Special Items Unique to Nonprofit Financial Statements

Nonprofit organizations play a crucial role in our society, working tirelessly to address various social, cultural, and environmental issues. To effectively fulfill their missions, nonprofits must focus on their programs and initiatives and maintain a sound financial foundation. This requires a deep understanding of nonprofit financial statements, which provide valuable insights into an organization's financial health, transparency, and accountability. This article explores the unique components of nonprofit financial statements that differ from standard for-profit financial statements.

An Overview of Nonprofit Financial Statements

Nonprofits, like for-profit businesses, must prepare and present financial statements to give stakeholders a clear picture of their financial position, activities, and cash flows. However, there are some significant differences in the terminology and focus of nonprofit financial statements compared to their for-profit counterparts. The primary financial statements that nonprofits must prepare are:

• Statement of Financial Position
• Statement of Activities and Changes in Net Assets
• Statement of Functional Expenses
• Statement of Cash Flows
• Footnotes

The Statement of Financial Position

The statement of financial position for nonprofits is similar to the for-profit statement, the balance sheet. However, the statement of financial position has some unique elements. It distinguishes between two categories of net assets: without donor restrictions and with donor restrictions.

• Without Donor Restrictions, funds are not subject to donor-imposed restrictions and can be used for any purpose.
• With Donor Restrictions, funds that have donor-imposed restrictions for a specific period or purpose (temporarily restricted) or donations with restrictions that must be maintained in perpetuity (permanently restricted)

By analyzing the statement of financial position, stakeholders can assess the organization's financial stability, liquidity, and the availability of resources.

The Statement of Activities and Changes in Net Assets

The statement of activities and changes in net assets is the nonprofit equivalent of the income statement for for-profit businesses. It presents the organization's revenues and expenses for a specific period, typically a fiscal year. The report provides insights into the sources of revenue, such as donations, contributions, grants, program fees, and the expenses incurred in carrying out the organization's mission. It also highlights the change in net assets.

Conditional and Unconditional Contributions

One critical nonprofit distinction to understand is the difference between conditional and unconditional contributions.

• Conditional contributions are donations with specific barriers or conditions that must be overcome to earn the contribution. Conditional contributions are recognized in the statement of activities and changes in net assets when the conditions on which they depend are substantially met.
• Unconditional contributions, on the other hand, do not have any specific requirements and can be used at the organization's discretion.

The Statement of Functional Expenses

The statement of functional expenses provides a breakdown of the organization's costs based on their nature (e.g., salaries, rent, professional fees) and function (e.g., program, management, general, and fundraising). This statement is unique to nonprofits and helps stakeholders understand how resources are allocated across different areas of the organization.

Program Expenses: Costs incurred by a nonprofit organization to implement and deliver its core programs and services. They include any expenses directly related to program delivery (e.g., salaries, food, supplies, etc.).

Management and General Expenses: Costs associated with running the day-to-day operations of a nonprofit organization. These expenses support essential functions such as administration, finance, human resources, and governance (e.g., accounting fees, legal fees, a portion of staff member’s salary for time spent on administrative tasks, etc.).

Fundraising Expenses: Costs incurred by a nonprofit organization to raise funds for its programs and operations. These expenses include activities such as organizing events, direct mail campaigns, online fundraising efforts, and hiring fundraising staff or consultants. While fundraising expenses are necessary for generating financial support, nonprofits must strike a balance between the costs incurred and the funds raised.

Footnotes

The footnotes accompanying nonprofit financial statements provide additional information and disclosures essential for a comprehensive understanding of the organization's financial position and activities. These often include details about liquidity, restricted funds, endowments, and other significant accounting policies and practices. Footnotes provide insights into the organization's financial strategies, compliance with regulations, and the impact of specific transactions or events on the financial statements.

Liquidity

The FASB Accounting Standards Update (ASU) 2016-14 requires nonprofit entities to provide information about liquidity and the availability of resources. This disclosure is intended to give readers of the financial statement a better understanding of the financial assets available to meet cash needs for general expenditures within one year.

NFPs can include a discussion about the available fund sources, such as cash reserves or a line of credit. They should also consider any internal limits on resources, such as board designations. The information provided should relate to the corresponding items in the financial statements.

Endowments

An endowment is a donation of money or property to a nonprofit organization with the intention of providing ongoing support for its mission. Unlike regular contributions, endowments are typically larger and structured in a way that preserves the principal amount while allowing the organization to utilize the investment earnings.

This approach ensures that the impact of the donation extends over a longer period, contributing to the nonprofit's long-term financial stability. Endowments may come with specific stipulations regarding their usage, such as restrictions on the principal balance or requirements for reinvesting a portion of the earnings.

There are three primary types of endowments: true endowments, term endowments, and quasi endowments. Each type has distinct characteristics and implications for how the funds can be utilized.

• True Endowments: A true endowment occurs when a donor restricts the principal balance of a gift in perpetuity, allowing only the investment earnings to be used for funding programs, operations, or scholarships. These funds are classified as permanently restricted net assets.
• Term Endowments: A term endowment is similar to a true endowment except that the principal can only be expended upon a specific passage of time or the occurrence of a particular event per the donor’s instructions. If such specifications are met, the term endowment may be either liquidated or reclassified to a Fund Functioning as Endowment.
• Quasi Endowments: Quasi endowments, also known as board-designated endowments, are funds that the organization sets aside from its own resources for investment. These funds are not subject to donor restrictions and can be utilized at the discretion of the board. Quasi endowments are classified as net assets without donor restrictions.

Best Practices for Reading and Analyzing Nonprofit Financial Statements

Analyzing nonprofit financial statements requires attention to detail and a thorough understanding of the organization's financial health. Here are some best practices for reading and analyzing nonprofit financial statements:

Review the Statement of Financial Position

This will give you insights into the organization's financial flexibility and ability to cover operating expenses. Analyze the organization's liquidity by examining the availability of cash and other liquid assets.

Examine the Statement of Activities and Changes in Net Assets

Identify the primary sources of revenue, such as contributions, grants, and program fees. Assess the trends in revenue over multiple periods to identify any significant changes or patterns. Compare the organization's expenses to its revenue, paying attention to the allocation of expenses between program activities, management and general functions, and fundraising efforts. This analysis will help you understand the organization's financial sustainability and its ability to effectively utilize resources to achieve its mission.

Assess the Statement of Functional Expenses

Understand how the organization categorizes and allocates expenses across various functions. Stakeholders can assess the efficiency and effectiveness of the organization's spending, the allocation of resources to programmatic activities, and the proportion of expenses dedicated to management and fundraising. This will help you evaluate the efficiency of resource utilization and the organization's commitment to its mission.

Consider Footnote Disclosures

Pay attention to the footnotes, as they provide additional information on liquidity, restrictions, and endowments. These disclosures offer valuable insights into the organization's financial position and compliance with regulations.

How Lutz’s Nonprofit Accounting Services Can Help

Nonprofit financial statements are valuable tools for promoting transparency, accountability, and the long-term sustainability of organizations. By carefully analyzing them and adhering to best practices, stakeholders can glean a clear picture of the company and make informed decisions. If you’d like to worry less about your financials and spend more time focusing on your mission, Lutz’s nonprofit accounting services can help. If you have questions, please contact us.