Understanding & Using Financial Statements

(As Business Tools for Nonprofits)

J. Scott Denlinger, CPA

Director, CBIZ MHM, LLC Bethesda, Maryland

Overview
How to read financial statements.
Some key indicators and ratios. Financial statements are a tool for running your business. Building and maintaining cash reserves. DONT BE AFRAID TO ASK QUESTIONS!

Why Review Financial Statements?

Assess the current financial health of the organization (may be better than you think)
Assists in gauging of viability of new programs and services

Helps to identify issues before they become serious problems

More important than ever given current economic conditions

Cash vs. Accrual Basis Accounting

Cash recognizing revenues as you receive them and expenses as you pay them Accrual recognizing revenues as you earn them and expenses as you incur them rather than at the time of cash flow

Statement of Financial Position

Nonprofit equivalent of the Balance Sheet Tells you what you own (assets), what you owe (liability) and what you have leftover (net assets)

ASSETS CURRENT ASSETS Cash and cash equivalents Promises to give Receivables Prepaid expenses TOTAL CURRENT ASSETS INVESTMENTS PROPERTY AND EQUIPMENT, at cost, less $25,844 of accumulated depreciation and amortization OTHER ASSETS Promises to give Deposits

540,052 277,987 127,250 59,379 $ 1,004,668 981,770

15,293

494,470 26,053 520,523

TOTAL ASSETS LIABILITIES CURRENT LIABILITIES Accounts payable and accrued expenses Deferred membership dues Deferred rent liability TOTAL CURRENT LIABILITIES NET NET ASSETS Unrestricted Temporarily restricted Permanently restricted ASSETS

2,522,254

277,769 453,496 4,532 $ 735,797

997,049 289,408 500,000 1,786,457

TOTAL LIABILITIES AND NET ASSETS

2,522,254

Receivables
Receivables primarily earned revenue Promises to Give Restricted Unrestricted Key issues: Split out long-term receivables (dont kid yourself) Allowance for bad debts (donors intent may not equal donors ability)
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Prepaid Expenses
Prepayments for future goods or services (meeting space deposits, etc.)
Useful in matching revenues with expenses (conferences, trade shows, etc.) Key issues: Dont forget to expense them later Dont worry about the small stuff
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Property and Equipment

Key Issues:
Establish a capitalization policy ($500?, $1,000?, more?) Maintain fixed asset listing on Excel or other program Use good descriptions could save you personal property taxes) Keep depreciation simple straight-line
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Investments
Key Issues:
Need an investment policy Dont forget unrealized gains and losses especially in current economy! Review performance monthly

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Other Assets
Long-term receivables
Multi-year pledges

Deposits
Recording can help serve as a reminder

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ASSETS CURRENT ASSETS Cash and cash equivalents Promises to give Receivables Prepaid expenses TOTAL CURRENT ASSETS INVESTMENTS PROPERTY AND EQUIPMENT, at cost, less $25,844 of accumulated depreciation and amortization OTHER ASSETS Promises to give Deposits

540,052 277,987 127,250 59,379 $ 1,004,668 981,770

15,293

494,470 26,053 520,523

TOTAL ASSETS

$ 2,522,254

Accounts Payable/Accrued Expenses

Keep on top of this
Know what you owe Consider recording estimates if you dont have the invoice yet (contractors, large expense reports, etc.)

Avoid surprises
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Deferred Revenue
Member dues, conference registration, etc.
Assist in matching revenues and expenses Key issues:
Member dues vs. Contributions
Maintain good schedules Dont worry about the small stuff

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Net Assets
Unrestricted
Temporarily Restricted

Permanently Restricted
Board Designation vs. Restriction

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LIABILITIES CURRENT LIABILITIES Accounts payable and accrued expenses Deferred membership dues Deferred rent liability TOTAL CURRENT LIABILITIES NET ASSETS NET ASSETS Unrestricted Temporarily restricted Permanently restricted

277,769 453,496 4,532 $ 735,797

997,049 289,408 500,000 1,786,457

TOTAL LIABILITIES AND NET ASSETS

$ 2,522,254

Ratios
Current ratio:
Shows organizations ability to meet short-term obligations.

Current Assets Current Liabilities

Your current ratio helps you determine if you have enough working capital to meet your short-term financial obligations. A general rule of thumb is to have a current ratio of at least 1.0. A current ratio under two may indicate an inability to pay current financial obligations with a measure of safety.

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Ratios
Quick ratio:
More stringent test of your ability to meet current obligations. Used by banks and management. Should not be less that 1.0.

Quick Assets*
Current Liabilities
*Quick Assets generally means Current Assets minus Inventory and Prepaid Expenses.

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Ratios

Industry Benchmarks
Public Charities Trade Associations

Quick Ratio Current Ratio

1.42 2.97

1.27 2.36

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Sample Ratio
TOTAL CURRENT ASSETS TOTAL CURRENT LIABILITIES $ 1,004,668 = $ 735,797 1.37

Sample Ratio
TOTAL CURRENT ASSETS LESS: Prepaid expenses TOTAL QUICK ASSETS TOTAL CURRENT LIABILITIES $ 1,004,668 59,379 $ $ 945,289 = 735,797 1.28

Use Templates As Tools!

YOUR Balance Sheet
Current ratio [A/B] Quick ratio [(A-C)/B] Cash ratio [D/B] Stated in 000s -

Many Excel templates are available online, like this one available from Microsoft at http://office.microsoft.com/ [templates]

For the Period Ending [End Date]

Working capital [A-B] Debt-to-equity ratio [(G+H)/F] Debt ratio [(G+H)/E] $ -

ASSETS
Current assets Cash and cash equivalents [D] Short-term investments Accounts receivable [I] Inventories [C] Deferred income taxes Prepaid expenses and other current assets Total current assets [A] Fixed assets Property, plant and equipment at cost Less accumulated depreciation Total fixed assets Other assets Long-term cash investments Equity investments Deferred income taxes Other assets Total other assets Total assets [E] $ $ $ $ -

% of ASSETS

LIABILITIES & OWNERS' EQUITY

Current liabilities

% of ASSETS

Loans payable and current portion long-term debt [H] Accounts payable and accrued expenses Income taxes payable Accrued retirement and profit-sharing contributions

Total current liabilities [B] Other liabilities

Long-term debt [G] Accrued retirement costs Deferred income taxes Deferred credits and other liabilities

Total other liabilities Total liabilities Total owners' equity [F] Total liabilities + owners' equity $ $ $ $ -

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Statement of Activities
Nonprofit equivalent of the Income Statement Shows how the organization performed during the period

Change in Net Assets is nonprofit equivalent of Net Income

Nonprofits are measured differently

Negative change in net assets isnt necessarily bad

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Statement of Activities
Unrestricted REVENUE AND SUPPORT Grants and contributions Conferences Publications Rental income Investment income Miscellaneous income Net assets released from restrictions: Satisfaction of purpose restrictions TOTAL REVENUE AND SUPPORT EXPENSES Program services: Research Student Services Government Affairs Communications Conferences Total program services Management and general Fundraising TOTAL EXPENSES CHANGE IN NET ASSETS $ 1,209,176 1,137,432 1,222,682 67,943 35,482 5,914 324,615 4,003,244 $

Temporarily Restricted

Total

441,269 (324,615) 116,654

1,650,445 1,137,432 1,222,682 67,943 35,482 5,914 4,119,898

2,125,836 136,920 167,976 261,630 250,971 2,943,333 602,073 412,639 3,958,045 45,199

116,654

2,125,836 136,920 167,976 261,630 250,971 2,943,333 602,073 412,639 3,958,045 161,853
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Revenue Considerations
Contributions/Grants
Membership Dues Special Events Investment Income Unrelated Business Income Tax (UBIT)

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Contributions/Grants
Restricted vs. Unrestricted
Unrestricted
Provides more flexibility Can be more difficult to raise

Restricted
Can engage donors more than unrestricted No disputes over usage Potential for being painted into a corner
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Contributions/Grants
Corporate grants
One can lead to more Can be unreliable long-term

Foundation grants
Can be more reliable than corporate May have more reporting requirements

Government grants
Need proper controls in place State grants may be risky Single Audit considerations for federal grants
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Membership Dues
More predictable less dynamic
Raising dues rates Determining proper dues rates
Cost of soliciting new members (direct mail, telephone solicitation, new member kits,etc) Cost of retaining the member (newsletters, other member benefits) Dues rates should cover costs per member
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Membership Dues
Additional Considerations
Tiered dues structure Based on Benefits Based on Size Student memberships

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Special Events
Can provide visibility
Large upfront costs How confident are you regarding the revenue? Consider lower cost alternatives

Consider partnering
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Investment Income
Record reinvested interest and dividends
Dont forget to record unrealized gains and losses (especially in todays economy)

Know what have!

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Unrelated Business Income Tax (UBIT)

Represents taxable income
Reportable on Form 990T

Considerations:
Advertising in magazines or newsletters Corporate sponsorship

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Ratios
AIP Benchmark

Operating Efficiency:
Indicates percentage of each dollar spent on programs.

Program related expenses Total expenses

75%

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Ratios
AIP Benchmark

Fundraising Efficiency:
A measure of the cost of raising money.

Fundraising Expenses Related Contributions

Ideally 25% (no more than 35%)

Sample Ratio
Operating Efficiency
Program services Management and general Fundraising Total Expenses $ 2,943,333 602,073 412,639 3,958,045

Program services Total Expenses

$ $

2,943,333 = 3,958,045 74%

Sample Ratio
Fundraising Efficiency
Fundraising expenses Grants and contributions $ 412,639 = $ 1,650,445 25%

Cash Flow Statement

Equally important, but frequently ignored
Reconciles change in net assets to change in cash Answers the question: We made money - where did it go?

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Cash Flow Statement

CASH FLOWS FROM OPERATING ACTIVITIES Change in net assets Adjustments to reconcile change in net assets to net cash flows from operating activities Depreciation and amortization Net unrealized and realized gains on investments (Increase) decrease in operating assets Receivables Prepaid expenses Increase (decrease) in operating liabilities Accounts payable and accrued expenses Deferred revenue NET CASH FLOWS FROM OPERATING ACTIVITIES CASH FLOWS FROM INVESTING ACTIVITIES Purchases of investments Proceeds from sales of investments NET CASH FLOWS FROM INVESTING ACTIVITIES CASH FLOWS FROM FINANCING ACTIVITIES Repayments on line of credit NET CASH FLOWS FROM INVESTING ACTIVITIES NET DECREASE IN CASH CASH, BEGINNING OF YEAR CASH, END OF YEAR $ $ 161,853

5,144 (3,058) (107,401) 48,209 (127,530) (39,195) $ (61,978)

(281,871) 450,000 168,129

(50,000) (50,000) 56,151 483,901 540,052

Statement of Cash Flows

Cash Flows from Operations
Shows cash provided by (or used in) operations

Ideally this number should be positive

Items which affect operating cash flow
Depreciation Collection of receivables Paying of accounts payable
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Statement of Cash Flows

Cash Flows from Investment
Shows cash provided by (or used in) investing activities

Items which affect investing cash flow

Buying and selling marketable securities Buying and selling of property and equipment

Not bad if this number is negative

Similar to your personal finances
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Statement of Cash Flows

Cash Flows from Financing
Shows cash provided by (or used in) financing activities Items which affect financing cash flow

Bank loans
Lines of credit Equipment leases

Not bad if this number is negative

Similar to your personal finances
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Cash Flow Statement

CASH FLOWS FROM OPERATING ACTIVITIES Change in net assets Adjustments to reconcile change in net assets to net cash flows from operating activities Depreciation and amortization Net unrealized and realized gains on investments (Increase) decrease in operating assets Receivables Prepaid expenses Increase (decrease) in operating liabilities Accounts payable and accrued expenses Deferred revenue NET CASH FLOWS FROM OPERATING ACTIVITIES $ 161,853

5,144 (3,058) (107,401) 48,209 (127,530) (39,195) $ (61,978)

Cash Flow Statement

CASH FLOWS FROM INVESTING ACTIVITIES Purchases of investments Proceeds from sales of investments NET CASH FLOWS FROM INVESTING ACTIVITIES CASH FLOWS FROM FINANCING ACTIVITIES Repayments on line of credit NET CASH FLOWS FROM INVESTING ACTIVITIES NET DECREASE IN CASH CASH, BEGINNING OF YEAR CASH, END OF YEAR $ (281,871) 450,000 168,129

(50,000) (50,000) 56,151 483,901 540,052

Specialized software programs can help you goal seek and consider what if scenarios.

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Operating Reserves
What is an appropriate level of operating reserves?
Using the Statement of Cash Flows to evaluate cash flow performance. Preparing cash budgets and cash projections

Building and maintaining an appropriate level of operating reserves

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Operating Reserves
How do you calculate operating reserves?
Unrestricted net assets Fixed assets = Operating reserve Total expenses Depreciation = Operating expenses

Operating reserve divided by operating expenses

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Sample Calculation
Unrestricted net assets Less: Fixed assets Operating reserve Total expenses Less: Depreciation expense Operating expenses Operating reserve Operating expenses $ $ 997,049 15,293 981,756

$ 3,958,045 5,144 $ 3,952,901 $ 981,756 = $ 3,952,901 25%

This means 25% (or 3 months) of their annual expenses

Operating Reserves
What is an appropriate level? Minimum of 25%, or 3 months, of operating expenses Other factors to consider:

Type of organization Types and diversity of revenue streams Peaks and valleys in expenses How susceptible the organization is to economic downturns Large outlays of cash projected in future?
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Type of Organization
Type of revenue stream
How predictable is it? Grant driven (Recurring or nonrecurring?) Membership dues Special Events Less predictable higher reserve
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Diversity of Revenue Streams

How dependent are you upon one or a few donors? How reliable are those donors? Less diversity higher reserve

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Peaks and Valleys in Expenses

Quarterly or annual publications? Annual conference or fundraiser? Less predictable higher reserve

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Susceptibility to economic downturns

Dependent upon contributions
Individual, Corporate, Foundation

Dependent upon membership dues

How strong is the industry (small business, oil, medical, etc.)

More susceptible higher reserve

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Large Outlays of Cash Projected

Upgrading computers or database
Implementation of new program or service Moving to larger facility Trade show or conference Expanding membership base
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Operating Reserves
Determining the appropriate level for your organization Your Board should be involved in these discussions: Determine how your organization will define operating reserves Include Prepaid expenses, Deposits, etc? Determine what level your organization wants to maintain

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Operating Reserves Determining the appropriate level for your organization Your Board should be involved in these discussions: Establish a minimum level that must be kept intact and how it will be replenished if used

Develop a policy as to how the reserves will be invested Safety no big risk Establish how often the reserves will be evaluated (monthly?, quarterly?) Financial statements, investment statements
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Budgets & Projections

Preparing cash budgets and cash projections
Use operating budget as a starting point Convert accrual basis items to cash basis

Back out noncash expense (depreciation and amortization)

Add in non-expense outlays, such as loan repayments or equipment purchases

Add in line items for additions to operating or other reserves

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TEXT Cash Flow Budget Worksheet BOX WHITE Year ending December 31, 20XX
XYX Organization Adjustments SUPPORT AND REVENUE Contributions Interest and dividend income TOTAL SUPPORT AND REVENUE CASH INFLOWS Contributions Interest and dividend income TOTAL CASH INFLOWS

1,404,125 52,525 1,456,650

36,000 2,932 38,932

a a

1,440,125 55,457 1,495,582

EXPENSES Administrative fees Board expenses Cleaning Commission - rentals Depreciation Insurance Miscellaneous expenses Office expense Personnel expenses Property taxes

7,200 1,050 26,706 4,752 80,436 9,023 173 1,300 1,005,455 97,250

(4,752) (80,436) 2,904 (4)

a b a a

Repairs and maintenance Security Trash and hauling Travel Utilities TOTAL EXPENSES CHANGE IN NET ASSETS

32,042 2,701 4,683 551 51,503 1,324,825 131,825

150,000 28,477 39,618 3,934

c c c a

139,741

CASH OUTFLOWS Administrative fees Board expenses Cleaning Commission - rentals Depreciation Insurance Miscellaneous expenses Office expense Personnel expenses Property taxes Transfer to reserve Purchases of property and equipment Repayment of notes payable Repairs and maintenance Security Trash and hauling Travel Utilities TOTAL CASH OUTFLOWS NET CASH FLOWS $

7,200 1,050 26,706 11,927 169 1,300 1,005,455 97,250 150,000 28,477 39,618 35,976 2,701 4,683 551 51,503 1,464,566 31,016

a b c

Adjustments to reverse out accruals Elimination of non-cash expenses Inclusion of cash outflows not recognized as expenses

TEXT BOX Quarterly Cash Flow Budget Worksheet WHITE Year ending December 31, 20XX
XYX Organization 1st Qtr BEGINNING CASH CASH INFLOWS Contributions Interest and dividend income TOTAL CASH INFLOWS CASH OUTFLOWS Administrative fees Board expenses Cleaning Insurance Miscellaneous expenses Office expense Personnel expenses Property taxes Transfer to reserve Purchases of property and equipment Repayment of notes payable Repairs and maintenance Security Trash and hauling Travel Utilities TOTAL CASH OUTFLOWS NET CASH FLOWS ENDING CASH $ $ 150,469 $ 2nd Qtr 117,249 $ 3rd Qtr 189 $ 4th Qtr 365,117 Total $ 150,469

250,125 13,864 263,989

166,286 13,864 180,150

774,000 13,864 787,864

249,714 13,864 263,578

1,440,125 55,457 1,495,582

1,800 263 6,677 2,982 42 325 251,364 9,905 8,994 675 1,171 138 12,876 297,210 (33,221) 117,249 $

1,800 263 6,677 2,982 42 325 251,364 9,905 8,994 675 1,171 138 12,876 297,210 (117,060) 189 $

1,800 263 6,677 2,982 42 325 251,364 97,250 28,477 9,905 8,994 675 1,171 138 12,876 422,937 364,928 365,117 $

1,800 263 6,677 2,982 42 325 251,364 150,000 9,905 8,994 675 1,171 138 12,876 447,210 (183,632) 181,485

7,200 1,050 26,706 11,927 169 1,300 1,005,455 97,250 150,000 28,477 39,618 35,976 2,701 4,683 551 51,503 1,464,566 31,016 $ 181,485

Breakeven Cash Flow

Monthly fixed costs: Rent & Utilities Payroll & Benefits Loan/equipment lease payments Other monthly costs Breakeven cash flow refers to the nondiscretionary costs that you must cover each month - it is the amount of cash you must have on hand (not revenue on the books).

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Operating Reserves
Building and maintaining an appropriate level of operating reserves - additional considerations:

What types of reserves (emergency, expansion, equipment, etc.)

Determine time frame for building up reserves
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Operating Reserves
To borrow or not to borrow
Lines of credit
How will the organization pay it back? Specific purpose vs Operating expenses Trade show, fundraiser How confident are you regarding revenues How will the organization pay it back? Consider building an intermediate reserve
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Term Loans

Potential Obstacles

Donors Staff Board Desire to fulfill mission

Importance of communication!
Effective communication can help navigate obstacles.

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Communication with Donors

(recognizing/navigating obstacles)

Doesnt energize donors Reserves can be viewed as waste or abuse Communicate need for long-term reserves

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Communication with Staff

(recognizing/navigating obstacles)

May not be understand finances May be viewed as robbing programs Communicate need for long-term reserves Engage certain staff in budget process

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Communication with Board

(recognizing/navigating obstacles)

Same issues as both donors and staff Importance of monthly/quarterly review of financial statements Communicate need for long-term reserves
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If you have questions . . .

Contact:
J. Scott Denlinger, CPA, Director and Practice Lead
Outsourced Financial Services

Scott has more than 20 years experience in accounting, tax, consulting and auditing. CBIZ MHM, LLC Bethesda, MD (301) 951-3636 sdenlinger@cbiz.com

Mr. Denlinger designs and manages outsourced CFO and accounting engagements serving both forprofit and nonprofit organizations. He also performs CFO duties for several organizations, assisting in the preparation of internal financial statements and presentation to their Boards. With his extensive auditing experience, Mr. Denlinger is able to assist our outsourcing clients in preparing for their yearend audits. Combining his communication skills and ability to translate difficult accounting concepts into laymens terms, as well as his penchant for teaching, Mr. Denlinger is frequently asked to lead seminars and workshops by various organizations on a broad range of financial management and reporting topics. He is a member of the MACPA Government and Nonprofit Conference Committee and serves on the Board of Family and Children Services of Central Maryland.

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