What Are a Nonprofit’s Basic Financial Statements?
All you need to know about nonprofit financial statements
Below you will learn all about the three (or four) basic nonprofit financial statements.
This story may sound familiar: you got an invitation to get some lunch by a fellow association member. Maybe it was a short conversation you had with your friend from church talking about being involved in the board over some coffee. Or a co-worker talked to you about this great charity that is doing wonderful things in the community and asked you to serve in the board
With much enthusiasm, you accepted. At your very first meeting, you are handed some reports you’ve never seen before. “Statement of financial position? Statement of activities? Bank statements were enough for me. What is a functional expense anyways? I didn’t know expenses had functions!”
You ask these questions to yourself, of course, but you don’t dare ask them to your fellow directors. Why? You don’t want to appear uninformed, ignorant, or unprepared. First impressions are everything after all. For this reason, your questions go unmuttered and unanswered.
Before that hypothetical scenario becomes a reality, or even if it already did, let me walk you through a basic nonprofit’s basic financial statements. Let guide you through nonprofit financial reporting and bring clarity to what is an obscure subject to first-time nonprofit board members with no finance or accounting background.
The Basic Nonprofit Financial Statements
The Statement of Financial Position
This is your balance sheet. I know, I know. You may also not know what a balance sheet is. A balance sheet is one of the four basic financial statements for a for-profit organization. The balance sheet shows your assets (the stuff and rights you own to make money or further your mission); your liabilities (how much you owe to your creditors and lenders); and your equity (the stuff leftover after paying all your creditors and lenders or the stuff you actually own).
The difference is that a nonprofit does not technically have equity because a nonprofit does not have owners or stockholders. For this reason, equity is known as net assets or the assets that are leftover after paying the nonprofit’s creditors and lenders.
In nonprofit accounting, the balance sheet is renamed to statement of financial position to tell readers of the financial statements that these numbers belong to a nonprofit.
Pro Tip: Make sure that total assets in the statement equal the sum of total liabilities and total net assets. If they are not equal, the statement is not balanced and management must correct it.
The Statement of Activities
The second statement shows the nonprofit’s activities and is essentially the nonprofit’s income statement. Most of the time, you will see it divided into three sections: support and revenue, expenses, and change in net assets.
In the support and revenue section, you will see the nonprofit’s major sources of revenue. These depend on the type of nonprofit but usually include lines showing total donations, grants, registrations, sponsorships, member dues, tuition, etc.
In the expenses section, you will see total expenses separated out by function. U.S. generally accepted accounting principles (U.S. GAAP) require that expenses be presented in the statement of activities by function and by nature. In this section you will only see the sum of all expenses for a given function. The main functions include program activities, which are all activities that a nonprofit performs to further its mission, and supporting activities, which, as the name suggests, support program activities.
The last section of this statement shows the results of the nonprofit’s activities. Unfortunately, it is not named net income but “change in net assets”. This is calculated by taking total revenues less total expenses. A reconciliation is shown at the bottom, listing net assets as of the beginning of the year. The statement will add the change in total net assets to this number to calculate for you ending net assets.
Depending on the type of nonprofit and the existence of donor restrictions, the statement will show one or three columns as required per U.S. GAAP. One will be labeled “without donor restrictions” and will show all activities that are free from donor restrictions. The second column will be named “with donor restrictions” and will present all activities that were restricted by donors and how much expenses went to fulfill donors’ wishes. The third column is a total column.
Pro Tip: Ending net asset balances (the very last line or number in the statement) must equal the net assets presented in the statement of financial position. This is just one way how financial statements are interrelated.
The Statement of Functional Expenses
Our third stop on our tour de nonprofit (not sure if that is French, but let’s roll with it) is the statement of functional expenses. As previously mentioned , U.S. GAAP requires reporting expenses by their nature (salaries, rent, supplies, etc.) and by their function (program, general and administrative, fundraising). You should see this statement arranged as a matrix showing the natural expense categories as the rows and the functional expense lcategories as the columns.
This statement may not even be part of the financial package you receive before the meeting. Why? Because U.S. GAAP does not require a statement. The functional expenses can be shown as a note to the financial statements too. For this reason, you may only see three statements.
Pro Tip: The total in each column should equal the total balances presented in the expenses section of the statement of activities. This depends on how many columns are shown here and how many rows are presented in the statement of activities.
The Statement of Cash Flows
The last and most liked statement is the statement of cash flows. I say this because most people without a finance or accounting background understand much better cash flows than accrual accounting. This is, of course, because we run our finances this way. Cash coming in, less cash going out, equals ending cash balance in our bank accounts. This statement shows the same concept but goes a step further by categorizing each cash flow under three main types.
Operating cash flows come from the nonprofit’s operations such as cash coming in from donations, grants, or tuition. It also lists cash going out to pay for operating expenses such as salaries, rent, and vendors.
Investing cash flows result from the nonprofit’s investing activities such as purchasing or selling assets, stocks, mutual funds, etc.
Cash flows from financing activities are those that result from either obtaining or paying a long-term loan or mortgage. There are other very specific financing outflows that I will cover in another post.
And there you have it! All four basic nonprofit financial statements covered. Take the above explanations as summaries or as a quick crash course before your first board meeting.
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