• Number of phones

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Fundraising-Joint Costs

• Nonprofit organizations often have joint purpose
  printed materials or events. Organizations wish
  to classify expense as program, G A and
  fundraising
• The default classification for joint expenses is
  fundraising expense. To overcome this
  presumption
• Purpose must have a program component and request
  an action other than fundraising.
• Audience must be selected to meet a program need.
• Content must support program goals.

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Three Bucket Reporting

• The three buckets of Net Assets (Unrestricted,
  Temporarily Restricted and Permanently
  Restricted) must be presented in Statement of
  Activities.
• Can be presented in columns
• Can be presented in sections

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Interpreting the Statement of Functional Expenses

• Required for Voluntary Health and Welfare
  organizations.
• Large donors require the information.
• Natural expense categories
• Required to allocate expenses between program and
  support (G A and fundraising).

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Interpreting the Statement of Cash Flow

• Cash and cash equivalents that have been
• designated for long-term purposes , or
• received with donor restrictions for long-term
  use should be excluded from cash or equivalent.
• Receipt of contributions restricted to long-term
  purposes is classified as a Financing activity.
  The amount would also need to be a reduction from
  operating activities to balance the statement
  when using the indirect method.

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Interpreting Nonprofit Disclosures

• Unconditional Promise to Give
• Amounts receivable in one to five years.
• Amount of the Allowance for Uncollectible
• Unamortized discount ( also face amount and
  discount rate)
• Conditional Promises to Give must be disclosed
• Property policy for the handling of donations of
  long-lived assets.
• Nature of relationship with owner of donated
  property
• Nature of restrictions on assets.
• Details of permanent and temporarily restricted
  net assets.

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Interpreting Nonprofit Disclosures

• Donated services disclosure can include the hours
  of service not recorded.
• Concentrations of revenue (grants, contributions,
  etc.) should be disclosed.
• Nature and amounts of related party transactions.
• Allocation methods should be disclosed.
• Income tax status is disclosed.

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Using Financial Ratios in Interpreting Financial
Statements
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Financial Ratios For Nonprofits
FINANCIAL RATIO   MEANING IF HIGH IF LOW
Statement of Financial Position      
Net assets (excess of assets over liabilities) A measure of reserves available to the organization-net worth. Indicates good financial health, however if very high organization could look too rich. Organization is not in good financial standing.
Ratio of net assets to total expenses. Organizations should strive for a ratio of 50 to 100 Again measures overall financial health of the Organization Low indicates Organization should increase retained profits or poor financial health.
Current ratio (ratio of current assets divided by current liabilities) Ratio should be 1.5 to 3.00 times. Indicates if Organization has proper working capital to finance operations. Organization has good working capital to meet immediate needs of the operation. Organization may have inadequate cash and working capital to finance the operations.
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Financial Ratios For Nonprofits
FINANCIAL RATIO   MEANING IF HIGH IF LOW
Statement of Activities      
Excess of revenues over expenses Indicates if operations are profitable. Operations are profitable. If too high Organization may not be providing all services it could. Unprofitable operations will lead to financial difficulties if continued.
Comparison to budget Assesses the Organizations ability to plan. Should be close to budget. Should be close to budget.
Ratio of supporting expenses to total expenses Measures efficiency of Organization how much of the funds are used for support of the Organization. A ratio under 25 is good. A measure that funds are not being used to support mission of the Organization Indicates operational efficiency
Investment income to total investments. Gauges effectiveness of investment management. Could indicate too much risk. Organization may not be generating as much income as possible from investments.
Ratio of fundraising expenses to contributions and funds raised. Efficiency in raising money. Fundraising efforts may be inefficient. Indicates efficient fundraising effort, however if too low could indicate lack of aggressive fundraising.
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Sample Report to Management

• Net assets/expenses 77.6 - 54.9
• Months of expenses in
• net assets less property 3.9 - 3.4
  months
• Current ratio 6.84 - 4.08 to 1.00
• Return on investment 41.5 - 20.9
• Profitability to revenues 18.5 - 8.7
• GA to total expenses 16.8 - 16.7
• Fundraising to total expense 0.3 - 2.1
• Fundraising efficiency 1.3 -
  22.7
• Revenue growth 12.3 - 5.5
• Increase in revenues 920,385 - 387,712
• Expense growth (reduction) .2 - (1.3)

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Presenting Financial Statements to Boards,
Members and Management.
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Myth Busting

• Nonprofit

• No Profit

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Interpreting Financial Results for Management

• Understand that 90 if your audience panics when
  reviewing columns of numbers.
• Use tables and graphs when practical.

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Sample Chart Report
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Sample Table Report
HOURS WORKED COMPARED TO BUDGETED HOURS FOR THE
YEAR

  Program 1 Program 2 Program 3 Program 4 Program 5 Program 6 Program 7 Program 8 Total
Hours Worked 6,039.35 8,463.99 13,289.88 15,408.01 17,646.55 6,572.92 7,018.64 6,183.03 74,439.34
Budget hours 6,377.54 9,634.15 11,847.23 15,472.15 18,848.31 7,409.77 5,120.77 6,438.92 74,709.92

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Sample Graph Report
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Overview - Statement of Financial Position

• Liabilities
• (Amounts owed to outside creditors)
• Net Assets

• Assets
• (Resources of the Organization)

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Overview-Statement of Financial Position

• The Statement of Financial Position is a
  represents asset, liabilities and net assets in a
  point in time.
• Assets increase of decrease as resources are
  obtained, or disposed of, become less valuable,
  or become used up in the course of operations.
• Liabilities increase or decrease as obligations
  are incurred or liquidated. In some cases,
  liabilities may need to be estimated and are
  subject to adjustment in latter periods.
• Net Assets increases or decreases primarily as a
  result of income or loss from operations of the
  organization.

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Overview-Statement of Activities

• Revenues (or support)
• - Expenses
• Program Services
• Supporting Services
• Net increase in net assets
• Net assets, beginning of year
• Net assets, end of year

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Overview-Statement of Activities

• Program service expenses include expenditures
  incurred for activities in accordance with the
  organization mission.
• Supporting services expenses include management
  and general and fund-raising expenses.
• Changes in temporarily restricted net assets
  include restricted contributions and restricted
  investment income less amounts spent in
  accordance with donor restrictions.
• Changes in permanently restricted net assets
  include donor restricted for endowment
  contributions.
• Increase in net assets is the all-inclusive
  bottom line that reflects all financial
  activity by the organization for the report
  period (month, quarter, year).

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Overview-Statement of Cash Flows

• Cash provided by operations
• /- Cash provided or used by investing
  activities
• /- Cash provided or used by financing
  activities
• Net increase (decrease) in cash
• Cash, beginning of period
• Cash, end of period

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Overview-Statement of Cash Flows

• Operating activities include the cash effects of
  essentially all transactions that are the result
  of basic operations of an organization.
• Includes the increase (decrease) in net assets
• Changes in accounts receivable, accounts payable
  and deferred revenues.
• Investing activities include the purchase of
  property and equipment, or proceeds from the
  disposition, and also includes investments
  activities and other long-term assets.
• Financing activities include the borrowing and
  repayment of debt, as well as the receipt of
  endowments.