Before New York’s Federation Employment and Guidance Service (FEGS) filed for bankruptcy last year, nobody saw it coming. The nonprofit was 80 years old and had $260 million in revenues, but lurking behind those successes was an unseen $20 million deficit. Nobody – including the board and management – seemed to know there were liquidity and cash flow problems. How did this happen? That is the question everyone has been asking. Answering it requires an understanding of the complexities of nonprofit financial statements. The three complexities that we are going to discuss in this blog post are liquidity, performance measures and net assets.
Liquidity, an important metric that we’ve discussed in previous blog posts, has never been emphasized in nonprofit financial statements other than how items are sequenced on the statement of financial position (balance sheet). To date, the FASB has not required entities to measure and report cash flow, but all that may soon change for nonprofits. As it deliberates the proposed Accounting Standards Update for Not-for-Profit Entities, commenters have supported improving disclosures of information useful in assessing liquidity, as well as other indicators of financial performance. Boards, lenders, creditors and big donors tend to be the biggest users of nonprofit financial statements, but while mission and overhead are open to scrutiny, critical financial information around liquidity is opaque – or worse, not present.
Currently, one of the biggest problems for readers of nonprofit financial statements is that nonprofit financial statements do not read like for-profit financial statements, which emphasize financial performance and return on investment for stockholders. Nonprofits, which have no stockholders, are prohibited by the FASB’s Accounting Standards Codification from using phrases like “net income” or “operating income,” so their statements don’t provide much information on financial performance. This can have serious implications for stakeholders trying to understand the overall health and sustainability of the nonprofit organization. Additionally, nonprofits currently do not have standards or a framework to measure and report KPIs about financial performance.
One solution the FASB is exploring is requiring nonprofits to present better disclosures related to net assets with and without restrictions, in order to provide more meaningful information and a better understanding of the resources available to the organization versus resources that are set aside to meet a donor’s intent. Without that distinction, most of an organization’s net assets may be locked up in various ways—such as endowments, property and plant, or other restrictions or designations—which may lead stakeholders falsely to believe the funds are available for use when they are not.
While there are advantages to reporting on liquidity, there are also concerns nonprofits must address, such as the effect this new information will have on donors. An organization with faltering liquidity may either face skepticism from major donors, or they could see an influx of donations from supporters who see a dire need for resources. Before any changes to financial reports become mandatory, nonprofit leaders should become keenly aware of their liquidity and cash flow situation and prepare to address their stakeholders accordingly.
Fortunately for organizations, none of the changes the FASB is considering will cost much to implement. Rather, they are simple measures intended to help the reader of statements better understand the financial results, which is something that should ultimately benefit the financial health of nonprofits.
This article was reprinted in its entirety with the permission of the BDO Alliance USA.
For more information contact a BerganKDV Nonprofit Advisor.