Wednesday, January 20, 2010

New to Nonprofit Finance and Accounting: Here's a Brief Overview

This will be the second year that I'll be co-teaching (as a Doctoral Teaching Assistant) the Nonprofit Finance course at University of San Diego. For those of you interested in understanding nonprofit finance here's a brief overview:

The Unified Chart of Accounts was developed for nonprofits to use in their accounting practices. This chart of accounts makes it easier for nonprofits to file their annual 990 tax form.

Introduction nonprofit financial terms (From Nonprofit Principles and Practice - Michael Worth - Chapter 12 Financial Management)

  • Financial Accounting: “financial information published for use by parties outside the organization"
  • Managerial accounting: “information that is useful to an organization’s managers"
  • Bookkeeping: “methods and systems by which financial transactions are recorded”
  • Financial Management: “Planning, directing, monitoring, organizing, and controlling of the monetary resources of an organization.” (From business dictionary)
  • Differences between for-profit and nonprofit accounting
    • Treatment of Restricted Contributions
      • Unrestricted – can use these funds for any expense
      • Temporary Restricted – must use these funds during a specific time period or for a specific use (example: grant related funds)
      • Permanently Restricted – never use these funds (example: endowment- can only spend interest, cannot spend principle).
    • Functional Classification of Expenses
      • Program – all expenses directly associated with a specific program
      • Administrative – expenses not directly associated with a program (example : legal fees, accounting fees)
      • Fundraising – expenses related to engaging in fundraising activities (example: fundraising event, fundraising lunch)
  • Other key nonprofit financial terms: Assets, Liabilities, Net Assets, GAAP, Revenue, Expenses, Net Income. The Nonprofit Finance Fund provides a great glossary of these and other nonprofit financial terms.

Internal controls (From Business Dictionary and Streetsmart Financial Basics for Nonprofit Managers by Thomas A. McLaughlin)

· Definition of Internal Control: Systematic measures (such as reviews, checks and balances, methods and procedures) instituted by an organization to:

    • conduct its business in an orderly and efficient manner
    • safeguard its assets and resources
    • deter and detect errors, fraud, and theft
    • ensure accuracy and completeness of its accounting data
    • produce reliable and timely financial and management information
    • ensure adherence to its policies and plans.

· A good internal controls system will eliminate 3 general conditions present when fraud occurs

o Incentive/Pressure

o Opportunity

o Attitude and rationalization

o More information about internal controls for nonprofits from the Nonprofit Genie & Blue Avocado.

Identifying and interpreting nonprofit financial statements

· There are four main financial statements for nonprofits.

    • Statement of Financial Position a.k.a balance sheet:

· Statement summarizes Assets, liabilities, and net assets of an organization
as of a specific date. (Peters & Schaffer, 2005)

    • Statement of Revenue and Expenses

· Statement reports the financial activity of the organization by function over
a period of time. (Peters & Schaffer, 2005)

    • Statement of Cash Flows

· Cash inflows and outflows of the organization between one date and another.

    • Statement of Functional Expenses (this statement is unique to the nonprofit sector)

§ Shows distribution of costs between three functional categories: Program, Admin, Fundraising

· Papers about nonprofit financial statements here & here.

Key nonprofit financial ratios

· Financial ratios are helpful in assessing the financial health of the organization. The nonprofits assistance fund explains nonprofit financial ratios are useful if they are:

o Calculated using reliable, accurate financial reports

o Calculated consistently from period to period

o Used in comparison to benchmarks or goals

o Viewed both at a single point in time and as a trend over time

o Interpreted in the context of both internal and external factors

Example nonprofit financial ratios:

  • Current Ratio:
    • Current Assets/Current Liabilities
    • For every $1 the organization owes it has ___ cash and receivables.
    • Shows organization’s ability to pay obligations in a timely way (within 12
    • Ideally ratio will be higher, however not excessively high
  • Quick Ratio:
    • Total Cash and Investments/ Total Current Liabilities
    • For every $1 the organization owes it has ___ in the bank. The closer the organization gets to 1: 1 the more precarious it is.
  • Days Cash
    • Cash & Equivalents X 365/Expenses-Depreciation
    • A test of the operating cash
    • Shown as # of days
    • Want to be higher
  • Cash Flow to Total Debt
    • Net income + depreciation/Total liabilities
    • Ideally want higher

· More nonprofit financial ratios are explained by the Nonprofits Assistance Fund

Steps in the budgeting process (From Financial Leadership for Nonprofit Executives by Jeanne Bell and Elizabeth Schaffer)

· A budget is a financial reflection of what a nonprofit business expects to accomplish over a twelve-month period. Key steps in the budgeting process.

    • Define the planning context and goals
    • Estimating Costs
    • Forecasting Income
    • Striking the balance between goals and resources
    • Approving the plan

· Article about nonprofit budgets.

Other Nonprofit finance resources

1 comment:

Alan said...

Nice post Heather, a great introduction and explanation. Thanks for the mention!