Financial Statements

What Your Form 990 and Financial Statements Tell Major Gift Donors?

Nonprofit Major Gift Funding

We spent our last two articles focusing on Form 990 requirements.  Now we turn our attention to Form 990 and Financial Statements as it relates to potential funding.  We are in a new era of giving where nonprofits are being judged and evaluated on multiple levels.  One way nonprofits are evaluated is based on ratio analysis.  Hence, in this article we will walk you through certain financial ratios that your funders may use to analyze the financial health of your organization.  Keep in mind that financial ratio analysis is not the only useful means to analyze financial health. Moreover, a single ratio does not say much about your organization’s financial standing.  However, some funders and charity evaluators use financial ratios as part of their due diligence review of nonprofit organizations. With that said, let’s discuss how financial ratios are used and calculated.

Financial ratios are used to obtain a more accurate interpretation of an organization’s financial health over time, especially when compared to similarly situated organizations or industry benchmarks.  Financial ratios can be used to measure a nonprofit’s efficiency, growth rates, liquidity, cash reserves among other things.  Financial ratios are also very powerful measurements for analyzing trends (how an organization changes from year to year).   Significant shifts in a key area may cause concern for a potential funder that requires additional explanation or inquiry into the nonprofit’s financial operations. Also, most ratios are best used in two ways: 1) in comparing similar organizations and 2) in analyzing an organization over time.  Ideally, you should track internally certain ratios so that your organization zeros in on areas ripe for improvement.

Ratios are calculated based on financial data generated from financial statements or your Form 990 report. Audited financial statements provide the most comprehensive data about your organization, which is one reason funders request this information.  However, because many nonprofit organizations are not required to be audited some funders request Form 990.  Form 990 also provides relevant financial data that can be used to perform a reasonable analysis of an organization’s financial history.  To calculate a ratio, you take one total and divided it by another total.  For instance, a Quick Ratio equals current assets minus inventory all over current liabilities (Quick Ratio= Current Assets – Inventory/Current Liabilities).

Here are a few ratios and how they can be used:

Dependency Ratio

Largest Type of Income/Total Income

A potential funder who is interested in knowing the depth of your support base may use this ratio.  In this instance, the potential funder is analyzing whether your organization is dependent on a few major sources of income.  Overreliance on a few sources of income causes higher risks for your organization.  Diversification of funding sources reduces overall risks for an organization, and makes an organization more attractive to potential funders.

Self-Sufficiency Ratio

Income Source/Total Expenses

This ratio examines the organization’s ability to sustain itself without certain funding sources such as government funding or grant assistance.  For instance, a funder may examine an organization’s ability to be self-reliant by including on the top line only unrestricted donations, program services fees, and investment income.  By analyzing the trend line, a funder can determine whether you are broadening your donor base and public appeal.

Program Expense Ratio

Program Service Expenses/Total Expenses

This ratio is used by various watch dog organizations to determine how much of a donor’s contribution is being used to support programs versus administrative or fundraising expense.  This ratio is probably one of the most widely debated ratios of those listed here.

Current Ratio

Current Assets/Current Liabilities

This ratio gives insight on an organization’s ability to satisfy its obligations.

Fundraising Efficiency

Contributed Income/Fundraising Expense

This ratio measures how efficient your organization is in raising funds per dollar spent.  Funders may be interested in knowing whether their contributions will be spent efficiently if they decide to fund your organization.

Personnel Expense Ratio   

Personnel Expense/Total Expense

A potential funder who wants to know how labor-intensive your organization is compared to other similar organizations may use this ratio.

There are dozens of other ratios.  Listed here are only a few.  You are encouraged to give us a call at 1-888-206-0066 if you would like to speak to one of our consultants about the needs of your nonprofit organization.  SP Consulting is a division of The Scott Practice, LLC, an Atlanta based law practice. This is not legal or any other type of professional advice and may not be relied upon as substitute. Readers seeking professional advice should contact a professional advisor.

Let’s Talk About IRS Form 990

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Do you feel overwhelmed by IRS Form 990?  We want to provide helpful information for newly formed nonprofit organizations that are required to file IRS Form 990 Informational Returns. There will be several parts to this blog entry where we discuss certain aspects of Form 990 and steps that nonprofits can take to cut costs in its preparation. In this first segment, we will discuss the need to maintain proper bookkeeping practices. Yes, maintaining accurate financial data that is properly compiled is essential. Proper bookkeeping practices will result in cost or time savings in the long-run and should be at the top of every organization’s list of priorities when it comes to the financial operation of the organization.   If the organization uses an outside preparer, ask the preparer if they also provide bookkeeping services and whether the organization can receive a reduced fee for its Form 990 preparation if the preparer performs year long bookkeeping.

If the organization properly maintains its financial data within an accounting software program, then the organization will also have the ability to produce financial statements. Of course proper setup of the accounting program along with accurate transaction reporting is necessary to achieve accurate financial statements. For instance, the nonprofit organization’s chart of accounts must be set up properly to generate reports that conform to Generally Accepted Accounting Principles. Hence, seeking accounting or bookkeeping advice in advance of preparation of Form 990 is warranted. Once the accounting software is set up properly and transactions are entered accordingly, then the organization can produce financial records such as a Statement of Activities and a Statement of Financial Position.

The Statement of Activities has several parts that identify the income and expenses of the organization for a specified time period such as an annual period. An organization’s Statement of Activities has strong importance not just for assisting a preparer with Form 990 preparation, but also the statement is extremely useful for budgeting, forecasting and other operational analysis purposes. Again, the organization must enter its transaction details accurately in order to receive ascertainable results.

Other transaction details will be reported on the Statement of Financial Position also known as a Balance Sheet. This information includes details about the organizations fixed asset mix, asset depreciation, liquidity, and stability. If balance sheet information is collected and reviewed overtime, the various data points can will also say something about the organization’s growth and growth potential. Two other financial statements – Statement of Cash Flow and Statement of Net Assets are also essential in providing a complete picture of the health of the nonprofit organization.

One should not take shortcuts when it comes to the financial health and viability of the nonprofit organization. Maintaining accurate financial data throughout the year in an accounting system with proper reporting of transaction history is the first step in potentially cutting the cost of Form 990 preparation. It also in the long run will pay off by yielding financial data necessary to improve efficiencies of the organization.