What a Balance Sheet Can Reveal About the Health of a Nonprofit Organization
The IRS requires most 501(c)(3) nonprofit organizations with annual incomes in excess of $50,000 to file either a 990EZ or 990 (Those with less income file a 990N). The 990EZ and 990 are detailed reporting forms that require an organization to generate a “Balance Sheet,” which is a financial report that describes an organization’s assets, liabilities, and net assets and fund balances at the beginning and end of its fiscal year. The Balance Sheet, however, is also an important tool that nonprofit boards of directors can use to determine the overall financial health of the organization throughout the year.
Recently we attended a Los Angeles Social Venture Partners (LASVP) workshop on how to read and interpret financial statements for nonprofits. The training was designed for grant-makers, donors and nonprofit directors. We found the high-level presentation very informative, and we identified two points we feel are particularly important to share with our readers: first – the cash liquidity of an organization reveals the health of the organization, and second – the total assets of an organization must be broken down into different parts to understand whether the organization has the capital to manage its program work.
The Balance Sheet’s “cash” column shows an organization’s “monthly liquidity,” or how many months an organization can survive on the cash it currently has in the bank. This figure is crucial. The presenter, David Grecco of Nonprofit Finance Fund, gave a shocking statistic: about 57% of nonprofits in California have less than 3 months’ liquidity. This means that most nonprofits are struggling to make ends meet, they cannot innovate new programs, and they are constantly fundraising. Mr. Grecco noted that 3-6 months of liquidity is the benchmark for a nonprofit to have the freedom to engage in longer term planning. Nonprofits with 6 or more months of liquidity are considered to be sustainable and healthy organizations that can plan, grow, and handle risks and crises. Knowing your monthly liquidity is reason enough to generate a Balance Sheet on a frequent basis, not just when it’s time to complete your 990 tax filing.
Mr. Grecco also pointed out that the numbers reported in the Form 990 Balance Sheet can give an organization and its donors a misleading picture of its health. For example the “total assets” on the Form 990 Balance Sheet will not explain what assets are actually liquid or available for immediate use. It is crucial to dive deeper to see how much of those assets are receivables (funds promised but not received), temporarily restricted (restricted for specific uses and/or for specific purposes), permanently restricted (such as an endowment which can only be used to generate investment income), and land/equipment (brick and mortar investment). By parsing out these numbers, a nonprofit board and its funders can determine the organization’s ability to actually fund its programs. Importantly, the nonprofit and its funders need to consider the impacts of locking up a large percentage of assets in land/equipment or restricted income. The higher the percentage of assets that are unrestricted and available for the organization to use, the more stability it has.
Would you like to learn more? As nonprofit attorneys we are happy to advise you on the best strategies to keep your nonprofit healthy and sustainable. Contact us at: www.sustainable-lawyer.com