Understand Financial Statements: a NFP Board Member’s How-to Guide
This article is part of a four-part series that defines key terms and important information for a board member to know and understand. The other three articles discuss accounts payable/accrued liabilities, accounts receivable and deferred revenue and contributions.
Anyone that joins the board of a non-profit organization (NPO) has their heart in the right place. There is no requirement for a board member—save for a treasurer or chair of a finance committee—to have in-depth financial knowledge. But it’s certainly beneficial to understand the basics.
This article addresses how the financial process of an NPO should operate and how that impacts board members who, collectively, share the responsibility of ensuring that proper financial controls exist.
The budget process
A well-considered budget is a key control for any NPO
The budget is a representation of the organization’s expected results for the upcoming year. It should be prepared before the year begins. Every board member should be able to look first to the bottom line of the budget to see the expected results.
Most organizations are good at estimating expected income and expenses and tend not to prepare budgets of their balance sheet. This means that the budget is effectively a cash budget wherein all revenues are assumed collected and all expenses are assumed paid.
A year-to-date budget with actual results that show a net result close to the budget can inspire confidence that there have been no negative changes in the organization’s operations. However, if the results for the period show a significant variance from the budget, then the board should be asking why and what is being done to correct course.
Even if the net result is close, the board should still ask two questions.
- Are the receivables collectable? If they’re not, the revenues may be overstated.
- Are accounts payable and accrue liabilities complete? If not, the expenses could be understated.
An overstatement of revenue and/or an understatement of expenses could have a significant impact on the actual results for the organization.
Frequency of financial information
Ideally, the board would be provided with interim statements that reflect financial information at monthly board meetings. If the board meets less frequently than once per month, it’s important to answer the following two questions.
- Who reviews the internal financial statement in the off months?
- What processes are in place for reporting on deviations from expected results?
If things begin to go off the rails wrong financially and the board only finds out about it three months after the fact, the organization has lost precious time in responding to the situation.
Forecast based on financial statements
It’s important that an organization not commit to spending money it doesn’t yet have. Membership numbers could unexpectedly drop. A grant that was all but assured could never materialize. Be proactive. Have a process to determine how to protect the overall financial health of the organization and how to adjust spending to compensate for loss in revenue. Proactive boards have a much better chance for success than a reactive board.
Remember, if you take on the responsibilities of board membership, you are also taking on the responsibility for the organization’s finances. Not everyone on the board has to be an accountant, but everyone has to be fiscally responsible and should have a basic understanding of how to read and understand a financial statement.