Nonprofits are vital in addressing societal needs, positively impacting communities, and driving social change. These organizations must understand their financial position to ensure sustainability and success. 

Quality financial records are essential for nonprofits, as they measure performance objectively and reflect how resources are used. Internally, the organization uses them to identify trends, make projections for future growth, and assess management performance. Externally, creditors, such as banks and leasing companies, view the financials to determine if the nonprofit can meet its obligations. Potential donors and grantors examine the statements to decide if they are worthy of donations and funding. 

This blog will explore four crucial financial statement items that every nonprofit organization should understand.

1. Statement of Financial Position

The Statement of Financial Position, also called the Balance Sheet, is a snapshot of an organization's financial health at a specific point in time. It presents their assets, liabilities, and net assets.

• Assets - The resources owned or controlled by the organization, such as cash, investments, property, and equipment.
• Liabilities – An obligation or debt owed to an external party, including loans, accounts payable, and accrued expenses.
• Net assets – The accumulation of activity over time and is calculated by subtracting liabilities from assets. Nonprofits categorize net assets into two classes: unrestricted and restricted (temporary and permanent).

Understanding the Statement of Financial Position allows nonprofit leaders to assess their organization's liquidity, solvency, and financial stability. It provides valuable insights into the organization's ability to meet short-term and long-term monetary obligations.

2. Statement of Activities

The Statement of Activities, also referred to as the Income Statement or Profit and Loss Statement, presents a summary of the organization's revenue, expenses, gains, and losses during a specific period. It typically includes three components:

• Revenue – Income from contributions, grants, program service fees, fundraising activities, investment income, or other sources of income.
• Expenses - Include program costs, administrative overhead, fundraising costs, and other expenditures.
• Change in Net Assets - The change in net assets represents the difference between the beginning and ending balances of net assets for the reporting period. It can be further broken down into assets with and without donor restrictions.

It is important to note that a negative change in net assets does not necessarily mean negative results. View the statement as if it’s telling a story instead of just a reflection of numbers. For example, an organization may have experienced a decrease in fundraising due to the COVID-19 pandemic but still had a positive impact on its mission.

By analyzing the Statement of Activities, nonprofit leaders can evaluate the organization's revenue sources, cost structure, and overall financial performance. It helps identify trends, areas of strength, and areas that require improvement. This statement is vital in assessing the organization's ability to generate sufficient income to sustain its programs and fulfill its mission.

3. Statement of Functional Expenses

The statement of functional expenses is a comprehensive breakdown of how a nonprofit organization spends its money. This statement, unique to nonprofit organizations, covers a specific period, and each expense is assigned to one of three categories:

• Program Expenses
• Management and General Expenses
• Fundraising Expenses

Each expense is allocated to a category based on time, square footage, or other factors. This statement provides transparency regarding how the organization uses its resources and helps nonprofit leaders and stakeholders gain insight into its cost structure. It ensures accountability and enables them to evaluate the organization's financial management practices.

4. Net Asset Classifications

Unlike a for-profit entity, nonprofit assets can have restrictions placed on them by the donor.

• Unrestricted Net Assets - Funds that are not subject to donor-imposed restrictions, allowing the nonprofit to allocate them for any purpose within its mission.
• Restricted Net Assets – Restricted assets can fall into one of two categories:
  • Temporary - Funds with donor-imposed restrictions specifying their use for certain programs or within a defined timeframe. For example, a donor contributes money specifically to purchase a new van.
  • Permanent - Funds subject to donor-imposed restrictions that require the principal be maintained in perpetuity. The income generated from these assets can be utilized for specific purposes as defined by the donor while the principal remains intact.

When looking at the financial statements of a for-profit business, most people look at the bottom line to determine how well they’re doing. However, that isn’t the best way to measure a nonprofit’s success. The bottom line may be affected by factors outside the organization’s control, and it doesn’t always reflect the true impact of an organization’s work, such as its positive effects on society or the environment.

With a thorough understanding of the different components of nonprofit financial statements, you can assess the organization's overall financial standing and identify areas for improvement. Contact us if you have any questions or want to learn more about our nonprofit accounting and consulting services.