Reading and understanding nonprofit financial statements is essential for making sound decisions about your organization’s future. If you’ve never read one before, they can be daunting documents.
This step-by-step guide will teach you everything you need to know about reading nonprofit financial statements. By the end, you’ll be able to confidently analyze your organization’s financial health and make informed decisions about where to allocate its resources.
To make informed financial decisions, nonprofit leaders should learn to read and understand their financial statements and reports. The nonprofit’s financial statements help you understand the organization’s current financial standing and predict its future. In other words, if you know your data on revenues, expenses, and changes in assets, you will be able to assess the performance of your nonprofit and identify where you can improve for a stellar performance. In today’s podcast, Joseph Scarano from Araize and Stephen Halasnik from Financing Solutions discuss how to read a nonprofit financial statement and report.
What are nonprofit financials?
Nonprofit financial statements are important because they provide an accurate report of the organization’s financial health and progress. They allow for informed decisions on how to allocate resources, as well as help with audits and compliance. Accrual accounting is used to provide more accurate data about any changes in finances over time, allowing for informed predictions of future performance. The statement of financial position (SOFP) includes assets, liabilities, and net assets which can be compared to industry standards or year-on-year results to assess overall performance.
Key Steps for Reading Financial Statements
Step 1: Review the Statement of Financial Position (Balance Sheet)
The Statement of Financial Position, also known as the Balance Sheet, is a report that provides a snapshot of a nonprofit organization’s financial health. It is more accurate if the organization uses an accrual method of accounting and reports three main sections: assets, liabilities, and net assets. The statement shows how much money has been brought in by the nonprofit and how much has been spent on expenses. It also breaks down revenue and expenses by restrictions on when or how they can be used. This information helps answer the important question: “Did we bring in more money than we spent?”
Step 2: Analyze the Statement of Activities (Income Statement)
To understand a nonprofit’s financial health, it is important to read and interpret their Statement of Activities. This report provides information on how much money the nonprofit has earned and spent during a certain time period. The main sections of the Statement of Activities are Revenue, Expenses, and Change in Net Assets, which can be analyzed to answer the question: “Did we bring in more money than we spent?” The Statement of Activities provides transparency and accountability for those interested in understanding the financial status of a nonprofit organization. It should be read alongside other financial statements for an accurate assessment.
Step 3: Calculate the Statement of Functional Expenses
Calculating the Statement of Functional Expenses requires categorizing expenses according to functional area. These areas include management and administration, fundraising, and programs. In order to accurately calculate the statement of functional expenses, it is important to include all costs associated with each area in order to get an accurate total. Once these costs are accounted for, they can be summed up into one total which will provide a view of how much each area is costing the nonprofit organization.
Step 4: Examine the Statement of Cash Flow
The Statement of Cash Flow is important in understanding the financials of a nonprofit organization because it shows how much cash is available to pay expenses. It details the sources of cash (such as revenue and borrowing) and what it was used for (such as investing, operating, or financing). This statement allows investors and donors to assess whether the nonprofit has adequate resources to meet its obligations.
Step 5: Calculate the Change in Net Assets
The Change in Net Assets section of the Annual Report is significant because it provides an easy way to see if a nonprofit’s revenues and expenses are balanced. If the net assets are going down, then it indicates that the organization is spending more money than it is bringing in, which could be a sign that something needs to fix.
Step 6: Analyze the Revenue and Expenses
Analyzing revenue and expenses in a nonprofit financial statement is essential for understanding the financial health of the organization. It helps to answer questions about income and spending trends and provides insight into how much money is being spent on programming activities versus management and fundraising activities. Additionally, it can be used to identify any unusual increases or decreases in expenses and determine whether they are reasonable.
Step 7: Understand the Generally Accepted Accounting Principles (GAAP)
The Generally Accepted Accounting Principles (GAAP) are important for nonprofit organizations because they ensure that financial statements are transparent and easily understandable. The GAAP also help to provide a consistent set of standards, so that all organizations can accurately compare their results with others in their industry. By understanding the GAAP and how it applies to nonprofit financial statements, nonprofits can better ensure accurate and reliable reporting in order to remain accountable to those who depend on them for services.
Step 8: Understand the 501(c)(3) rules
The 501(c)(3) rules are important for nonprofits to understand when reading and interpreting their financial statements. These rules require a nonprofit organization to be recognized as tax exempt under the Internal Revenue Code, and they provide guidelines on how a nonprofit should conduct its operations. The federal government requires that the nonprofit file an annual return with the IRS in order to maintain its tax-exempt status, as well as potentially file audited financial statements with the IRS if it meets certain criteria. Additionally, state governments may have their own requirements regarding taxes or other filings that must be met by nonprofits in order for them to remain in compliance. Understanding these regulations will help nonprofits ensure their financial health and abide by necessary regulations when preparing and presenting their financials.
Actionable Insights Gained from Reading Financials
1. Revenue and expenses
Analysis of a nonprofit’s revenue and expenses can reveal trends in the sources of their income, such as donations, grants, or earned income. It can also show the breakdown of restricted vs unrestricted revenue and spending associated with special events. Additionally, any excess or deficiency in funds can be determined by subtracting expenses from revenue, which will be reflected in the Net Asset Balance.
2. Changes in net assets
It is important to monitor changes in a nonprofit’s net assets in order to assess the organization’s overall financial health and stewardship responsibilities. By looking at the Statement of Activities every month, it becomes easier to identify trends and shifts in sources of revenue, expenses, and changes to net assets. Such monitoring can help identify potential problems early on so that necessary steps can be taken for correcting them before it is too late. Doing this allows nonprofits to stay financially viable and achieve their long-term objectives.
3. Cash flow
Cash flow is an essential measure of a nonprofit’s financial health. It shows the total amount of cash that has been received and spent over a specific period of time. Reviewing a nonprofit’s cash flow statement can provide insights into its operations, allowing one to identify potential areas for improvement or risks that need to be managed. By understanding the sources and uses of cash, nonprofit managers can make better decisions about how best to allocate resources in order to maximize their impact. This step-by-step guide will provide an overview on how to read a nonprofit financial statement and interpret its associated cash flow data.
4. Assets and liabilities
Assets and liabilities are important components of a nonprofit’s financial statements as they provide an indication of the organization’s financial position at a given point in time. Assets are typically liquid, while liabilities refer to amounts that are due within the year or further out over multiple years. By assessing both assets and liabilities, it is possible to calculate the nonprofit’s net assets which can help determine overall financial health.
5. Overall financial health
Overall financial health is an important indicator of a nonprofit’s ability to manage its resources and meet its goals. It can be measured through various metrics, such as liquidity, which is the ability to convert assets into cash quickly. Understanding a nonprofit’s financial health helps leaders assess their current budget and plan for future investments in order to grow the organization. It also gives them insight into how their decisions may affect the organization’s long-term success and sustainability. By examining past performance and comparing it with industry standards, they can make better decisions regarding spending patterns and strategic initiatives.
6. Major contributors
Major contributors to a nonprofit organization typically include donors, volunteers, influential staff and board members. These individuals provide invaluable support through their donations of both finances and time. By honoring major donors in annual reports, organizations can demonstrate their appreciation for these generous individuals. Furthermore, by allowing major contributors to share their stories and experiences in the report – or on the organization’s website – potential donors can be inspired to get involved as well. As such, recognizing those who have helped make a nonprofit successful is an important part of any annual report.
7. Donors’ accomplishments
Donors want to see their donations used effectively and they appreciate stories that highlight the impact of their contributions. They also want to be thanked for their support, featured in annual reports, and have the opportunity to share why they support a given organization. Furthermore, donors want to know how their money is being used and what impact it has had on the organization’s achievements. Nonprofits should showcase the accomplishments of both small and major donors in order to demonstrate appreciation for all levels of support.
Keeping an accurate report of your nonprofit’s financial statement can be undeniably daunting, especially when you lack the required skills and have a lot on your plate. However, in recent times, numerous software that nonprofits can readily leverage to help with their finances are out there. For example, FastFund Online has all the tools that help you solve your nonprofit accounting, fundraising, and payroll needs.
Learn More About Stephen Halasnik
Stephen Halasnik is the host of the popular Nonprofit MBA Podcast. The Nonprofit MBA podcast’s purpose is to help nonprofit leaders and their teams. Stephen is the Co-founder and Managing Partner of Financing Solutions, a leading provider of loans for nonprofits in the form of a Line of Credit. Stephen is a best-selling Amazon author and is considered a leading authority on building great, purpose-driven businesses.
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