The word “nonprofit” is a bit of a misnomer. Charitable organizations may not pursue financial gain above all, but that doesn’t mean they don’t need funding to operate or further their cause. Indeed, without surplus revenue, a nonprofit can’t grow or scale its mission. And no organization can afford to ignore the financial realities of the world we live in. It takes money—and, usually, greater sums of it—just to stay afloat.
Not-for-profit organizations have a fiduciary responsibility to show their donors what their finances look like at the end of each fiscal year. Mission-based organizations in compliance with Generally Accepted Accounting Principles (GAAP) should prepare these financial statements:
- Statement of Financial Position (Balance Sheet) provides a picture of the NFP’s assets and liabilities.
- Statement of of Financial Activities reports revenue and expenses on activities by those with donor restrictions and without.
- Statement of Functional and Natural Expenses shows expenses by function (i.e., program, fundraising, and administrative) and nature (i.e., supplies, marketing, and salaries).
- Statement of Cash Flows is similar to a for-profit report on cash flow and is meant to show how cash circulates in three main areas: investing, financing, and operating.
What’s so essential about a balance sheet?
Balance sheets are essential for every going concern, nonprofits, and for-profits alike. A balance sheet shows how well your organization is performing financially. The nonprofit term for the financial statement makes it explicit. The balance sheet is also known as a “statement of financial position.”
Whatever you call it, nonprofit balance sheet needs to cover three things:
- Net Assets (or, in the case of a for-profit company, retained earnings or owner equity)
Three parts of a nonprofit statement of financial position
A statement of financial position or balance sheet of a nonprofit has three main parts.
Assets encompass resources such as cash, investments, equipment, and pledges receivable. Not all assets are tangible or material at the moment. A pledge, for instance, represents a donor’s promise to give (typically with a signed form and an agreed-upon payment schedule) rather than the money itself.
Liabilities, as with for-profit entities, are a nonprofit’s debts and financial obligations. A typical statement of financial position differentiates between “current” and “long term” liabilities, with the former category representing obligations owed within one year.
The third item on any balance sheet should show the difference between assets and liabilities—the total financial gain or loss. The net assets of a nonprofit balance sheet signify the departure from for-profit bookkeeping.
A for-profit entity’s balance sheet includes retained earnings or owner’s equity (measured as assets minus liabilities). By contrast, a nonprofit doesn’t retain earnings; it uses them to support its mission. And because no one owns a nonprofit, there’s no equity to be had. Instead, a nonprofit’s statement of financial position defines the difference between assets and liabilities as net assets.
Net Assets post-FASB Accounting Standards Update 2016-14
Before the Financial Accounting Standards Board (FASB) created a 270-page Accounting Standards Update (ASU) 2016-14, how net assets were reported on a balance sheet created confusion for donors, grantors, and creditors to not-for-profits (NFP).
Before the update, nonprofit net assets were divided as follows:
- Unrestricted net assets are not tied to any program or grant. An organization can use unrestricted net assets for general purposes, such as funding operational expenses.
- Temporarily restricted net assets are unavailable for general use at the moment. They get released through either satisfaction of a donor-imposed restriction (such as use in a particular program), or the passage of time. In other words, your nonprofit must exclusively use temporarily restricted net assets for specified purposes in a given period. When that period is up, they become unrestricted net assets.
- Permanently restricted net assets are funds that are essentially limited in use forever. An organization can withdraw from its permanently restricted net assets only when paying for activities or initiatives the money’s donor has designated in advance. Permanently restricted net assets typically include endowment funds held in perpetuity to provide ongoing, periodic funding for particular programs. (An endowments fund’s investment earnings, however, are generally not constrained and can be released to unrestricted net assets to help fund general operations.)
To reduce complexity in reporting, make cash flow, financial performance during the year, and liquidity more transparent, the FASB ASU 2016-14 eliminated the distinction between permanent and temporarily restricted resources.
Net assets were to be classified as either:
- Net assets with donor restrictions are those assets restricted by donors (including grants) or
- Net assets without donor restrictions (including certain grants).
To explain the nature and how many donor restrictions (i.e., of use, of time, or investment return, etc.), nonprofit balance sheets include disclosures (notes).
“Enhanced disclosure in notes to financial statements will provide useful information about the nature, amounts, and effects of the various types of donor-imposed restrictions, which often include limits on the purposes for which the resources can be used as well as the time frame for their use.” FASB Accounting Standards Update No. 2016-14, page 4.
Donor-restricted net assets are those designated specifically for a purpose or a period of time. Endowment funds of cash, securities, or other assets for the maintenance of the NFP are still subject to donor stipulations.
By generating a statement of financial position that covers all of the above, a nonprofit bookkeeper or accountant can easily determine their organization’s current performance. An NFP’s balance sheet also serves an important purpose when communicating with key stakeholders such as donors, grantmakers, and board members.
inDinero’s outsourced accountants have a deep understanding of nonprofit financial management and reporting. Schedule time with our team to learn about our nonprofit expertise.
Quick Note: This article is provided for informational purposes only, and is not legal, financial, accounting, or tax advice. You should consult appropriate professionals for advice on your specific situation. inDinero assumes no liability for actions taken in reliance upon the information contained herein.