Nonprofit board members are legally responsible for the oversight of their organization’s finances. Failing to ask probing questions about financial statements is not a defense in the event of financial mismanagement. Therefore, it is imperative questions are asked to ensure effective governance, sound stewardship, and early identification of risk when financial statements are being reviewed and approved.
Statement of financial position
The statement of financial position (also called a balance sheet) summarizes the assets, liabilities and net assets of the organization at a specified date. It’s a snapshot of the organization’s financial position on that date. Important questions to consider when reviewing include:
- How much of the organization’s cash and investments is truly unrestricted and available for operations (i.e., how much is donor-restricted vs. board-designated vs. freely available)?
- What portion of net assets carries donor restrictions that limit how and when those funds can be used? Are restricted funds only being spent for their intended purposes?
- What is the trend in net assets over the past three to five years? Is financial strength being built or eroded?
- What is the quick ratio ([current assets – inventories]/current liabilities)? Is it above 1? If not, are near-term obligations being managed appropriately?
- What is the debt ratio (total debt/total assets)? Is it 1 or less? If not, are there any liquidity problems?
Statement of activity
The statement of activity (also called an income and expense statement) reports the organization’s financial activity over a period of time. It shows income minus expenses, which results in either a profit or a loss. Important questions to consider when reviewing include:
- Did the organization operate at a surplus or deficit this period? If a deficit, is this planned or unexpected, and is there a plan to address it?
- How do actual revenues and expenses compare to the approved budget? What drove the largest variances?
- Is revenue diversified, or is the organization heavily dependent on one funder or revenue stream? What is the risk if that source declines?
- How is grant revenue recognized (i.e., at the time the grant is awarded, or as conditions are met)? Are there any grants the organization is at risk of not fulfilling conditions on?
- Are there any one-time or non-recurring items in this period’s results that should be excluded when evaluating underlying operating performance?
- What is the program expense ratio (program expenses/total expenses)? Is it trending in the right direction?
- Are administrative and overhead costs appropriate and well-controlled? Have there been any unexpected cost increases in key expense categories like compensation, occupancy, or professional fees?
Statement of cash flow
The statement of cash flow summarizes the resources that become available to the organization during the reporting period and the uses made of such resources. It’s especially useful in real-time because it reports income that has been received and expenses that have been paid. A statement of projected cash flow is helpful for the board and organization to be able to anticipate any shortfalls for planning purposes. Important questions to consider when reviewing include:
- Is cash flow from operations positive? If the organization reported a surplus but operating cash flow is negative, why? What is consuming cash?
- How much restricted cash does the organization hold? Is any of it being used (intentionally or inadvertently) to fund unrestricted operations?
- How many months of operating expenses are currently in unrestricted, liquid reserves?
- Is the organization funding operations from investing or financing activities rather than operating activities? If so, is that sustainable?
- Have there been any significant capital expenditures this year? Were they planned and budgeted, and how are they being financed?
- Does the organization have a line of credit? Has it been drawn recently? What are the terms and covenants?
Statement of functional expenses
The statement of functional expenses reports all expenses as related either to program services or to supporting services. Expenses under program services are shown divided among the various programs. Expenses under supporting services are generally divided between (1) management and general expenses and (2) fundraising expenses. Important questions to consider when reviewing include:
- What methodology is used to allocate shared costs (i.e., salaries, occupancy, technology) across functions, and is it reasonable, consistently applied, and documented? Is the allocation methodology periodically reviewed to still reflect actual staff/resource use?
- How is the executive director’s/CFO’s time and compensation allocated? Is it supported by time studies or is it an arbitrary estimate?
- How do functional percentages compare to prior years and do shifts reflect real operational change versus a methodology change?
- Do joint costs (such as fundraising combined with education/program activities) meet the criteria for allocation between fundraising and program, rather than being classified entirely as fundraising?
- Could any costs currently in management and general reasonably belong in program services (or vice versa), given the direct effect on the program expense ratio?
Nonprofit board service is one of the most meaningful ways individuals can contribute to the organizations they care about. But the fiduciary responsibility it carries requires more than attendance and good intentions. Financial statements are the primary instrument through which a board monitors organizational health, detects risk, and fulfills its duty of care. Asking questions about the financial statements helps to ensure that fiduciary responsibility is met.
Please contact the professionals at Gilliam Bell Moser if you have any questions.
