Financial reporting for non-profit

organizations
Armee Jay L. Cresmundo, BSA, CPA
Kelvin Jaluag Culajara, BSA, CPA
Assistant Instructors
School of Management and Accountancy
The importance of financial reporting
• Directors have fiduciary responsibilities to take steps to ensure that
funds are spent in accordance with donors’ or funders’ criteria, that
statutory obligations are fulfilled (such as payroll deductions to be
remitted to the BIR, SSS, Pag-ibig, Philhealth, etc.)
• A board can delegate the work to prepare financial information, but
the board as a whole is ultimately responsible for financial reporting.
• The ultimate responsibility of the board is stewardship of
organization’s resources (i.e. to protect the NPO’s assets and oversee
its financial affairs).
The importance of financial reporting
• Financial statements are the primary means of communicating
information about the organization’s financial position (at a certain
point in time) and financial results of its operations (over a period of
time).
• Financial reporting is not the job of the auditor.
Different financial statements
• Statement of Financial Position (sometimes called the Balance Sheet)
• Statement of Operations (sometimes called the Income Statement or
the Income and Expenditure Statement)
• Statement of Changes in Net Assets
• Statement of Cash Flows
• Notes and disclosures
Different financial statements
• But the statement of operations is commonly prepared first before all
the other financial statements.
Statement of financial position (balance sheet)
• The Statement of Financial Position (or Balance Sheet) shows an
entity’s financial position, that is, its assets, liabilities, and net assets.
• Assets are the resources of the NPO (like cash, short or long term
investments, buildings, furniture and vehicles, etc.)
• Liabilities are the debts of the NPO.
• Net assets are the portion of the assets which are self-financed by the
NPO. Alternatively, net assets are portion of the assets which are not
taken from debts.
The accounting equation

Assets = liabilities + net assets

ASSETS
• Assets are the resources of the NPO (like cash, short or long term
investments, buildings, furniture and vehicles, etc.)

CURRENT ASSETS – these are assets that are in the form of cash or expected
to become cash within the coming year. Examples are cash, accounts
receivable, and short-term notes receivable.

NON-CURRENT ASSETS – these are assets that are not expected to be

converted to cash within a year. They can either be materialized for more
than one year, or they have a life for more than one year. Examples include
long-term investments, furniture and fixtures, building, land, etc.
liabilities
• Liabilities are the debts of the NPO.

CURRENT LIABILITIES – these are debts that have to be paid within the
year. These may include accounts payable, or short-term notes payable.

NON-CURRENT LIABILITIES – these are debts that have to be paid at a

date more than one year. These may include long-term loans payable,
or long-term notes payable.
Net assets
• Net assets are the portion of the assets which are self-financed by the
NPO. Alternatively, net assets are portion of the assets which are not
taken from debts.
• Also called as working capital. This is another way of assessing the
organization’s ability to pay its bills as they come due.
Statement of operations (or income statement)
• This statement reveals the results of the entity’s operations during a
given period. A profit generally suggests that the company is
operating well and is able to grow its capital. A loss generally suggests
otherwise. A zero profit or loss suggests that the company is
operating at break-even with no profit or loss.
• It summarizes the revenues and expenses over a period of time.
• Normally, the statement of operations already include the changes in
net assets.
revenues
• These are the amounts recorded by the organization associated with
increases in economic resources related to its operating activities.
Examples are grants from governments or foundations, contributions
and donations, tuition and miscellaneous fees, etc.
• Colleges and universities should recognize revenues on the accrual
basis.
Special types of revenues
• NPO organizations often receive donations from their supporters. The accounting
term for donations is contributions.
• Contributions are a type of revenue unique to NPOs. It is a non-reciprocal
transfer. This means that the donor does not receive anything in exchange for the
contribution.
• There are three (3) types of contributions:
• A restricted contribution – subject to externally imposed conditions specified
by the donor;
• An endowment contribution – type of restricted contribution specifying that
the resources contributed be maintained permanently.
• An unrestricted contribution – contribution has no externally imposed
conditions.
expenditures
• These are the amounts spent by the NPO in its operating activities.
Examples are salaries, rent and office supplies. Also included in
expenditures is “depreciation” of capital asset.
• Expenses should be recognized on the accrual basis.
Net revenues
• This is the difference between total revenues and total expenses. A
positive number reflects an operating surplus, whereas a negative
number means an operating deficit.
Statement of changes in net assets
• Presents an increase or decrease in the entity’s capital out of the
earnings or losses during a given period.
• This shows the accumulated wealth of the entity over the years.
Statement of changes in net assets
• There are certain instances where the statement of operations are
merged with the statement of changes in net assets. This combined
statement is what we call the statement of activities.
Final considerations in financial reporting
• Determine your reporting period.
• Include a Statement of Management’s Responsibility for your financial
statements.
• Recently the Board of Accountancy issued a resolution mandating the
issuance of Sworn Statement of Financial Statement Preparation. Make
sure to attach such statement in your financial statements.
• Determine whether you are liable for income tax during the period.
• Dominance Test – if more than 50% of your gross revenues comes from
activities not related to the operation of a school, then you are held to
be liable for income tax.
• Certificate of tax exemption by the BIR – currently held by the Court of
Tax Appeals as not mandatory.
Financial statement analysis
The Story of Numbers
• “financial executives are now inclined to believe that numbers, no
matter how neatly presented often aren’t as telling as they could.
What they need to accompany them...is language that can clarify and
connect their meaning survey respondents concurred that both
external and internal reports should offer more than just a barrage of
numbers [nearly 70%] report that narrative analysis is at least as
useful for management as it is for external constituencies.””
• David Owens, CFO Magazine, March 2013
(The full report referenced is “Linking Numbers and Narratives:
Quantitative Reports with Qualitative Analysis.”)
Introduction
• Most businesses have a goal of earning profit for stockholders. Thus,
the financial statements of most businesses are designed to allow
stockholders and others concerned with profitability a means to
monitor the performance of the business in question.
• Universities and colleges ostensibly have an entirely different
purpose. These are institutions of higher learning established
primarily to create and disseminate knowledge. Universities and
colleges receive a significant portion of their funding from donors and
governmental entities. These funds are often given with certain
restrictions and conditions.
Critical Elements
• Review the fundamental concepts and structure of nonprofit financial
statements
• Understand how to analyze this information for your own organization and
be able answer the following questions:
• What is my “bottom line”?
• What is my net worth?
• Why do these matter?
• Improve ability to:
• Articulate financial information to your staff, constituents, board, and potential
funders
• Make decisions that strengthen your organization’s financial health and support
effective program delivery
What can we learn from the Income
Statement?
• Revenue Dynamics
• Where does the organization’s money come from?
• Is it reasonably diversified or at risk?
• Do revenue streams appear reliable / consistent?
• Cost Dynamics
• What does the organization spend on operating activities?
• Are expenses adjusted in line with revenue changes?
• Note: Statement of Activities will not present expenditures on capital items or debt
principal repayments.
• Profitability and Savings
• Does the organization cover its costs?
• Are surpluses sufficient to meet balance sheet obligations?
• Is the agency saving? If so, is it enough?
Appreciating Depreciation
• Every fixed asset purchased will depreciate over its useful life
• Accountants use pre-determined useful life data for various types of fixed assets.
• By definition, fixed assets are “capitalized” (i.e., appear on the balance sheet and are
depreciated on the income statement as a non-cash expense)
• Reflects concept that fixed assets lose value over time
• Arguably an approximation of how much surplus cash needs to be set aside
(or raised through a campaign) for replacements
• Full costs include:
• Total operating expenses
• Depreciation expense
• Debt payments
• New capital investments
• Savings for the future
What can we learn from the Balance Sheet?
• What you ‘own’ vs. what you ‘owe’ and the net result
• The balance sheet reflects everything that has happened to
• your organization up and until that point
• The cumulative impact of the circumstances that surround you and
the decisions that you make
• It indicates your ability to manage risk or pursue new opportunities
Managing Risks
• Economic environment risk
• Funding shifts and cutbacks
• Audiences reduced ability to pay
• Field-wide risk
• Demographic shifts
• Changes in audience engagement/participation
• Technology advances and expectations
• Artistic risk
• Artistic success may not translate into profits
• Commercial success may require artistic compromise
The Balance Sheet: Revealing Strength and
Ability to Absorb Risk
• Several “tools” on your balance sheet are key to assessing financial health
and ability to absorb risk
• Cash: How much? Is it restricted?
• Receivables: Are they slow to collect? Non-existent?
• Property & Equipment: Is the organization investing in its fixed assets?
• Debt: Does the organization owe more than it owns?
• Line of Credit: How is cash flow managed?
• Net Assets: Are they restricted? Do temporarily restricted net assets best
support core programs? Are unrestricted net assets liquid?
• Reserves: Do they exist? What are board policies concerning the use of
reserves? Are reserves suitable to the agency’s needs?
How to Assess Financial Performance
• Common-Sizing Financial Statements
• Trend analysis
• Comparisons in Relation to Budget
• Key Financial Ratios
• Peer Benchmarking
Common-Sizing Financial Statements
• To become familiar with an organization’s emphasis, it is helpful to
determine how its resources are distributed. This can be
accomplished through common sizing, i.e. converting to percentages,
several financial statements.
• The Statement of Financial Condition is generally divided by total
assets, the Statement of Activities is divided by total revenues, and
the Statement of Functional Expenses is divided by total expenses.
Common-Sizing Financial Statements
• Insights:
• Asset Concentrations – can help identify the resources available to deliver
future services. Missing from this analysis is the value of a nonprofit’s staff or
any internally developed expertise.
• Revenue Concentrations – one can assess a non-profit’s reliance on different
forms of revenue, see if this reliance has shifted over time, or if it has a
substantially different profile from some if its industry peers.
• Expense Concentrations – can reveal the nature of the production function
needed to run organization. For example, how important are personnel costs
relative to total costs; does the organization provide indirect services through
giving grants to others or does it provide the services directly.
Trend Analysis
• For this approach, at least three years of financial information is required.
The annual growth rates in important accounts such as program expenses,
support services, total revenues, cash and compensation are computed.
• Generally, stakeholders look for positive and sustained growth in these
categories with program expenses growing as fast or faster than support
services or compensation. If this is not occurring, it may be that the
organization had previously underinvested in compensation or support
functions, or it may be an indicator that management is inefficient or is
being excessively compensated or accepting perquisites, such as an
expense account. If revenue growth consistently exceeds program service
growth, it may be an indication that the organization is strengthening its
long-term financial health or that it is not sufficiently expanding its
programs.
Comparisons in Relation to the Budget
• Another method of assessing an organization’s performance is to
compare its reported financial information to its budget.
• Most nonprofits undertake an annual budgeting process that entails
developing budget projections for the following year, obtaining the
approval of the board for incurring the anticipated expenses, carrying
out its operations, and then reporting to the board on its
performance for the year.
• The annual budget is not a formally disclosed document, but board
members and selected donors can receive copies.
Key Financial Ratios
• Resource Management Ratios
• Personnel Cost Ratio – (wages, taxes and benefit expenses)/(total expenses)
• Percentage of budget used for staff and benefits. Personnel is usually the largest cost.
• Fundraising efficiency – (contributed income)/(fundraising expense)
• Average peso of contributions raised from each dollar spent on fundraising activities.
• Program Service Efficiency – (program service costs)/(total functional
expenses)
• Funds spent for program expenses compared to all expenses.
Key Financial Ratios
• Profitability Ratios
• Return on Investment – (Investment income)/(average investments)
• Gross Margin – (sales of merchandise – cost of goods sold)/(sales of
merchandise)
• Margin on Rental Activities – (rental revenue – rental expenses)/(rental
revenue)
Key Financial Ratios
• Liquidity Ratios
• Current ratio – (current assets)/(current liabilities)
• This ratio evaluates the organization’s ability to meet short-term demands.
• Net Working Capital – Current Assets - Current Liabilities.
• This is an alternative method of assessing a nonprofit’s ability to pay its short-term obligations.
• Days Cash on Hand – (cash and cash equivalents)/(avg. monthly expenses)
• Assuming that the organization stops receiving revenues, this measures gives a sense of how many
months a nonprofit can continue to pay bills. It has been suggested that having at least, three, if not six
months of cash on hand is desirable.
• Defensive interval – (cash + securities + receivables)/(avg. monthly expenses)
• Indicator of how long an organization’s cash reserves will last if no additional funds are received.
• Conversion accounts indicator – (PPE – unrestricted N.A. + accounts payable) / (avg. monthly
expenses)
• A cautious indication of the number of month(s) expenses can be paid through use of existing assets.
Key Financial Ratios
• Solvency Ratios
• Viability ratio – expendable net assets (including unrestricted and temporarily
restricted net assets)/long-term debt
• This ratio indicates a not-for-profit's relative liquidity or its ability to cover its debt. It serves as
a basic indicator of financial strength because it measures the availability of cash and other
liquid assets to meet the organization's financial obligations.
• Debt to Assets – (total debt) / (total assets)
• A high value indicates problems with liquidity or reduced capacity for future borrowing.
• Net Asset Total – (net assets) / (total expenses)
• A comparison of the overall equity of an organization in relation to annual expenses
• Temp. Res. Net Assets – (temporarily restricted net assets) / (cash + investments +
pledges)
• Useful in determining if an organization is spending restricted cash for unrelated purposes.
Non-financial measures
• Don’t forget about non-financial measurements as well!
• Donors
• Board members
• Employees
• Volunteers
• Service area / market share
• Other mission related measurements
• Very important to factor in non-financial aspects of the organization
when analyzing financial measurements
Peer Benchmarking
• Two non profits teach the same skills, are the same size and age, and
are located in similar areas. The only real differences are:
• Organization B provides more intensive training on how to be a
valuable employee (office etiquette, problem solving, effective
communication) than Organization A
• Organization B sponsors support groups for clients who have made
the transition from welfare to the working world
Peer Benchmarking
Peer Benchmarking
• Benchmarking a firm against a peer can lend perspective to the
analysis.
• Several attributes should be considered when searching for an
appropriate benchmark. Often computing an average of three to four
organizations will create a benchmark that is not overly volatile. The
peers should be roughly comparable in mission, industry
classification, and size.
Why Benchmark?
• Because numbers are meant to be compared!
• Because the most effective measures of financial health represent
relationships!
• As a way to share and collaborate, stimulate conversation and reflection,
and take pulse of environmental trends.
• To get what you want!!!
• Benchmark when you want to...
• Compare like attributes from similar organizations
• Make better-informed decisions
• Answer the question “how do I compare?”
• Take pulse of your financial health
• Obtain a single version of the truth
Summary
• Reliable, accurate and timely financial data is a first step to “owning”
your numbers and telling your story.
• Even with good data, it is important to know what to look for (e.g.
indicators that reveal the degree or risk an enterprise can tolerate,
given its future plans and goals).
• Key stakeholders need to have a common understanding of your
financial story. Remember: it is the health of your enterprise that
supports or jeopardizes the success of your programs.
• Ask questions often!