Serve on a Nonprofit Board? Here’s a Quick Guide to Reviewing Financials
I’ve served on a lot of nonprofit Boards, and I often find myself serving in some role related to organization finances. This could be as Chair, Treasurer, or a member of the Finance/Audit Committee.
I enjoy those roles. But remember, any board member, whatever role they play, has a fiduciary duty to reasonably understand the organization’s financial standing. Sorry to be the skunk at the garden party with that reminder! But it’s good to understand this fact; after all, even while volunteering your time, you’re taking a personal risk by glossing over this stuff.
But here’s a better way of thinking about this: Digging in on an organization’s financial picture is the cheat code for Board Membership! Seriously, if you understand the financials, you can skim through almost everything else in your board book and still know most of the important things that are going on. (Don’t tell anyone it was me that told you that 😊)
That’s because almost anything the organization does that is meaningful will require money. Both money that is coming in (revenues), and money that is being spent (expenses). After that, the amount of money the organization keeps in hand (revenues minus expenses) will usually show up directly in the size of its piggy bank (the balance sheet).
When you understand the basics, you’ll have a direct path to understanding the health of the organization and how well it can survive a financial shock. You’ll also be able to notice things that seem a bit off from what you expected (variances) that probably deserve some explanation.
It's really not much different than managing your own personal finances. But for whatever reason, I see lots of brilliant, successful Board members gloss over the financials and not ask the tough and important questions. Maybe they assume someone else knows it better and has already asked the questions. Or maybe they get intimidated by the accounting terms they don’t fully understand.
Whatever the reason, without these questions being asked and answered, a nonprofit with great aspirations but limited resources can move pretty quickly into financial freefall. And guess what? Then your fiduciary duties really kick in, and you have much less fun conversations. Topics thrown your way probably start to include layoffs, furloughs, the elimination of service areas, the need for a merger or even organizational dissolution. Blech.
Sadly, this happens a lot more than you would think. So I always encourage Boards I work with to understand the financial basics and then poke at anything that looks soft. Almost always, after a few reps, Boards become pretty adept at getting to the root of any issues quickly and strengthening their financial core. Here’s where you can start:
Understand Major Categories in Your Income Statement. A nonprofit’s income statement can be called a Statement of Activities, a Profit & Loss or occasionally something else. It can also be presented within your “Budget to Actuals” report. In all cases, it will present both revenues and expenses, and those should be broken down into major categories/ areas where money is flowing.
Make a lot of money from government grants or program fees? This should show up within a category under revenue. Do you give out grants or hire a lot of contractors to support your programs? This will show up under your program expenses. Take the time to go through this financial statement purposefully, and you’ll gain a deeper understanding of how your leadership understands and executes on its work. And as you look at the numbers, you’ll also begin to see what’s more or less important as part of your strategy – the amount you spend (or make) proportionally to other categories tells that story in plain terms.
Look for Variances and Seek Explanations. Do a purposeful look at the budget to actuals report. We are not looking for perfection against a budget, more for indications that something is going wrong. You really don’t care about little things that don’t cost much - but when budgeted amounts for significant parts of your enterprise show more than a 15-20% variance, it probably deserves an explanation. The variance can be for very understandable reasons – a donor didn’t pay funds when expected or a vendor didn’t invoice in time so the expense will show up next month – but issues should be asked about and easily answered. And a reluctance or inability to answer might suggest a deeper challenge that needs to be addressed.
Understand your Burn Rate & Months of Cash on Hand. The balance sheet will give you a quick look at cash, investments, and other liquid assets. These funds are broadly available to help fund your daily operating expenses. Then a quick and easy calculation is to take your annual expense budget and divide it by 12 to understand, on average, how much cash you burn through each month. Do your reasonably liquid assets represent less than 3 months of cash needed? If so, you probably should be asking questions at that point about your cash flow, the grants you are expecting to come in, and the potential need for a line of credit. Hopefully your exec team will be on top of this and show you their path to greater financial stability. But if not, it’s better you ask these questions now rather than in about 6 weeks when payroll obligations are starting to cause concern.
Calculate your Program Expense Ratio. In full transparency, I really despise this metric as I think it is a very clumsy way of looking at financial health. But it is a regular metric used by donors and, if your numbers are significantly different than market standard, your executive team should be able to explain why. The simplest way to calculate this ratio is to take all of your program expenses and divide by your total organizational expenses. A ratio of 80% or more is what you want to see, with lower ratios seen in specialized types of nonprofits or those that largely receive grants from the US Government. Below 80% starts getting you into trickier territory with donors. Of course, one of the key reasons this metric is frustrating is that depending on the donor, they may feel that all of your staff expenses – even for those staff that work 100% on program efforts – are counted as operational expenses. Hopefully you are seeing why I despise this metric now!
Finally, ask the question! The most important rule to me is that if you don’t understand something, by all means ask! You have the fiduciary responsibility to do so as a board member. That’s a legal responsibility that subjects you to potential personal liability for not asking reasonable questions when you are presented with information that should be questioned. If you’re not ready to jump in during the board meeting with your questions, that is certainly fine. Ask the CFO for some time outside the meeting to give you an orientation and allow you to ask your questions. If they hesitate to be of help, that is often an indication of something more serious to look into.
These are the basics, but your questions will help point to issues that need to be resolved or where you need additional, professional help. And if you have questions about these other areas, we’re here to help! Reach out for a free consultation and, if useful, we are available to conduct a summary review of your organization’s financial health and systems. We’ve found this can be a powerful tool to help secure your mission and steward your donor-supported efforts. Contact us at info@yieldcreative.net.
As part of Yield Creative and Summit CPA’s work together, we’re sharing this blog (and more to come!) because we are hyper passionate about helping our clients - brilliant entrepreneurs, boards, leaders and their amazing teams - execute on their strategies and reach new heights. If you have any questions about these areas or would like to discuss how to build and maintain your financial engine, certainly reach out.