Assessing Nonprofit Financial Health
As the calendar turns to December, many nonprofits are reviewing their 2014 results and planning for the new year.
These strategic planning sessions are a great opportunity for nonprofit professionals to evaluate the health of their organization and determine what new investments or operating expenses to prioritize. In our most recent HR Pro Bono Corps webinar, David Greco of Social Sector Partners, provided an in-depth overview of how nonprofit leaders can use their organization’s financial statements to better inform those decisions.
Financial statements such as balance sheets, income statements, and IRS Form 990s are often viewed as the most reliable and accessible data sources for any evaluation of financial performance. But Greco cautions that nonprofit leaders who use these statements for strategic planning should view them through a very different lens than that of their accountant or tax auditor.
Greco provides how nonprofit leaders can analyze their financial results to address two critical questions:
Question #1: Are we staying within our means?
Put another way, did we generate enough revenue (e.g. grants, donations, earned income) to cover our operating expenses (e.g. salaries, program fees, administrative costs).
One of the first places many managers would go for this information is the Statement of Activities (also known as the income statement). In the sample Statement of Activities below, ABC Center has $1.262M in total expenses and $1.016M in total revenue. With - $246M in total change in net assets, this nonprofit appear to be running a deficit. And from an accounting standpoint, they are. But for the purposes of evaluating the operational health of the organization – “are we living within our means” – Greco recommends focusing on the unrestricted column under Operating Activity. By considering the unrestricted revenue – the only dollars that are available to pay for operating expenses – ABC Center has $1.707M in unrestricted revenue to cover $1.262M in expenses, which yields a positive change in net asset or operating surplus of $445M.
By analyzing the figures in the unrestricted column of the organization’s income statement, nonprofit leaders can get a more realistic assessment of the available revenue that can be used to cover its operating expenses.
The second question relates to an organization’s ability to manage risk.
Question #2: Can your organization afford to pursue new opportunities?
When an organization is running at an operational surplus, the Executive Director and Board might consider expanding high-performing programs, hiring more employees, or enhancing their infrastructure. But what are the risks of these new investments? And how much financial cushion should the organization have in place to withstand unexpected expenditures.
The Statement of Financial Position, better known as the balance sheet, provides good visibility into the nonprofit’s ability to handle risk. The balance sheet includes the organization’s assets – everything the organization owns – and its liabilities – everything that is owed to them. The difference between assets and liabilities is the Net Assets or the nonprofit’s net worth.
In evaluating net assets on the balance sheet, Greco recommends zeroing in on the liquid net assets – those that are both unrestricted (accessible today) and liquid (cash or cash equivalents). Managers can then use this figure to calculate the number of months the organization could operate exclusively with cash on hand or availability through a line of credit.
There are no set guidelines on how many months of liquidity the organization should have on hand. 20-25% of nonprofits have between 3-6 months of available cash, and Greco considers this to be a good benchmark. Once the organization falls below 3 months of cash on hand, any delay in funding or unanticipated costs become a catastrophic event. In most cases, having more than 6 months provides an adequate safety net and a good opportunity to consider new investments.
Our webinar on Nonprofit Finance Fundamentals covers these key financial sustainability issues in much greater detail. Greco also provides actionable recommendations on how nonprofit leaders can use financial information to better communicate their strategic priorities and funding needs to their board and supporters. View the full recording along with more than 200 nonprofit resources at no cost on NonprofitReady.org.