The Statement of Financial Position: What Does It Tell You About Your Nonprofit?
For a lot of nonprofits, generating regular financial reports is only part of the operational battle.
The other part — arguably the bigger one — is translating financial reports into usable information.
So today we are explaining the Statement of Financial Position, which is critical in supporting you and your leadership team as you run your nonprofit day-to-day and year-to-year.
Here’s what we’ll cover:
The Purpose of the Statement of Financial Position (the Balance Sheet)
What the Statement of Financial Position Contains
What the Statement of Financial Position Reveals
Red Flags in Your Statement of Financial Position
Potential Reasons for Declining Net Assets
Decisions Supported by Your Statement of Financial Position
Let’s get into it!
The Purpose of the Statement of Financial Position (the Balance Sheet)
First, let’s talk terminology. In the nonprofit world, the Statement of Financial Position is the official term for the report commonly known as the Balance Sheet.
If you’ve ever worked in the private sector, you almost surely used the term “balance sheet.” A lot of nonprofits use that term too. It’s a lot more concise!
For the sake of clarity in this post, we’ll use official nonprofit terminology and call it the Statement of Financial Position.
The purpose of the Statement of Financial Position is to give a comprehensive picture of your nonprofit’s financial stability and resources at a given moment in time.
It is typically prepared monthly or quarterly, and at a minimum, yearly. So it shows you your nonprofit’s financial position in that period of time.
What the Statement of Financial Position Contains
The Statement of Financial Position is typically presented in a format that lists your nonprofit’s assets first, followed by liabilities, and then net assets.
The assets section is usually divided into current assets and long-term assets. In the same way, the liabilities section is usually divided into current liabilities and long-term liabilities.
Net assets are divided into two groups: those without donor restrictions and those with donor restrictions.
Here’s a list of the elements you’ll typically see on the Statement of Financial Position:
1. Assets
a. Current Assets
i. Cash and cash equivalents
ii. Accounts receivable
iii. Grants receivable
iv. Pledges receivable
v. Prepaid expenses
vi. Inventory
b. Long-term Assets
i. Long-term investments: Investments with a maturity date more than one year from the statement date.
ii. Property and equipment: Land, buildings, vehicles, and equipment you own.
iii. Less: Accumulated depreciation on the property and equipment.
iv. Intangible assets: Non-physical assets such as trademarks, copyrights, or patents.
v. Long-term pledges receivable: Pledges expected to be collected beyond the next fiscal year.
2. Liabilities
a. Current Liabilities
i. Accounts payable
ii. Accrued expenses: Obligations you owe for goods or services already received, but that you’re not required to pay for until a future date. These include salaries and wages, professional fees, and utilities.
iii. Deferred revenue: Unearned revenue, or revenue that you’ve received from customers, donors, or grantors in advance for goods or services that you have not yet provided.
iv. Current portion of long-term debt
b. Long-term Liabilities
i. Long-term debt: Loans, bonds, or mortgages with repayment terms extending beyond the next fiscal year.
ii. Deferred compensation: Compensation earned by employees but not yet paid, such as pensions.
iii. Capital lease obligations: Long-term commitments for leased property or equipment.
iv. Asset retirement obligations: Estimated costs associated with the future retirement of long-lived assets.
3. Net Assets
a. Without Donor Restrictions (Unrestricted)
i. Undesignated
ii. Board-designated
b. With Donor Restrictions
i. Temporarily restricted
ii. Permanently restricted
What the Statement of Financial Position Reveals
In listing all your nonprofit’s assets and liabilities, the Statement of Financial Position reveals the net worth of your nonprofit. Net worth is an indicator of overall financial health and long-term sustainability.
Ideally, you should aim for a positive net worth, which is when assets exceed liabilities. A positive net worth suggests that your organization is financially stable.
That seems almost too obvious to state. And in fact, it’s not quite that simple!
When it comes to the financial health of your nonprofit, the degree to which assets exceed liabilities matters. And this degree depends on your nonprofit’s size, structure, circumstances, and objectives.
So a deeper analysis of the Statement of Financial Position is important, because:
- The composition of your assets and liabilities reveals not only your nonprofit’s financial health but its financial flexibility. For example, if a large portion of your assets is tied up in property and equipment, your ability to adapt quickly to changing circumstances may be compromised.
- As a nonprofit leader, you want to understand how to interpret the relationship between your assets and liabilities and communicate it to your board and donors.
Here are some key metrics to consider when comparing assets to liabilities:
Current Ratio
This is the ratio of current assets to current liabilities. A current ratio of 1.0 or higher indicates that you have sufficient current assets to cover current liabilities.
As a general rule of thumb, a current ratio between 1.5 and 3.0 is considered healthy for most nonprofits. A ratio significantly higher than 1.0 may suggest that you’re not using your resources effectively.
Debt-to-Asset Ratio
This ratio compares total liabilities to total assets. A lower debt-to-asset ratio indicates that you own more of your assets outright and you’re less reliant on debt.
A ratio below 0.5 is generally considered favorable. It suggests that your assets are primarily funded by what you own, rather than by borrowing.
Liquidity
In addition to the overall relationship between assets and liabilities, it’s important to consider the liquidity your nonprofit’s assets.
Liquidity refers to how quickly your assets can be converted into cash to meet short-term obligations. Having a sufficient portion of assets in liquid form, such as cash or short-term investments, ensures that you can meet your immediate financial needs.
Red Flags in Your Statement of Financial Position
As you compare your nonprofit’s assets to liabilities, here are some events and elements to watch out for:
- Consistently declining net assets (more on this in the next section).
- A current ratio below 1.0, indicating insufficient current assets to cover current liabilities.
- A high debt-to-asset ratio, suggesting an overreliance on borrowing.
- Insufficient liquidity to meet short-term obligations, indicating that operational disruptions may be imminent.
Potential Reasons for Declining Net Assets
Net assets represent the cumulative surplus of revenues over expenses since the time of your nonprofit’s inception. So if you’re seeing a consistent decrease in net assets, it indicates that you’re consistently spending more money than your nonprofit is bringing in.
If this is happening, here are the usual culprits:
Operating Deficits
Your nonprofit’s regular expenses may exceed revenues. If this is the case, your Statement of Activities (the nonprofit term for the Income Statement) will show this. Operating deficits erode your net assets over time because they force you to dip into reserves or borrow money to cover constant shortfalls.
Insufficient Revenue
Your nonprofit may not be generating enough revenue to support your programs, services, and operations. If this is the case, it could be due to a variety of factors, such as a decrease in donations, grants, or earned income, or a lack of diversification in revenue sources.
Unsustainable Spending
Your nonprofit may have more than an “expenses exceeding revenues” problem. It may be structured in a way that you’re spending more money than you can afford in the long run. If this is the case, the issue, paradoxically, may be your growth. You might have hired too many people too soon, or expanded programs beyond what you can currently support.
Inadequate Financial Planning
Your nonprofit may lack a comprehensive financial plan aligned to your mission. Every nonprofit needs a financial strategy that includes budgets, forecasts, and internal controls. These allow you to operate with foresight and stewardship.
External Factors
Your nonprofit may be impacted by factors outside not of your own making, such as changes in the economy, shifts in donor preferences, cuts in government funding, or some type of crisis or emergency.
Decisions Supported by Your Statement of Financial Position
Armed with a regular Statement of Financial Position, along with an understanding of the relationship between your nonprofit’s assets and liabilities, you can make informed, strategic decisions about all of the following:
Budgeting
The Statement of Financial Position is the starting point for an organization-wide budget grounded in a realistic understanding of your financial position and capacity. The clear presentation of assets, liabilities, and net assets enables you to identify areas where resources are best allocated, and where you may need to reallocate them.
For example, if your Statement of Financial Position shows a significant increase in liabilities, you may need to create a budget that prioritizes debt repayment or reduces expenses. Or, if your Statement of Financial Position shows a strong net asset position, you may have more flexibility to invest in new programs or initiatives.
Revenue Diversification
By analyzing the assets and revenue sources articulated in your Statement of Financial Position, you can assess your nonprofit’s reliance on particular funding streams. Reliance is a risk, and it prompts you to create mitigation strategies.
For example, if you see that a large portion of your assets are restricted by donors for specific purposes, you may need to build revenue sources to support other priorities or operations in general. Or, if you see that your nonprofit relies heavily on a single revenue source, such as a government grant or a major donor, that’s another instance that demands diversified revenue sources.
Ultimately, your Statement of Financial Position supports sustainability because it points to those areas where sustainability is vulnerable.
Capital Investments
The Statement of Financial Position shows your property and equipment, such as buildings, vehicles, and technology infrastructure. By analyzing the depreciation of these assets, which means understanding their age and condition, you can decide when it’s time to invest in new capital assets or upgrade existing ones.
Reserve Funds
Given the Statement of Financial Position’s role in enabling you to assess your nonprofit’s financial flexibility, you can better decide how to allocate your resources. Should you build up your operating reserves? Endowment funds? Other long-term savings? The Statement of Financial Position offers your best answers to these questions.
Program Expansion or Contraction
By reviewing net asset balance and liquidity shown on your Statement of Financial Position, you can make strategic decisions about whether to launch new programs or services, expand existing ones, support underperforming but core ones with more resources, or perhaps discontinue some.
Debt Management
The Statement of Financial Position shows your nonprofit’s outstanding debts, such as loans or mortgages. You can use this information to decide whether to pay down existing debt, refinance to secure better terms, or take on new debt to finance growth or capital projects.
Investment Strategy
If you have any significant financial assets, such as endowments or long-term investments, the Statement of Financial Position supports the investment strategy you create to protect and grow these. This statement will show the performance of your investment portfolio and thus guide you in asset allocation, risk tolerance, and spending policies that support your mission well into the future.
Staffing and Compensation
Patterns in your Statement of Financial Position show you the relationship of your talent to your financial outcomes over time and will help you assess your nonprofit’s capacity to support its human capital. Not only will this statement help you make decisions about headcount, leadership, and compensation packages, but it will also guide your practices around initiatives designed to attract and retain top talent, like professional development programs.
Collaborations and Mergers
When an opportunity to partner with or join other organizations presents itself, the Statement of Financial Position for all organizations involved is your key to evaluating these opportunities and then, if you decide to proceed, structuring and financing them.
Risk Management
Potential risks can seem vague, but your Statement of Financial Position makes many of them concrete and visible. This means you can take corrective action before a crisis erupts. For example, if you see a high concentration of assets in a particular investment or property, you can diversify your holdings to reduce risk exposure.
Need to make sense of your Statement of Financial Position more quickly? Or discuss it with your board? Or generate it with timely financial data? Denise Henning, CPA can help. There’s no need for you to labor over this when we can take it off your hands and give you exactly the information you’re looking for. Reach out to us today, or call us at (412) 719-8900. We look forward to hearing from you!