Understanding Nonprofit Financial Statements: A Guide for New Board Members

Understanding Nonprofit Financial Statements: A Guide for New Board Members

January 20, 2024

Nonprofit organizations, like public companies, rely on sound financial management and transparent reporting to fulfill their mission. However, nonprofit financial statements differ significantly from those of for-profit entities. For board members accustomed to corporate financial reporting, understanding these differences is essential to provide effective governance and oversight. This article breaks down the key components of nonprofit financial statements and highlights their unique aspects.

The Purpose of Nonprofit Financial Statements

Unlike public companies, nonprofits are not focused on generating profits for shareholders. Instead, their goal is to fulfill a mission or provide services for the public good. Nonprofit financial statements aim to:

• Demonstrate accountability to donors, grantors, and other stakeholders.
• Provide transparency about the use of funds.
• Help assess financial health and sustainability.

Key Financial Statements in the Nonprofit Sector

Nonprofits produce four primary financial statements, which parallel but differ in terminology and structure from those of public companies:

• Purpose: Provides a snapshot of the organization's financial position at a specific point in time.
• Key Components:
  • Assets: Includes cash, investments (usually classified as trading), receivables, and fixed assets (e.g., property and equipment).
  • Liabilities: Represents obligations, such as accounts payable and loans.
  • Net Assets: The nonprofit equivalent of equity, categorized as:
    • With Donor Restrictions: Funds restricted by donors for specific purposes or time periods.
    • Without Donor Restrictions: Funds available for general use.

• Purpose: Shows revenue and expenses over a reporting period, illustrating the organization's financial performance.
• Key Differences from For-Profit Entities:
  • For most nonprofits the primary revenue sources include donations, grants, program service fees, and investment income rather than sales revenue.
  • Expenses are categorized by function, such as program services, management and general, and fundraising.

• Purpose: Breaks down expenses by both natural classification (e.g., salaries, rent, supplies) and functional classification (e.g., program, administrative, fundraising). It helps assess how effectively the nonprofit uses its resources to achieve its mission.

• Purpose: Tracks cash inflows and outflows, highlighting how cash is generated and used in operating, investing, and financing activities.

Unique Aspects of Nonprofit Financial Reporting

• Many nonprofit revenues come with donor-imposed restrictions. These restrictions dictate how and when the funds can be used.
• Board members should monitor compliance with these restrictions to maintain donor trust and avoid legal complications.

Nonprofit revenue recognition is often the most difficult to comprehend for new board members. Some things to consider as a new board member include:

• Nonprofits must follow specific guidelines for recognizing revenue from contributions and grants, often based on conditions and restrictions.

• Contributions are generally recognized as revenue when they are promised, unless they are conditional. Conditional contributions depend on the occurrence of a specified future event, such as meeting a fundraising target or completing a program deliverable.

• Restricted contributions are recognized as "with donor restrictions" and moved to "without donor restrictions" when the restrictions are satisfied (e.g., funds used for their intended purpose).

• Grants and contracts may be exchange transactions (revenue recognized when services are performed) or contributions (recognized based on restrictions and conditions). It is more common for a government grant or contract to be recognized as a contribution rather than an exchange transaction.

• Proper revenue recognition ensures that financial statements accurately reflect the timing and purpose of funds received. However, the recognition of contributions does not follow the matching principle of when funds are expended. Revenue is generally recognized upfront but may be delivered or expended in a future period.

Conclusion 

Understanding nonprofit financial statements is crucial for board members transitioning from the corporate world. By grasping the unique elements of nonprofit reporting, board members can provide informed oversight, ensure accountability, and help the organization achieve its mission effectively. Regular financial education sessions and collaboration with nonprofit finance professionals can further enhance governance and decision-making.

Contact your Larson & Company advisor for any additional questions you may have on this topic.  Larson and Company has developed a suite of services specifically to serve the needs of companies of all sizes in a wide range of industries.