Have you ever looked through an old family photo album? You definitely know some people, but others you only vaguely recognize.
Nonprofit financial statements can feel like looking at a somewhat familiar for-profit relative. They definitely share the same gene pool, but there are notable differences.
It’s crucial to understand how nonprofit and for-profit financial statements differ. Nonprofits are held to an even more detail-oriented standard than for-profits, and failing to include certain information can put you in danger of losing your tax-exempt status or funding.
Keep reading to learn about the four most important nonprofit financial statements you’ll need to track in order to keep the IRS and donors happy.
What is a statement of financial position?
Every business needs a balance sheet. But when your business doesn’t have equity, you replace it with net assets. Say hello to the Statement of Financial Position (SOP). This statement will give you a snapshot of your organization's financial position at a given moment.
Usually your SOP is made annually. However, SOPs can be made quarterly or monthly depending on the size of the organization. Like a for-profit business, this statement lists assets in order of liquidity and liabilities in order of maturity.
Normally in a for-profit business you’d factor in shareholders equity to complete the picture. This is where nonprofits differ. Because there is no shareholder equity, the formula changes from:
Assets - Liabilities = Capital
All those leftover funds are going right back into the organization, making them assets again.
“Net assets” are then categorized by donor restriction. “Restricted” vs “unrestricted” will determine when and how these net assets can be used. Net assets can be cash and accounts receivable (liquid) or goods, equipment, property (fixed).
Net assets represent what an organization is worth. However, those “donor restricted” funds come with all sorts of strings attached. Only taking “unrestricted” accounts into consideration will give you a more accurate valuation.
What is a statement of activities?
Another familiar face in the financial statement family album is the “income statement.” So how does it translate to the nonprofit world? Meet the statement of activities (SOA).
Similar to an income statement, an SOA provides insight into the revenue and expenses for a certain period of time.
A typical for-profit income statement focuses on profit and loss. But what do you do if your business doesn’t make a profit? When dealing with nonprofits, the focus shifts to “net assets” and how they fluctuate.
Just like with the SOP, the revenue here is divided by restriction. Expenses are always considered “unrestricted” even if they use “restricted” funds. When looking at a statement of activities, you might see an amount jump from the “donor restriction” column to the “unrestricted” column under the line item “released from restriction.” This indicates funds have been used for their designated purpose or within their specific time frame.
The SOP and SOA are directly linked. If you were to look at the two side by side, you’d know they weren't twins…but they’re definitely related.
Do you need a cash flow statement?
The third financial statement that your nonprofit will need is a familiar face. Is that financial statement an evil twin?! Nope, it’s a very familiar and friendly cash flow statement.
This is one statement nonprofits and for-profits have in common. A cash flow statement tracks how cash flows in and out of your organization over a given time period. It’s vital in helping you understand your organization’s spending habits versus the cash you have on hand.
The cash flow statement of a nonprofit breaks down into three different categories: operating, investing, and financing activities. Just like with statements of financial position and statements of activities, you can never be too specific.
What is a statement of functional expenses?
Speaking of specificity, nonprofit accounting is hyper detail-oriented. It’s the trade-off for having so much tax-exempt freedom. A statement of functional expenses is one branch of the financial statement family tree that is all nonprofit.
The name says it all—the breakdown of expenses by the function they serve. These functions are:
- Member Development
Once they’re broken down by category, they’re then sorted by the nature of their specific use — whether it’s employee salaries or the plain old electric bill.
Eventually the statement of functional expense will be used to determine how funds are being allocated among the four categories. It helps show that funds are being allocated in a reasonable and appropriate way.
It can start to get tricky when sorting out the function and nature of each expense. That’s where the expert eye of an accountant can come in handy.
Why are annual reports important?
The final member of both the nonprofit and for-profit financial family album is the annual report. Think of it like a grandma. It’s related to both sides and carries a big purse full of all the juicy tid-bits that couldn’t fit in the other statements. And maybe a butterscotch.
Individual financial statements can tell you a lot about the financial health of a business. But while they are thorough, they might not always tell the whole story.
An annual report can help to clarify certain trends in your numbers throughout the year. They might even provide supplementary information like insights into particular fundraising successes or member participation that could help entice future donors.
Ready to make a statement?
Well-crafted financial statements are the key to winning the trust and confidence of those who read them. For a nonprofit, they can be the difference between being awarded that enormous grant…or kissing it goodbye.
Financial statements are also an important tool to ensure that your organization is healthy and functioning. When finances are in order, you can focus on your nonprofit’s mission of making a difference.
Need help sorting out your functional expenses? Reach out to KYN Accounting today for some friendly insight into your nonprofit’s financial health.