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Non Profit Financial BasicsBudgetA key component of financial sustainability is the commitment of board and staff to financial management that includes timely review of financial reports and advance planning. One way that board and staff plan for income and expenses in the future is by creating a budget. Approval of the annual budget is one of the fundamental building blocks of sound financial management.Creating the annual budget is initially staff’s responsibility, but board members (usually those on the “finance committee” and/or “executive committee”) often review the proposed budget and the full board usually adopts the budget at a full board meeting. The approved budget then serves as a guide for financial activity in the months ahead. Budgets should not be “written in stone” because the financial position of the nonprofit may change during the year.A budget is a?guide?that can help a nonprofit plan for the future as well as assess its current financial health. It is quite common to periodically review the budget as well as compare it to the actual cash flow and expenses, to determine whether they are playing out as expected during the course of the year. It may be necessary to amend the budget during the year.(tools-resources/budgeting-nonprofits)THE BUDGETING PROCESSStep 1: Planning the Process? Identify who will coordinate the budgeting process and which staff, board members and committees need to be involved; ? Agree upon key definitions, assumptions and document formats; ? Set timelines and key deadlines; ? Determine and schedule any training or key meetings. Step 2: Communicating about the Process ? Clearly communicate responsibilities, expectations and deadlines to everyone involved; ? Explain and distribute forms and assumptions. Step 3: Programmatic Goal Setting ? Determine program goals and objectives; ? Project staffing requirements and salary and benefit assumptions based on program goals; ? Get board agreement on goals and assumptions. Step 4: Information Gathering ? Research and gather information about income and expenses based on program goals and assumptions; ? Construct budget details by program; ? Communicate regularly to avoid duplication of effort and to share information and assumptions.Step 5: Compilation and Revision? Have one person compile all information, review it for consistency and redistribute to everyone involved; ? Leave plenty of time for review and revisions. Step 6: Committee Review ? Have the finance committee and other appropriate staff and board committees review a budget draft and key assumptions? Be sure to allow enough time between committee meetings and the final approval deadline to address questions and recommendations and make revisions. Step 7: Final Approval ? Distribute information to the board prior to the board meeting, including budget draft, program goals and other supporting information;? Have program and development committees play a role in making an informative presentation to the board based on the opportunities, challenges and resources behind the budget numbers; ? Have the finance committee or treasurer present the budget proposal to the board. Step 8: Implementation and Management The real work begins once the budget is approved: ? Communicate budget, program goals and timelines for the next year to staff; ? Review actual income and expense compared to the budget on a monthly basis; ? Update and revise the budget as there are changes during the year. Depending on the significance of changes, the board may need to approve revisions.KEYS TO A SUCCESSFUL BUDGETING PROCESS 1. Clearly identify programmatic objectives that are aligned with the mission and strategic plan. 2. Determine the financial resources needed and available to achieve program goals. 3. Involve staff and board members in the process to improve accuracy of information and commitment to the plan. 4. Document! Don’t rely on memory. Write down assumptions and formulas. This will be very important in managing the budget throughout the year. 5. Customize your process. The steps each organization takes will be somewhat different.()Income Statement or Statement of ActivitiesSince a nonprofit's primary purpose is to provide programs that meet certain societal needs, it issues a?statement of activities?(instead of the income statement that is issued by a for-profit business).The statement of activities reports revenue and expense amounts according to the three classifications of net assets discussed above. Here is an outline of the statement of activities without its heading and without amounts:* Revenues often include the reclassification of net assets at the time they are released from restriction.RevenuesThe caption Revenues is often expanded to be more descriptive. Here are some of the possibilities:Support and RevenuesRevenues, Support and ReclassificationsRevenues, Gains and Other Supportsome variation of the above or a more descriptive captionRevenues that may be listed on the statement of activities include:ContributionsMembership duesProgram feesFundraising eventsGrantsInvestment incomeGain on sale of investmentsReclassifications when net assets are released from restrictions (a negative amount in the temporarily restricted column and a positive amount in the unrestricted column)Under the accrual method of accounting, revenues are reported in the accounting period in which they are earned. In other words, revenues might be earned in an accounting period that is different from the period in which the cash is received.ExpensesThe caption?Expenses?could be termed?Functional Expenses?since expenses are reported according to these functions:Program expensesSupporting services expenses1. Program expensesProgram expenses?(or program services expenses) are the amounts directly incurred by the nonprofit in carrying out its programs. For instance, if a nonprofit has three main programs, then each of the three programs will be listed along with each program's expenses.2. Supporting services expensesSupporting services expenses are reported in two subgroups:Management and generalFundraisingIn order to accurately report the amount in each of these subgroups, it may be necessary to allocate some management and general salaries to fundraising based on the time spent by employees performing fundraising activities. For example, a management employee might be spending 30% of her time in fundraising activities but her entire salary has been recorded as management and general expenses.Under the accrual method of accounting, expenses are to be reported in the accounting period in which they best match the related revenues. If that is not clear, then the expenses should be reported in the period in which they are used up. If there is uncertainty as to when an expense is matched or is used up, the amount spent should be reported as an expense in the current period.()Balance Sheet or Statement of Financial PositionA nonprofit's statement of financial position (similar to a business's?balance sheet) reports the organization's assets and liabilities in some order of when the assets will turn to cash and when the liabilities need to be paid. The amounts are as of the date shown in the heading which is usually the end of a month, quarter, or year. Net AssetsSince a nonprofit organization does not have owners, the third section of the statement of financial position is known as?net assets?(instead of owner's equity or stockholders' equity).A nonprofit's statement of financial position is represented by the following accounting equation:Because of double-entry bookkeeping, the accounting equation and the statement of financial position should remain in balance at all times. For example, if a donor contributes $500, the effect on the nonprofit's accounting equation and its statement of financial position is:If the nonprofit pays $100 for supplies that will be used immediately, the effect on its accounting equation and its statement of financial position is:The items that cause the changes in Net Assets are reported on the nonprofit's income statement/statement of activities The?net assets?section of a nonprofit's statement of financial position reports totals for each of the following classifications:Unrestricted net assetsTemporarily restricted net assetsPermanently restricted net assetsThese classifications are based on the restrictions made?by the donors?at the time of their contributions.1. Unrestricted net assetsIf a donor does not specify a restriction on his or her contribution, the amount received by the nonprofit is recorded as an?asset?and?as?unrestricted contribution revenues. Unrestricted contribution revenues (reported on the statement of activities) also cause the amount of?unrestricted net assets?to increase. For instance, if a nonprofit receives an unrestricted contribution of $800 of cash, the effect on the statement of financial position is:If the nonprofit's board of directors designates some of the nonprofit's unrestricted assets for a specific purpose, those assets must continue to be reported as?unrestricted net assets.2. Temporarily restricted net assetsIf a nonprofit receives a contribution that has a donor-imposed restriction (other than to be held in perpetuity), the amount is usually recorded as an asset?and?as?temporarily restricted contribution revenues. Temporarily restricted contribution revenues (reported on the statement of activities) also cause the amount of?temporarily restricted net assets?to increase. For example, James donates $20,000 with the requirement that the nonprofit use it to purchase a vehicle that is urgently needed in one of the nonprofit's programs. The effect on the nonprofit's accounting equation at the time the contribution is received is:When the nonprofit purchases the vehicle at a cost of say $21,000, the purchase and the release of the restriction will cause the following changes:3. Permanently restricted net assetsIf a donor stipulates that her contribution must be held by the nonprofit in perpetuity (forever, not be used up), the amount is recorded as an asset and as?permanently restricted contribution revenues. Permanently restricted contribution revenues (reported on the statement of activities) also cause the amount of?permanently restricted net assets?to increase. To illustrate, let's assume that Mary contributes $100,000 to a nonprofit and stipulates that only the interest on the $100,000 can be spent. This contribution will have the following effect on the nonprofit's statement of financial position:If Mary also stipulates that the interest earned must be used for scholarships and $3,000 is earned on the $100,000, the $3,000 must be reported as temporarily restricted net assets until the restriction is released by the payment for scholarships.Total net assetsThe grand total of the three classifications of net assets is reported as?Net Assets?or as?Total Net Assets.()AuditAn audit is the examination of the financial statements by an accounting professional to determine whether they conform to accounting standards. An "independent audit" is performed by a public accounting firm or an individual who is a certified public accountant ("CPA") who is engaged to provide an independent opinion to the management whether or not the nonprofit's financial statements/records comply with accounting standards known as "GAAP" (generally accepted accounting principles). In an independent audit the person conducting the audit is not a board member or an employee of the organization being audited, therefore the review is thought to be more objective than if the reviewer were under the control of, or controlled the nonprofit. Laws in Texas surrounding Audit of Non Profit OrganizationsAudit Required:?No?state law requirement.Statute and Description:?Tex. Bus. & Org. Code § 22.352?| A charitable organization with annual contributions over $10,000 must have current and accurate financial records in accordance with GAAP. Based on these records, the board should prepare or approve a financial report that conforms to AICPA standards. The financial report must be made available to the public (§ 22.353(b)). Exemptions (§ 22.355). (nonprofit-audit-guide/state-law-audit-requirements#TX)Report from auditors presented to BOD annually upon completion that describes the fairness of the financial statements, and provides an opinion as to whether they conform to generally accepted accounting principles. The report must also address other issues such as whether there are any material weaknesses in the nonprofit's financial statements.(nonprofit-audit-guide)Reach has to conduct two audits each year: one for Reach Unlimited, Inc. and one for Reach Unlimited I (HUD homes) for a total of about $20,000.IRS Form 990What is the IRS Form 990?The IRS Form 990 is the reporting form that many federally tax-exempt organizations must file with the IRS each year. This form allows the IRS and the general public to evaluate a nonprofit’s operations; it includes information on the nonprofit’s mission, programs, and finances.The type of Form 990 to be filed by an organization depends on the filing year and the gross receipts of the organization. The different forms include?Forms 990, 990-EZ and 990-N.Who files the IRS Form 990? Which Form 990 do we file?Most federally tax-exempt organizations (with some exceptions like churches and state institutions) file a 990. All 501(c)(3) private foundations file a 990.The IRS provides?information?to help you determine?which form to file.Larger nonprofits with gross receipts of more than $50,000 file Form 990 or 990-EZSmaller nonprofits with gross receipts of less than $50,000 file Form 990-N (e-Postcard)( Flow StatementThe?cash flow statement?shows how much cash comes in and goes out of the company over the?quarter?or the year. At first glance, that sounds a lot like the?income statement?in that it records financial performance over a specified period. But there is a big difference between the two.?What distinguishes the two is?accrual accounting, which is found on the income statement. Accrual accounting requires companies to record?revenues?and?expenses?when transactions occur, not when cash is exchanged. At the same time, the income statement, on the other hand, often includes non-cash revenues or expenses, which the statement of cash flows does not include.Because it shows how much actual cash a company has generated, the statement of cash flows is critical to understanding a company's?fundamentals. It shows how the company is able to pay for its operations and future growth.?Just because a company shows a profit on the income statement doesn't mean it cannot get into trouble later because of insufficient cash flows. () Capital vs. Operating FundsA?capital expense?is used to purchase or invest in a long-term asset, while an?operating expense?is any short-term expense associated with the general, sales or administrative functions of the company.()Donors to a?nonprofit organization?may designate or "restrict" the use of their donations to a particular purpose or project. An example is a gift to a special scholarship fund at a university."Unrestricted" funds are donations that are available for the nonprofit to use for any purpose. Unrestricted funds usually go toward the operating expenses of the organization or to a particular project that the nonprofit picks.()Financial Ratios: What do they mean?Viability ratio.?It compares expendable net assets (including unrestricted and temporarily restricted net assets) to long-term debt. This ratio indicates a not-for-profit's relative liquidity or its ability to cover its debt. It serves as a basic indicator of financial strength because it measures the availability of cash and other liquid assets to meet the organization's financial obligations.Current ratio.?This ratio indicates your organization's ability to meet short-term financial obligations by comparing your current assets to your current liabilities. Ideally, you want to have a current ratio of at least 1.0, and preferably greater. A current ratio under 2.0 may indicate an inability to pay current financial obligations with a measure of safety.Quick Ratio.?Many banks use the quick ratio comparison to gauge financial stability. It compares quick assets (current assets less inventory and prepaid expenses) to current liabilities. Your organization's quick ratio should not be less than 1.0.Operating reserve.?This ratio addresses the question of whether resources are sufficient and flexible enough to support your mission without having to borrow externally. It compares expendable net assets to total expenses. It describes your organization's ability to fund programs and other expenses from expendable net assets, should no additional operating revenue be available. Not-for-profit organizations should aim to have an operating reserve ratio of no less than 25 percent, or enough to cover at least three months of their annual expenses.Change in net assets.?It measures financial performance by answering the question: "Did your organization live within its means during the year?" While an organization's success shouldn't be judged by whether it had a positive or negative change in net assets for one year, consecutive deficits should be cause for concern.Operating margin.?This is an important forecasting ratio because it illustrates your not-for-profit's ability to produce a potential surplus, which could be drawn on if needed in future years. It's determined by subtracting expenditures from revenues then dividing that sum by your revenues.Program efficiency.?It compares total program expenses to total expenses. Having this information can help you demonstrate to potential funders how efficient your organization is in fulfilling its mission.Operating reliance.?To show how much your not-for-profit is able to pay for total expenses solely from program revenues, divide program revenues by total expenses.(insights-resources/details/articleid/2541/nine-ratios-to-help-measure-your-not-for-profits-financial-health-article) ................
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