How to Read Nonprofit Financial Statements

Nonprofit financial statements provide a clear picture of an organization’s financial health and how it utilizes resources to achieve its mission. Understanding these statements is important for stakeholders, including donors, volunteers, and the public, to assess a nonprofit’s accountability and effectiveness.

The Essential Nonprofit Financial Statements

Nonprofit organizations typically prepare three primary financial statements to report their financial activities and position, adhering to Generally Accepted Accounting Principles (GAAP). These statements offer different perspectives on the organization’s financial narrative and are designed to provide transparency.

The Statement of Financial Position, often called a balance sheet in the for-profit sector, presents a snapshot of the nonprofit’s financial standing at a particular point in time. It details what the organization owns (assets), what it owes (liabilities), and the remaining value (net assets). Assets are economic resources that provide future benefits, while liabilities are obligations to other entities. Net assets represent the residual value after subtracting liabilities from assets, indicating the organization’s equity.

The Statement of Activities serves a similar purpose to a for-profit income statement, outlining the organization’s revenues and expenses over a specific period, such as a fiscal year. This statement shows how the organization’s net assets have changed due to its operations. Revenues include contributions, grants, program fees, and investment income, while expenses are the costs incurred to run the organization and deliver its mission. The difference between revenues and expenses is reported as the change in net assets.

The Statement of Cash Flows reports the movement of cash into and out of the organization over a period. It categorizes cash flows into three main activities: operating, investing, and financing. Operating activities relate to primary mission-driven functions, investing activities involve buying or selling long-term assets, and financing activities include transactions related to debt or endowments. This statement helps evaluate a nonprofit’s ability to generate and use cash to meet its obligations and fund its programs.

Key Elements Within Nonprofit Financial Statements

Nonprofit financial statements contain specific classifications that offer deeper insights into an organization’s financial flexibility and operational focus. Understanding these elements is important for a comprehensive interpretation.

Net assets are classified as either with donor restrictions or without donor restrictions, reflecting how contributions can be used. Net assets without donor restrictions are available for any purpose consistent with the organization’s mission and can be used at the board’s discretion. Net assets with donor restrictions are subject to specific donor-imposed limitations on their use, which may relate to a particular program, a future period, or require funds to be maintained permanently, such as in an endowment. This distinction is important for understanding the organization’s financial flexibility.

Nonprofits are required to classify their expenses by function: program services, management and general (administrative), and fundraising. Program services expenses are directly related to mission delivery, such as costs for educational initiatives or direct aid. Management and general expenses cover overall administration and oversight, including executive salaries and office rent. Fundraising expenses are incurred to solicit contributions, such as marketing costs for campaigns. This functional classification helps stakeholders assess how efficiently resources are directed towards mission-related activities.

The recognition of contributions and revenue in nonprofits has specific considerations. Cash contributions are generally recognized when received. In-kind contributions, such as donated goods or services, are recorded at their fair value. Pledges, which are promises to give, are recognized as revenue when the promise is unconditional. Donor restrictions on contributions impact when and how revenue is recognized, ensuring funds are accounted for according to the donor’s intent. This careful accounting ensures transparency regarding the availability and use of donated funds.

Analyzing Nonprofit Financial Performance

Analyzing nonprofit financial statements involves interpreting data to gauge the organization’s health, efficiency, and long-term viability. This analysis helps stakeholders understand if the organization is effectively achieving its mission while maintaining financial stability.

Key financial ratios offer insights into different aspects of a nonprofit’s performance. Liquidity ratios, like the current ratio, assess the ability to meet short-term obligations. The current ratio is calculated by dividing current assets by current liabilities, with a ratio of 1.0 or higher generally indicating a healthy short-term financial position. A ratio above 2.0 suggests strong liquidity.

Efficiency ratios measure how effectively an organization uses its resources. The program expense ratio, calculated as program expenses divided by total expenses, indicates the percentage of spending directly on mission-related activities. Many watchdog groups recommend this ratio be 65% or higher, with some suggesting 70% or more. The fundraising efficiency ratio evaluates the cost-effectiveness of fundraising efforts, calculated by dividing fundraising expenses by total contributions. A lower ratio, such as spending $0.20 or less to raise $1.00, is considered favorable.

Sustainability and solvency ratios provide insight into an organization’s long-term financial health. The operating margin, calculated as the operating surplus divided by total revenues, shows the ability to generate a surplus from operations. A positive operating margin indicates that the organization is covering its costs and potentially building reserves. The debt-to-asset ratio, which compares total liabilities to total assets, indicates the reliance on debt. A lower debt-to-asset ratio, often less than 30%, is preferred, indicating less reliance on borrowed funds.

Trend analysis involves examining financial data over several periods, typically three to five years, to identify patterns and changes. Looking at ratios and key figures over time can reveal growth, decline, or consistent performance, providing a more reliable assessment than a single year’s data. Consistent positive trends in program spending or liquidity are encouraging, while sustained negative trends can signal underlying issues.

Identifying potential red flags in financial statements can prompt further investigation. Consistently low program expense ratios, declining net assets, or significant increases in administrative costs without corresponding program growth may indicate inefficiencies or a shift away from mission focus. Other warning signs include inadequate cash reserves, continuous deficit spending, or a heavy reliance on a single funding source.

Where to Find Nonprofit Financial Information

Accessing nonprofit financial information is a practical step for understanding an organization’s operations and accountability. Several public sources provide detailed financial data and contextual information. These resources enable informed decision-making for donors, volunteers, and other interested parties.

The IRS Form 990 is a primary source of public financial information for most tax-exempt organizations. This annual information return provides details on a nonprofit’s revenue, expenses, governance, and compensation. Most nonprofits with gross receipts above $50,000 are required to file a Form 990. It can be accessed through various online platforms, including the IRS website’s Tax Exempt Organization Search, Candid’s GuideStar, and ProPublica’s Nonprofit Explorer.

Annual reports, often found on an organization’s website, offer a broader narrative beyond financial figures. While they typically include summarized financial information, annual reports also provide updates on mission achievements, program impact, and future goals. These reports combine financial summaries with qualitative information, offering a comprehensive overview of the nonprofit’s activities and successes. They can provide valuable context for the financial data presented in other statements.

The auditor’s report accompanies audited financial statements and provides an independent opinion on whether the statements are presented fairly and in accordance with GAAP. An “unqualified opinion” is the most favorable outcome, indicating that the financial statements are free from material misstatement. This report offers an important layer of assurance regarding the reliability of the financial information. It is prepared by an external accounting firm, adding credibility to the financial reporting.

Notes to the financial statements are an integral part of a complete set of financial statements and provide crucial additional details. These notes explain the accounting policies used, provide breakdowns of complex accounts, and disclose information not readily apparent on the face of the statements. For instance, they might detail restricted funds, significant accounting assumptions, or related party transactions. Reading these notes is important for a thorough understanding of the financial position and activities reported.