I was talking to a friend/prospective client recently about the accounting knowledge that is a key part of my work.
We agreed that in too many non-profits, the board’s finance committee doesn’t perform its necessary function. The committee members look at a few reports when they meet, but they don’t really dig in. They may have a soft connection to “numbers,” but they aren’t always great at picking apart financial statements.
So, the question came up: if you want to evaluate financial risk in your non-profit, where would you start?
While details may vary depending on the type of non-profit involved, these would be the first three things I would do:
1. Prove the Balance Sheet
Before you can do anything, you have to trust the numbers you’re given. This may seem obvious, but too often it’s not the case.
As I’ve written before, it’s too easy to “sin on the income statement, repent on the balance sheet.” So, I always want to start with the balance sheet. I want to know if every significant number on that balance sheet has a matching supporting schedule. In general, finance committees don’t dig that far into it. But if you want to spot possible issues, you have to get into the details.
You would hope that if there were problems, a non-profits’ auditor would point them out in the management letter. Unfortunately, the quality of audits ranges widely. Too many CPAs act like part-time bookkeepers and not outside auditors—and too many internal finance people can’t tell the difference.
2. Review Accounts Receivable
Many non-profits go bust because their accounts receivable isn’t what is seems to be.
Most of my clients are highly dependent on Medicaid and other government contracts. Therefore, if you want to understand their financial health, you need to understand the quality of the accounts receivable.
Determining A/R quality can be complex. Different programs from different funders will have different payment patterns. Surprisingly (or not, depending on your perspective), many non-profits can’t analyze A/R at the level of detail necessary to see where the risks are because of poor software, poor software configuration, poor process or all three.
The good news is that almost every system I’ve ever seen that can produce an income statement by program can also produce an A/R aging by program—even if not out of the box.
When I speak of A/R, of course, I would also include an analysis of unbilled revenue. Basically, any entry that created revenue but hasn’t created cash needs to be reviewed regularly. This review (along with a review of any other relevant high-level information), should be done by the board’s finance committee.
3. Review Statement of Cash Flows and the Rest of the Balance Sheet
After looking at A/R, I would then turn to the statement of cash flows and ask the following:
- What key numbers have changed?
- Where is cash syncing?
- Are restricted assets rising (making that great fundraising number just a promise for the future)?
- Are deferred revenue and cash out of whack (so we’re using next year’s deposits to pay off this year’s expenses)?
The type of business involved and its cycle will determine which key numbers I want to review next. But again, I’m still focusing on the balance sheet.
Only after going through the above will I start to look at budget vs. actuals on the income statement and current year vs. prior year to see if the organization can plan and keep to the plan.
But I will only go there after I know that the basic financial numbers are properly reported and key risk areas identified. Too often, folks look at these statements at a surface level and conclude that everything looks good.
Or even worse, they’ll start asking questions like “How can we keep copier expenses in line?” without having looked at the real risks.