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This question was recently posed to the ASU Lodestar Center’s “Ask a Nonprofit Specialist”:
A nonprofit Board of Directors has 2 essential financial responsibilities:
- Ensure assets are protected and used to support the organization’s charitable purpose in compliance with regulations and standards.
- Make certain the organization has sufficient resources to fulfill the organizational mission, otherwise known as fundraising and resource development.
The detailed review of financial statements is often delegated to a Board Finance Committee, but every member of the Board should be able to interpret financial statement basics. Training for members without financial expertise is essential for any effective Board of Directors.
An organization’s budget, financial statements and summary reports to Boards of Directors should all do the following:
- Set expectations (budget and/or prior year experience, plus acceptable variations to expectations);
- Compare actual activity to expectations (comparison of budget/prior year to actual);
- Present a picture of the financial health of the organization.
The numbers in financial statements are always relative to other numbers, and it is this relativity that gives the numbers meaning. Through a comparison of budget and prior year to actual, the Board should be able to answer the following questions:
- Does the organization have enough cash and receivables to meet our immediate and longer term cash and resource needs as defined by our budget?
- What is the trend of revenue, expense and other activities? How do these trends compare to expectations?
- Are changes necessary to accommodate changes?
- Are funds being generated and spent in alignment with internal and external expectations, restrictions and legal requirements?
- What is the overall financial health of our organization?
Nonprofit organizations come in all shapes and sizes—and with different challenges. Many ratios and other information can be derived from financial documents that are useful to interpretation. Some are critical to every organization and others are more particular to individual situations.
The Nonprofits Assistance Fund has a great resource that describes 14 different types of financial ratios. One of the most well known is the function expense ratio that illustrates administrative and fundraising expenses relative to program expenses. Other ratios include:
- Sources of revenue – useful to determine and monitor over and under reliance of different sources of revenue;
- Cost per unit of service – helpful in measuring efficiency of service delivery;
- Months of Liquid Net Assets - essential to determining the adequacy of liquid assets needed to cover upcoming expenses;
- Personnel Costs – monitors personnel costs relative to the budget as a whole, expectations and past experience.
Together with your Board, develop transparent strategies for focusing on agreed upon financial metrics, based on well defined expectations that reflect your organization’s unique needs. Limit the metrics to the most critical factors— those that truly reflect the challenges and opportunities for your organization.
The Lodestar Center’s Nonprofit Management Institute offers great training for nonprofit professionals and volunteers in its Financial Management classes, with courses later this month in Tucson and in July in Tempe. Check out our Frequently Asked Questions section on our webpage for information on financial management and other nonprofit management issues. You are also welcome to pose your own question to the Nonprofit Expert.
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