Regardless of whether you’re new to the nonprofit world or an experienced industry leader, navigating financial statements can be challenging.
When you first think of financial statements, your mind might jump to the standard balance sheets, income statements, and cash flow statements typically used by for-profit organizations.
Nonprofit accounting uses similar statements, although there are many subtle differences that are important to bear in mind.
Nonprofit financial statements paint a comprehensive picture of the activities and operations of the nonprofit. By reading them, board members, donors, industry watchdogs, and other interested parties can judge the performance of the nonprofit, viewing details on everything from liquidity to the effectiveness of fundraising efforts.
Recent years have seen the greatest changes to nonprofit accounting statements in decades, with new requirements that govern how statements are presented. Accounting Standards Updates (ASUs) issued by the Financial Accounting Standards Board have additional implications for nonprofits.
Understanding the purpose, scope, and intricacies of each type of nonprofit accounting statement is key to success. Many misconceptions exist in this area, but to deliver accurate, transparent financial statements and returns, you must have a comprehensive understanding of the nonprofit accounting process.
There are four major nonprofit accounting statements:
These statements are relatively consistent across different types of nonprofit organizations, although some nonprofits may be required to produce additional reports, statements, or disclosures.
The statement of financial position serves a similar purpose to the balance sheet of a for-profit organization. The statement lists the assets and liabilities of the nonprofit and shows the net assets of the organization.
However, the details of these assets and liabilities are different from those found in a conventional balance sheet. While a nonprofit’s assets will include standard line items such as cash and accounts receivable, it will also contain more complex assets such as donor or board designated endowments
The net assets section of the statement tells the story and should delineate donor-restricted assets from non-restricted assets. Donations are often made for a specific purpose: to fund research or open a new exhibit, for example. Specifying that these assets are donor-restricted is crucial to the veracity of your financial statements.
Nonprofits occasionally fail to account for these restrictions and later encounter problems when they unintentionally use restricted funds for a different purpose. Doing so runs the risk of upsetting donors and can cause issues with the audit process. To ensure accuracy, automate this process within your accounting system. A reliance on manual processes significantly increases the possibility of errors.
The statement of activities reports the revenue, expenses, and net assets of the nonprofit. These statements can be considered analogous to a for-profit organization’s income statement.
Much like the statement of financial position, the statement of activities must distinguish restricted funds from unrestricted funds. It should also break out distinct categories of revenue and expenses. Common revenue categories include earned revenue and donor contributions, while expenses are typically split into program and non-program expenses.
One recent development affecting these statements is ASU 2020-07. This update, which took effect for June 30, 2022 year-ends, states that nonprofits must present nonfinancial assets, commonly known as gifts in kind, as a separate line item on their statement of activities.
The statement of functional expenses serves as an indicator of how effectively the nonprofit is allocating funds toward advancing its mission. Expenses are typically categorized as program or non-program related.
Ideally, approximately 70% or more of expenses should be program expenses. These are expenses such as research and education that directly support the mission of the nonprofit. The remaining 30% or so of expenses are supporting expenses such as management and general or fundraising expenses. Categorizing expenses in this way allows the stakeholders of the nonprofit to determine how effectively the organization allocates its funds to support their programs.
Defining whether an expense is a program or support expense is rarely a black and white issue. Allocating these costs proportionally demands the expertise of specialized nonprofit accounting professionals.
Cash flow statements show the sources of the cash being received and spent by the nonprofit. They are typically broken into three categories: operating activities, investing activities, and financing activities. Each of these categories is broken down further into individual line items.
Cash flows from operating activities include income from fundraising activities and business operations such as ticket sales.
Cash flows from investing activities include the purchase and proceeds of any investments, properties, or equipment.
Cash flows from financing activities include line items such as income generated by issuing bonds and payments made towards debt. Cash flows from financing activities could also include cash received to support a capital campaign.
These four financial statements are critical to the long-term success of any nonprofit and it’s vital they are fully accurate. Each statement exists to hold the nonprofit accountable. Many industry watchdogs rate nonprofits according to their transparency in the publication of these financial statements.
For those in a senior leadership role at a nonprofit, it’s important to acknowledge that these accounting statements tell a story. Those who read the statements use them to assess the performance of the nonprofit and ensure donor funds are wisely spent. Each statement, and any accompanying disclosures, convey all kinds of information, from the liquidity of the organization to the effectiveness of the fundraising team.
Ensuring complete accuracy in these statements requires a robust financial infrastructure and support from specialized nonprofit accounting professionals. Nonprofit accounting has complex areas, and there are many nuances that must be considered during the preparation of these statements.
At Smith + Howard, our nonprofit accounting professionals have extensive experience preparing financial statements for nonprofit organizations, and can also provide support with audit, tax, and other accounting requirements.
To learn more about working with Smith + Howard, contact us today.
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