Nonprofit governance is by no means an easy task. To protect their financial health and viability, nonprofits must be aware of various factors that can affect corporate integrity. Many of the recent bankruptcies and financial mishaps in the nonprofit sector can be attributed to a failure to properly monitor relevant criteria and poor management of fiscal resources. Here are some tips for taking a proactive approach to guard against such problems at your organization.
Use dashboards for decision making: Most organizations produce monthly or quarterly financial statements that consist of a balance sheet, income statement and budget-to-actual report. However, the content and nature of such reports can vary widely. Financial dashboards can be used by decision makers to analyze tailored financial information using graphs and visuals. They keep everyone on the same page by presenting information in an easily digestible format. Consistent monitoring of dashboard metrics helps avoid surprises. Determine what information is most important for your senior staff and board members to view, then create a standardized dashboard tracking those metrics. Dashboards can also be used at the program level to analyze financial and other programmatic information. Better financial information leads to better financial decision making.
Understand your liquidity: Liquidity ratios can be used to measure an organization’s ability to meet its near-term financial obligations like rent, payroll, mortgage payments or payments against a line of credit. For example, the “current ratio” is the proportion of current assets available to cover current liabilities. (A quick Google search for “current ratio calculator” pulls up a nice one from BankRate.) This ratio can give you the information you need to plan for covering upcoming payments. In addition, a “classified balance sheet” can be prepared with assets and liabilities arranged in a format of current versus noncurrent assets and liabilities. Identify other organizations within your “peer group” to benchmark your organization's financial health and liquidity ratios against. The financial statements for most New York state charities can be found onwww.charitiesnys.com. Bear in mind, organizations that receive government funding may have their mortgage payments reimbursed by New York state. Therefore, when calculating their liquidity, consider that future mortgage payments may be paid for with future reimbursements.
Take the “balance sheet approach”: Nonprofit organizations tend to overlook the importance of the statement of financial position or “balance sheet” and focus instead on the “income statement” or “statement of activities” showing net income or loss for each period reported. The balance sheet measures the financial strength of an organization, while the income statement reports the profitability of one particular period. For example, the income statement doesn’t reflect when your accounts receivable will come in. You may also be reviewing line items that need to be reassessed to determine whether they should be written off or written down. The board should focus on the balance sheet and obtain periodic reporting on specific balance sheet items such as accounts receivable. Use an “aging report” to identify old receivables that may become uncollectible. An aging report will list your outstanding receivables by various categories, such as “less than six months old,” and “less than one year old.” Also consider calculating the average number of days it takes to collect revenue after it is billed, often referred to as “days outstanding.” Simple questions such as “Is this a realizable asset?” or “Is this a true liability?” can unearth more information about the validity of the amounts presented on your balance sheet. The board should never shy away from these questions.
Understand the economics of government contracts: Social service agencies struggle to meet their clients’ needs with the level of government funding they receive. Over recent years, we have seen government funding levels decrease while demands increase. Most government contracts are “cost reimbursement” contracts where the income equals expenses. These contracts can lead to losses when expenses exceed the level of reimbursements. As a good starting point, produce internal profit and loss reports by program. Plan ahead to obtain additional funding for programs where losses can be expected. Organizations with the luxury of large endowments often use these funds to cover losses. If this is not possible for your organization, you will need to create or rely on other revenue streams.
Tone at the top: The ethical environment that is created by the organization’s board of directors and top management has a trickle-down effect. The tone set by the board and management should promote ethics, integrity and transparency by clearly communicating expectations and leading by example. At a minimum, organizations should enforce their conflict-of-interest policy and communicate the code of ethics to employees. As the ultimate authority of the organization, the board should conduct annual performance evaluations of its top management employees, including, at minimum, the chief executive officer, chief financial officer, chief operating officer and chief information technology officer.
There is no single factor that a nonprofit can rely on to comprehensively evaluate its governance policies; the various components are interrelated and can only be effective when taken as a whole. The importance of each factor will vary by organization but collectively they will all play a role in the financial health of your organization. Be aware.
Sibi Thomas, CPA, CFE, is a partner at Marks Paneth LLP and an Adjunct Faculty at New York University. Thomas specializes in audit, advisory and tax services for nonprofits in New York and neighboring states. Thomas can be reached at firstname.lastname@example.org