Interpreting nonprofit financial statements: here's help in assessing your association's fiscal health.
As a board member, one of your primary responsibilities is to ensure that the association's funds are used in an efficient and effective manner. The mission of a nonprofit organization is not to earn excess funds for the benefit of investors but to provide members with beneficial programs and services. Proper financial management of a nonprofit organization also requires attention to a reserve fund (fund equity), which provides protection should the association's revenues drop or expenses increase unexpectedly.
As a volunteer leader, it's best to begin by understanding what is expected of you.
1. Review the association's bylaws. Pay special attention to areas that relate to the association's financial reports: budgeting and reporting, auditing, check signing, establishing reserves, and reviewing financial procedures.
2. Ask for a copy of the association's financial procedures manual.
3. Ask for copies of the association's audited statements for the past five years along with the management letters pertaining to each of these statements.
This may sound like a great deal of material to review, but you will find that you'll focus on a few basic items. Above all, don't hesitate to ask questions at any time. Your association staff and other volunteer members will certainly appreciate your interest in the association's financial stability.
Financial statement review
You need to regularly review three financial reports. If your association provides additional statements, ask your chief staff executive to outline their benefits and how they tie in with these basic financial reports.
1. Balance sheet. This statement provides the association's financial position as of a certain date. The balance sheet includes a summary of the association's current and fixed assets, along with current and long-term liabilities. Also included on the liabilities side is the association's fund equity, similar to the for-profit corporation's retained earnings.
The difference between fund equity and retained earnings reflects the perceptive difference between for-profit and nonprofit status. A for-profit corporation is in business to make money for the organization's investors, whereas the nonprofit corporation exists to provide services and benefits to the association's members. Your association is successful when you have sufficient reserves in your fund equity and are using members' dues in the most efficient and effective manner.
2. Revenue and expense statement. This financial reporting tool reflects the association's revenue and expenses recorded during a specific period. The revenue and expense statement needs to clearly reflect revenue and expenses for each program, separating these but including an overall summary.
Associations are now required by the Financial Accounting Standards Board's Generally Accepted Accounting Procedures to track employee time and overhead costs spent on each association program. The association needs to have methods of tracking employee hours on programs, along with a percentage calculation of the overhead costs such as rent, utilities, general insurance, salaries, and audit and legal fees that need to be allocated to each program.
Your association's financial statement records its revenue and expense on either a cash or accrual basis, and this determines whether the statement is reflecting the revenue and expense earned and incurred during a specific period. A cash basis statement reflects income and expense actually received and spent during the period. An accrual basis statement reflects income and expense actually earned and incurred during the period.
For example, with member dues of $1,200 paid in advance for 12 months, a cash statement would recognize the entire sum during the month it was received. On an accrual statement, the income would be spread over the full 12 months, recognizing $100 a month.
An accrual basis statement has additional accounts on the balance sheet, such as deferred revenue and prepaid expenses. Deferred revenue is considered a liability because it represents services and benefits owed individual members during future periods. Also, prepaid expenses are considered assets because they represent products or services paid in advance.
3. Cash flow statement. This report is perhaps one of the most important tools for planning the future expenditures of the association. Cash flow analysis provides projected actual revenue and expenses during the upcoming months, along with funds projected to remain at the end of each month.
This statement allows management to plan future programs and association investment strategy. The period of this statement needs to be at least 12 months. Note: The cash flow statement is based on cash received and spent; therefore it will not be easy for leadership to exactly match this statement with the revenue and expense statement.
Yearly and quarterly analysis
The following ratios and comparisons are merely suggestions for review by the volunteer leadership. Your association may have additional ratios and trends that are reported upon regularly. At least a five-year analysis of the ratios is beneficial for your understanding of the association's historical financial management.
Balance sheet ratios and comparisons:
* Fund equity (see graphs A and B). Graph A reflects a sample of an association's fund equity level on a yearly basis. Graph B reflects the fund equity level on a quarterly basis. The graph of yearly trends provides a quick review of the historical level of the association's fund equity. The graph of quarterly trends provides the opportunity to see any cyclical recurrence of high income or expense periods that may increase or decrease the association's fund equity significantly.
For example, associations that bill their members annually and report on a cash basis would find that the quarterly analysis shows a consistently high level in the first and second quarters of the year when most members pay their bills. These graphs give you the opportunity to ask for explanations regarding any significant yearly or quarterly changes.
Your association needs to establish the correct level of its fund equity so that the association has sufficient funds to cover its expenses should the association's revenue drop or expenses increase unexpectedly. A recommended level could be, for example, to have the fund equity equal to 50 percent of the association's total expense budget. This would ensure that the association could meet its expense obligations for at least a six-month period should the association's income completely cease.
* Current ratio. This ratio, which is determined by dividing the association's current assets by its current liabilities, helps determine the ability of the association to meet its financial obligations. For example, if the association's current ratio is 1:1, the association can meet its financial obligations. A ratio of 2:1 means that the association can meet its financial obligations twice with its current assets. A ratio of less than 1:1 indicates the association has liabilities that could not be met by the current assets of the association.
Reviewing this ratio on a yearly and quarterly basis will provide the same information as noted with the fund equity trend analysis. If the current ratio fluctuates significantly within the year, then the leadership needs to be aware of this and plan its investments and purchases accordingly. Note any downward trends in this ratio, as it will reflect the association's weakening financial position.
Revenue and expense ratios and comparisons:
* Member revenue versus total revenue. This analysis is useful for evaluating how much the association depends on its membership dues for income. Look for significant changes from year to year, and determine what services and benefits the association provides that caused the variance.
* Total expense versus total revenue. This yearly trend analysis provides a quick review of the association's stability over the reported period. Question any extreme profit or loss.
* General and administrative expense versus total revenue, and general and administrative expense versus total expense. Monitor general and administrative expense (overhead costs) closely. Find out at what level the general and administrative costs allow for an efficient and smooth-running organization. Resources for comparable association percentages are available through the American Society of Association Executives' financial surveys or by consulting with specialty association financial analysis organizations.
Some key advice
Ask your association's treasurer for these ratios and analyses on at least a quarterly basis. If you see large variances in current ratios from historical trends, ask why. As a volunteer for a nonprofit association, your goal is to use the members' investments wisely. You are a trustee for their money.
Financial reporting mechanisms are merely communication tools for your association to report its historical successes and failures and to show its current position because of this history. As a volunteer leader you will be asked to review this information, along with marketing surveys and industry information, to monitor and safeguard the financial stability of your association.
Categories of 501(c) Tax-Exempt Organizations
You will likely hear references to your association's tax-exempt status. The IRS Code created the 501(c) designations, which include:
* 501(c)(3) - religious, charitable, scientific, public safety, and educational organizations;
* 501(c)(4) - civic leagues or organizations established for the promotion of public welfare;
* 501(c)(5) - labor, agricultural, or horticultural organizations; and
* 501(c)(6) - business leagues, chambers of commerce, and boards of trade that are not organized for profit.
Note: A nonprofit association is required to maintain its nonprofit status by continuing to fulfill its nonprofit mission. If the association provides services and benefits that the IRS does not consider related to the association's nonprofit mission, the association will be required to pay unrelated business income tax, commonly known as UBIT. In extreme cases, an association's nonprofit status may be jeopardized. Consult with your chief staff executive regarding the association's IRS reporting procedures and whether the association's auditor sees a potential problem regarding the association's nonprofit status.
The key reporting document for nonprofit organizations is IRS Form 990. This is not a tax return. It is an information return in which the nonprofit organization informs the IRS of all sources of income, expenses, what the association owns, and what it owes. In addition, a multitude of questions are asked intending to find out whether the organization has acted appropriately under the laws and regulations that govern nonprofit organizations.
Unlike the Corporate Form 1120, the Form 990 is available to the public and the press, so it is important to use the 990 to communicate the good work of the association. And in keeping with the new intermediate sanctions law, associations must make the forms available in a timely manner and charge only nominal fees to cover reproduction and/or mailing only.
If a tax is owed by a nonprofit organization, the tax return used to report this information is the IRS Form 990-T. This document, which is not available to the public, is subject to IRS scrutiny. Both the 990 and the 990-T are usually prepared by an independent certified public accountant and are carefully reviewed by the association's executive management and board.
Judy Durham is executive vice president of the Architectural Woodwork Institute, Reston, Virginia.