As a management member or board director of a nonprofit organization, you play a crucial role in overseeing its financial health and ensuring its sustainability. Understanding financial statements can seem daunting, but with the right approach, you can leverage them to make informed decisions and drive your mission forward. Here are some key tips and tricks for effectively reading, understanding, and analyzing financial statements.

Start with the Big Picture: The Four Key Statements

Non-profits typically prepares four financial statements:

• Statement of Financial Position (Balance Sheet): This provides a snapshot of the organization’s assets, liabilities, and net assets at a given point in time. Pay attention to liquidity (cash and equivalents), debt levels, and the composition of net assets (restricted vs. unrestricted).
• Statement of Activities (Income Statement): This reports revenues, expenses, and changes in net assets over a specific period. Focus on revenue trends, major expense categories, and whether the organization is running a surplus or deficit.
• Statement of Functional Expenses: This is unique for nonprofit organizations. The report provides details of expenses by both nature and function and helps donors and other users access service efforts.
• Statement of Cash Flows: This details cash inflows and outflows from operating, investing, and financing activities. A positive cash flow from operations is essential for sustainability.
  
  

Focus on Key Performance Indicators

To assess the financial health of the non-profit, consider these key metrics:

• Current Ratio: (Current Assets / Current Liabilities) – Measures liquidity and the organization’s ability to meet short-term obligations.
• Operating Reserve Ratio: (Unrestricted Net Assets / Annual Expenses) – Indicates how many months the organization could sustain operations without new revenue.
• Program Service Expense Ratio: (Program Expenses / Total Expenses) – A higher ratio indicates that more funds are directed toward the mission rather than overhead.
• Fundraising Efficiency: (Contributions/Fundraising Costs) – Evaluates the effectiveness of fundraising efforts.
• Contribution Ratio: (Contribution and Grant Revenue/Total Revenue) – Evaluates how much the organization relies on external supports as opposed to program revenues.
  
  

Watch for Red Flags

While reviewing financial statements, be alert to these potential warning signs:

• Recurring Deficits: Consistently spending more than revenue could indicate sustainability issues.
• Declining Cash Reserves: A shrinking cash position can signal financial stress.
• High Debt Levels: Excessive liabilities may pose risks if not managed properly.
• Restricted Net Assets Constraints: If most assets are restricted, the organization may face operational challenges despite having a strong balance sheet.
  
  

Ask the Right Questions

To gain deeper insights, ask questions like:

• What is driving changes in revenue and expenses?
• How does our financial health compare to industry benchmarks?
• Are we maintaining adequate reserves for future uncertainties?
• What is our strategy for diversifying revenue sources?
  
  

Leverage Financial Statements for Strategic Decision-Making

Financial statements are not just compliance documents—they are tools for strategic planning. Use them to:

• Align financial resources with the mission.
• Identify trends and make proactive adjustments.
• Ensure compliance with donor restrictions and grant requirements.
• Support fundraising and grant applications with financial data.
  
  

Conclusion

By developing a strong understanding of financial statements, you can enhance your ability to govern effectively and guide your non-profit toward long-term success. If you need deeper insights or professional analysis, don’t hesitate to consult with a CPA who specializes in non-profit finance. Your informed oversight is key to driving impact and fulfilling your organization’s mission.