Seeing the story in your finances is the key to decision making.
More than ever, nonprofit organizations need a solid financial management foundation and professional financial leadership. Having your Board and senior staff understand your organization’s finances is fundamental to their fiduciary responsibilities and is crucial to meeting the demands of donors and the public. Without it the Board and staff face the potential liabilities of failing their fiduciary responsibilities, the loss of funding because of the disapproval of their donors, and most importantly the failure to server their constituents by failing to maximize the organization’s financial resources in pursuit of the organization’s mission.
Understanding a nonprofit’s finances, however, can be difficult. Nonprofits are complex. There are multiple programs, fundraising and administrative expenses to account for, as well as unrestricted and restricted net asset balances to track. The basic financial tool to inform the Board and staff about the organization’s finances is the budget vs. actual financial statement. It is typically multiple pages long with comparisons of budgeted revenue, expense for each program, fundraising and administration as well as for natural classifications of revenue and expense such as grants and contributions and salaries and wages. It will have summaries of unrestricted and restricted net asset balances and changes in those balances as well as a report on asset and liability balances compared to prior periods.
To make sense of all of these reports and bring meaning to all of the numbers, the budget vs. actual financial statements must be accompanied by a narrative analysis that summarizes results and highlights what is important. Without it Board members and staff will spend hours of time trying to make sense of the numbers leading to frustration and quite possibly still lack the understanding they need to meet their financial responsibilities.
The narrative should include at the outset total revenue, total expense and total revenue less expense and compare these figures to budgeted amounts. Total revenue and total expense express the gross volume of revenue generation and spending and when compared to budget give a big picture view of what has happened compared to expectations. These comparisons are key indicators of potential major changes that may have taken place. Revenue less expense reflects an organization’s net increase or decrease in net assets for the period or in other words if it is running a surplus or a deficit. This is important to know but it is more important in relationship to what was expected. Organizations may intend to run deficits or surpluses for a period of time within the scope of their long-term objectives.
Next the narrative should describe significant variances in both revenue and expense compared to budget. This description should start with the numbers but should quickly get to a discussion of the underlying activities. Perhaps a fundraising plan was not as successful as expected, a program became unworkable or a new opportunity presented itself. This is the information the Board needs to provide proper oversight. The numbers serve as indicators attracting attention to the more important story about activities that affect progress towards goals and strategies.
In addition to discussing revenue and expense, the narrative should discuss the organization’s assets and liabilities. These numbers reflect the organization’s stored resources available for future activities and claims against those resources and future activities; how much cash is available compared to what will be needed in the months ahead; is excess cash invested correctly; are pledge commitments being met; are liabilities paid on time. The narrative discussion of cash, pledges receivable and accounts payable balances should be tied to appropriate operating issues and cash, investment and loan balances should be discussed in the context of policies and contracts governing those balances such as investment and operating reserve policies and loan covenants.
The narrative analysis should contain a thorough discussion of the organization’s net assets. These balances reflect accumulated surpluses which are available for future operations. Nonprofits are not in the business of accumulating surpluses so balances here need an explanation of their purpose. A designated surplus of unrestricted funds equal to three months of operating expense is completely appropriate but a surplus of unrestricted and undesignated money should have an explanation of its intended use. Restricted funds should be described in relationship to the activity they support and the terms of their restriction. Net assets represent the organization’s “cushion” and the size and characteristics of that cushion needs to be thoroughly understood.
Finally, the narrative should look forward, at least to the end of the year, and beyond if the organization has a long-term plan. There should be a discussion of how the results of operations and the financial position will affect the organization’s plans for the remainder of the year. Will the funds be available to do what was planned? Do actions, goals or strategies need to be revised given the current circumstances and resources? What will the organization’s ability to carry on its activities into the next year be? If there is a long term plan, how will the changed environment and resources impact long term goals and strategies? Helping the Board make the right decisions about the future is the primary purpose of the narrative report.
A good narrative analysis – in addition to budget vs. actual financial statements – is an essential nonprofit financial management tool. It summarizes the results of operations, the current financial positon of organization and looks to the future. It highlights what is important so leadership has the knowledge to maintain accountability and make key decisions. It reduces frustration by simplifying complexity and minimizes the amount of time spent talking about finance rather than programs.
An effective narrative analysis can only be performed by a person with a thorough understanding of the organization’s finances, programs, goals and strategies. The analysis cannot be done in isolation, however. There needs to be a process in place that facilitates the gathering and processing of financial data and turning into information. This means sharing that data with the people whose activity it measures and learning their stories and communicating those stories in the context of the organization’s goals and strategies. With this knowledge, leadership can confidently move forward taking advantage of opportunities and maximizing the organization’s impact.