A Field Guide to Nonprofit Finances — Part 1: A Look at the Balance Sheet

by Rich Patterson
Director Emeritus, Indian Creek Nature Center
& Patty Weisse
Director Emeritus, Baltimore Woods Nature Center

 

Editor's note: This article was originally published in the Spring 2016 issue of Directions, the ANCA newsletter. Members can access the full issue via the member portal.

 

Nonprofit organizations provide services not available from for-profit or government sectors. People affiliate with nonprofits because they embrace the organization’s mission. Often board members are motivated but unfamiliar with the quirks of nonprofit finance. One of the most important questions every board member should know the answer to is: “Do we have enough money to meet our upcoming financial obligations?”

Understanding the basics of a Statement of Financial Position (sometimes called a Balance Sheet) helps all board members feel more comfortable answering this question.

 
The Legs of Nonprofit Funding

Successful nonprofits have these distinctly different pools of money reflected on their balance sheet:

Operating Fund:

This covers such day-to-day operating costs as staff compensation, insurance, rent, and supplies. Income typically is generated by memberships, unrestricted contributions, endowment distributions, grants, and sales. Both income and expenses are encompassed in the annual budget, which is really just a guide to monitor finances. Once the board approves the annual budget the executive director is responsible for managing it with board oversight. In general the more diverse the organization’s income stream is the more financially stable it will be.

You can tell if your organization has enough money to meet its obligations by tracking its current assets and current liabilities on the balance sheet. Simply put, the current assets (what you have) should substantially exceed the current liabilities (what you owe). If not, board members should be asking questions.

All organizations have fluctuations in cash flow throughout the year. While there is no magic formula for how much cash reserves an organization should have, generally having three month’s of operating expenses in cash reserves is a good idea.

Restricted Fund:

This is often a hard concept for people coming from the for-profit sector to understand. From time to time money is received from grants or contributions earmarked by the donor for a specific use outside normal operating costs. Sometimes restricted assets appear on the financial statement in one lump but are spent over a longer period. This makes the statement appear more robust than it truly is.

There are two common traps created by restricted assets. First, a cash strapped organization uses it for something other than what the donor intended. This is unethical and the use of restricted funds is legally and contractually restricted and often requires special accounting procedures. Second, sometimes cash strapped organizations apply for restricted donations or grants simply because they can get the money. If the income does not fit the organization’s purpose it creates “mission creep” and the tail begins wagging the dog.

Reserve Fund:

A reserve fund is unrestricted money that can be used for any purpose. It is the rainy day fund. Healthy organizations maintain a cash reserve to meet needs unanticipated in the budget, such as the failure of a septic system. Normally board approval is needed to spend from this fund.

Endowment:

An endowment is neither a contingency nor a reserve fund. Its sole purpose is to provide an annual distribution that normally derives from investment growth. A well-managed endowment will grow over time to provide increasing distributions each year. Generally endowed assets do not appear on monthly financial statements and the management of assets and distribution of funds can be assigned to a group separate from the board of directors. All managing, investing, and spending decisions should be well documented to demonstrate compliance with your organization’s policies. Individuals from outside your board of directors should review policies annually. Sometimes endowed funds bear the name of the donating person, group or family.

There are generally two types of endowed funds.

    • Unrestricted endowed funds produce an annual cash distribution that goes into the operating fund and can be used for any purpose.
    • Restricted endowed funds produce an annual distribution to be used only as the donor specified and the organization approved. These often support scholarships. Using the distribution for other purposes violates donor intent.