The Busy Person's Guide to Four Essential Finance Reports

Resource
Nonprofit Stewardship: A Better Way to Lead Your Mission-Based Organization

Contents
Four Essential Finance Reports
    1. Cash flow
    2. Budget
    3. Ratios
    4. Nonfinancial indicators
Conclusion

From Becky Andrews, Marketing Manager, Fieldstone Alliance:

MOST NONPROFITS across the country are, or soon will be, challenged by the effects of a lagging economy. Whether from cuts in public dollars, declining donations, or reduction in user fees, the economic downturn or recession—whatever you want to call it—is starting to hit us. Financing and monitoring operations is challenging in the best of times. During a tight economy, it's especially critical.

As a board member, executive, or manager, you need accurate and timely information so you know exactly where you stand and what corrections are needed. Of course, that’s in addition to everything else on your plate. To help make the task manageable, this issue of Tools describes four essential financial reports recommended by Peter Brinckerhoff in his book, Nonprofit Stewardship. (For an explanation of nonprofit stewardship, click here.)

Four Essential Finance Reports
The following is excerpted from Nonprofit Stewardship, Chapter 7, pp. 144-152 with minor changes.

1. Cash flow
You not only have to know your organization’s cash status (how much cash it has at any point), but also your cash flow projection (how much cash will come in and out of the organization in the near future). Cash status and cash flow projection can be shown in a single report. Peter suggests a six month forecast in monthly increments. The projection should show your anticipated receipts and disbursements (the cash equivalents of income and expenses) as well as a starting and ending cash amount.

Sample cash flow statement

Months are labeled 1-6 for simplicity. Receipts and disbursement detail has been reduced from what your organization would have. The idea here is to get the idea!

Note that in this projection, the current cash status (Month 1) is positive, but there is trouble coming. Because of intermittent funding, and because of a capital project, the agency, even with some cash to start with, runs out of cash in Month 3.

The projection won’t be perfect. It will be more accurate in the early months than later months, and it should be updated every thirty days. (Some organizations do this projection twice a month to reflect the impact of payroll disbursements. By projecting with twelve columns rather than six, they get a better idea of any real problems that might occur.) Accrual accounting covers a lot of cash holes, such as months when organizations earn money from the state but don’t get the check. This kind of projection will help your organization prepare for cash flow issues.

2. Budget
A budget is a reflection of your work plan, showing where income will come from and how to invest resources over some time period, usually a fiscal year. Think of a budget as a contract between board and staff—a contract that, once agreed to by both parties, should be monitored carefully. If the staff keep their part of the bargain and stay within the contract (the budget), the board should respect their success and not intervene.

Sounds good, doesn’t it? But this does not mean that the board should be cavalier about its budget monitoring duties, nor that staff should spend an inordinate amount of time on budget issues. Both board and management need to see regular reports on budget status in a way that allows efficient evaluation and facilitates raising questions if you feel that there are problems.

Look carefully at the budget report example below. It shows a hypothetical agency’s budget report to the board and staff. The key for easy use is context. Let’s look at the first four columns of numbers on the left. They reflect the previous month’s activities. The first column shows “Actual” income and expense figures; the second displays the amount budgeted (“Budget”) for each item. This puts the actual numbers in context. Then, in the third column, the math is done to compare the two. Finally, the fourth column offers further context by showing that variance as a percentage.

Moving to the four columns on the right, the entire report is repeated for the entire year to date (“YTD”). Why? Because every month is different. Thus one line item may be over or under budget for the month, but fine for the year as a whole—or vice versa.

Let’s examine a couple of line items to see how this can work for you. Under income, look at State Program A. You’ll see that the income from Program A exceeds the budget by $2,400. That’s good. But at the right side of the chart you’ll see that Program A is still behind for the year. The opposite is true for donations, which are 50 percent behind in column one, but up for the year over 250 percent.

Sample eight column budget report

This report helps stewards avoid obsessing over the actual numbers or even the budgets. Rather, stewards should run their fingers down the Variance columns and search for large problems—negative numbers in the Income, positive numbers in the Expenses. They should then check the year-to-date information and see if the problem is also reflected there.

Hint: Some of Peter's clients have a rule for board meetings: if the variance is less than 3% for a month, or 2% for the year, it cannot be discussed at the full board meeting—only at a finance committee meeting. Another excellent use for this reporting format is with area, project, and division budgets. Here, the executive director can quickly review the projects and raise appropriate questions if the numbers are significantly off budget.

Remember, if you view budgets as a contract (between board and staff or between executive director and program managers), the board shouldn't spend a lot of time asking questions when finances are within the bounds of the contract.

3. Ratios
In finance, ratios are ways of simplifying complex numbers to make them manageable, and quickly and easily useful. Ratios may look weird at first, but they are incredibly valuable management tools once you understand them. Ratios are really no more than the decimal results of fractions, so don’t be intimidated. They reduce really big numbers into digestible bites. With ratios, you don’t have to look at your balance sheet too hard, which many nonfinancially minded stewards consider a great advantage. The key isn’t the math, it’s the information behind the math.

One very common ratio is the “Current Ratio,” which is calculated by looking at your balance sheet and finding two numbers: current assets and current liabilities. Divide the current assets by the current liabilities and you have the “current ratio.”

A current asset is one that you can turn into cash quickly. Thus cash, savings, most receivables, equities, and so on, are considered current assets. In the ratio, these are weighed against current liabilities: debts that you might have to pay quickly, such as payables, short-term debt, and so forth. If current assets are less than current liabilities (generating a current ratio of less than 1.0), your organization could get into a serious cash crisis. Financial people would say, “The organization is not very ‘liquid.’” The current ratio measures short-term liquidity, and it’s something that you should pay attention to. If it drops below 1.0, that’s bad. If it drops way below 1.0, that’s really bad. If it rises too high, you may not be investing enough in mission.

What ratios should you monitor? This depends entirely on your organization, your cash flow, and the types and mix of income you have (grants, contracts, donations). Each kind of ratio looks at a different thing. For example, the quick ratio (total assets divided by total liabilities) shows your net worth; debt-to-equity ratio (total debt of all kinds divided by total net worth) shows how “leveraged” you are. Obviously if you have no debt, there is no point in monitoring debt to equity—but if debt is part of your world, you’d better attend to it!

Suggestions of ratios to consider:

• Current ratio (current assets divided by current liabilities) measures short-term liquidity
• Quick ratio (total assets divided by total liabilities) shows your net worth
• Profit margin (profits divided by total income) measures profitability
• Debt-to-equity (total debt divided by net worth) shows how “leveraged” you are

Let’s look at a couple of examples, and then some ways to use ratios in your stewardship. Your monthly financial report should include this month’s ratio, last month’s, and your goal. So your ratio report for this month might look like this table.

Sample monthly ratio report

This kind of report puts the ratios in a context that you can use. You look at the ratio’s status, the trend, and the goal. If there is a problem, raise it. If not, you can be comfortable that your financial situation is stable, given the goals you have established.

Ratios can really save you time and keep you comfortable with your financial status. They will help you use your own time well, as well as the time of your board members. Give them a try.

4. Nonfinancial indicators
There are some nonfinancial indicators that need to be provided alongside the financial reports. Such reports help provide a better context for the financial data. The management team should decide which nonfinancial indicators merit reports. Usually indicators are important when they affect your income, your service quality, your expenses, or other key aspects of performance. Typical indicators include number of clients served, number of training participants, number of housing units provided, staff or client diversity, and so forth.

Let’s look at some possible nonfinancial indicators by discipline.

• Performing arts: Number of tickets sold per performance, number of repeat season ticket purchasers, cost per seat per performance
• Residential human services: Occupancy percentage, employee turnover per month, referrals of new service recipients per month
• Education: Number of students, percentage of tuition paid by scholarship, new donors per month, percentage of alumni donations
• Place of worship: Congregants per service or per week, total offerings per week, number of volunteer hours donated per month

Choose three to five nonfinancial indicators whose monitoring by staff and board would help keep better track of your organizational health and help you see trouble coming.
Remember to put nonfinancial indicators in context, just as you did for your ratios. What’s your goal? What’s the history? What’s the trend? Without context they are just ink on paper.

Conclusion
Peter reminds us that "Financial stewardship is a focal point for good organization management, and one where a small mistake can turn quickly into a big one. Even if you are not a born financial manager, you do need to pay attention to money and understand your organization’s financial structure, and monitor how the money is coming in and going out. This may not be enjoyable, but it is part of the job."

Where to Learn More

Fieldstone Alliance
Articles:
Building a Better World—One Balance Sheet at a Time
Two Guiding Principles for Effective Budgeting
Financial Terminology Demystified
Have You Hugged Your Bookkeeper Lately?
Stewardship Helps Nonprofits Get More Mission for their Money

Books:
Nonprofit Stewardship: A Better Way to Lead Your Mission-Based Organization
Financial Leadership: Guiding Your Organization to Long-term Success
Bookkeeping Basics: What Every Nonprofit Bookkeeper Needs to Know

Consulting services:
Our expertise includes assisting organizations with alternative revenue strategy development. For more information, please contact Tom Triplett at 651.556.4504 or ttriplett@FieldstoneAlliance.org. Also, see Tom's recent articles:

Collaborating with a For-Profit: Some Risks but Huge Potential
Managing the End of a Funding Relationship

All the Best,

Becky Andrews
Fieldstone Alliance

May 14, 2008

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