Nonprofit organizations submit financial statements to government authorities, lenders and investors just like their for-profit counterparts, although the focus of the financial statements is slightly different. Understanding a nonprofit financial statement involves analyzing the items that are relevant to wise financial management and sustainability rather than placing emphasis on profit and revenue growth.
Read the income statement, also known as the statement of activities, to analyze the organization’s income and expenses for the period. Pay special attention to the ratio of total expenses to total income; an organization with a high ratio of expenses to income may be productively allocating all available resources to its services and programs, or it may not be managing its finances wisely. Keep this information in mind when reading other financial statements to get a clearer picture of the income statement’s implications.
Read the balance sheet, also known as the statement of financial position, to get an in-depth look into the organization’s assets. Take notice of the organization’s total liabilities, and compare it against its cash and liquid assets. As a rule, a nonprofit organization should not be accumulating large amounts of debt, since the organization is not likely to conduct profit-generating business activities to repay loans. Most of a nonprofit’s liquid assets should come from donations, grants, and investment income.
Read the statement of cash flows to analyze the organization’s spending patterns. The statement of cash flows details how much money came into the organization and where it came from, as well as how much money the organization spent and where it went. Pay attention to the ratio of overhead and salaries expense to direct program expenses. Frugal nonprofits know how to operate lean, diverting as much money as possible to their programs.
Browse the management’s discussion and analysis section and the accompanying notes to gain insight into any unexplained items. This section describes any extraneous events that influenced financial statement items. The discussion and analysis may also detail plans for future expansion of services or any changes to the organization’s top management team or strategic direction.
Perform ratio analysis on financial statement items, and compare the results against competitors and industry standards. Profitability metrics, such as net profit margin and return on assets, are not as important when analyzing nonprofit financial statements. Focus on metrics of financial sustainability and cash flow, such as the cash flow coverage ratio and times interest earned.
– David Ingram