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Understanding Financial Statements

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Understanding Financial Statements …

Understanding Financial Statements

* How to read financial statements.
* Some key indicators and ratios.
* Financial statements are a tool for running your business.

For more information, visit http://www.cbiz.com/MidAtlantic

Published in: Economy & Finance, Business
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  • 1. Understanding & Using Financial Statements (As Business Tools for Nonprofits) J. Scott Denlinger, CPA Director, CBIZ MHM, LLC Bethesda, Maryland
  • 2. Overview • How to read financial statements. • Some key indicators and ratios. • Financial statements are a tool for running your business. • Building and maintaining cash reserves. • DON’T BE AFRAID TO ASK QUESTIONS! 2
  • 3. Why Review Financial Statements? • Assess the current financial health of the organization (may be better than you think) • Assists in gauging of viability of new programs and services • Helps to identify issues before they become serious problems • More important than ever given current economic conditions 3
  • 4. Cash vs. Accrual Basis Accounting • Cash – recognizing revenues as you receive them and expenses as you pay them • Accrual – recognizing revenues as you earn them and expenses as you incur them rather than at the time of cash flow 4
  • 5. Statement of Financial Position • Nonprofit equivalent of the Balance Sheet • Tells you what you own (assets), what you owe (liability) and what you have leftover (net assets) 5
  • 6. ASSETSCURRENT ASSETS Cash and cash equivalents $ 540,052 Promises to give 277,987 Receivables 127,250 Prepaid expenses 59,379 TOTAL CURRENT ASSETS $ 1,004,668INVESTMENTS 981,770PROPERTY AND EQUIPMENT, at cost, less $25,844 of accumulated depreciation and amortization 15,293OTHER ASSETS Promises to give 494,470 Deposits 26,053 520,523 TOTAL ASSETS $ 2,522,254 LIABILITIESCURRENT LIABILITIES Accounts payable and accrued expenses $ 277,769 Deferred membership dues 453,496 Deferred rent liability 4,532 TOTAL CURRENT LIABILITIES $ 735,797 NET ASSETSNET ASSETS Unrestricted 997,049 Temporarily restricted 289,408 Permanently restricted 500,000 1,786,457 TOTAL LIABILITIES AND NET ASSETS $ 2,522,254
  • 7. Receivables • Receivables – primarily earned revenue • Promises to Give – Restricted – Unrestricted • Key issues: – Split out long-term receivables (don’t kid yourself) – Allowance for bad debts (donor’s intent may not equal donor’s ability) 7
  • 8. Prepaid Expenses • Prepayments for future goods or services (meeting space deposits, etc.) • Useful in matching revenues with expenses (conferences, trade shows, etc.) • Key issues: – Don’t forget to expense them later – Don’t worry about the small stuff 8
  • 9. Property and Equipment • Key Issues: – Establish a capitalization policy ($500?, $1,000?, more?) – Maintain fixed asset listing on Excel or other program – Use good descriptions – could save you personal property taxes) – Keep depreciation simple – straight-line 9
  • 10. Investments • Key Issues: – Need an investment policy – Don’t forget unrealized gains and losses – especially in current economy! – Review performance monthly 10
  • 11. Other Assets • Long-term receivables – Multi-year pledges • Deposits – Recording can help serve as a reminder 11
  • 12. ASSETSCURRENT ASSETS Cash and cash equivalents $ 540,052 Promises to give 277,987 Receivables 127,250 Prepaid expenses 59,379 TOTAL CURRENT ASSETS $ 1,004,668INVESTMENTS 981,770PROPERTY AND EQUIPMENT, at cost, less $25,844 of accumulated depreciation and amortization 15,293OTHER ASSETS Promises to give 494,470 Deposits 26,053 520,523 TOTAL ASSETS $ 2,522,254
  • 13. Accounts Payable/Accrued Expenses • Keep on top of this • Know what you owe • Consider recording estimates if you don’t have the invoice yet (contractors, large expense reports, etc.) • Avoid surprises 13
  • 14. Deferred Revenue • Member dues, conference registration, etc. • Assist in matching revenues and expenses • Key issues: – Member dues vs. Contributions – Maintain good schedules – Don’t worry about the small stuff 14
  • 15. Net Assets • Unrestricted • Temporarily Restricted • Permanently Restricted • Board Designation vs. Restriction 15
  • 16. LIABILITIESCURRENT LIABILITIES Accounts payable and accrued expenses $ 277,769 Deferred membership dues 453,496 Deferred rent liability 4,532 TOTAL CURRENT LIABILITIES $ 735,797 NET ASSETSNET ASSETS Unrestricted 997,049 Temporarily restricted 289,408 Permanently restricted 500,000 1,786,457 TOTAL LIABILITIES AND NET ASSETS $ 2,522,254
  • 17. Ratios Current ratio: Shows organization’s ability to meet short-term obligations. Current Assets Current Liabilities • Your current ratio helps you determine if you have enough working capital to meet your short-term financial obligations. • A general rule of thumb is to have a current ratio of at least 1.0. • A current ratio under two may indicate an inability to pay current financial obligations with a measure of safety. 17
  • 18. Ratios Quick ratio: More stringent test of your ability to meet current obligations. Used by banks and management. Should not be less that 1.0. Quick Assets* Current Liabilities *Quick Assets generally means Current Assets minus Inventory and Prepaid Expenses. 18
  • 19. Ratios Industry Benchmarks Public Trade Charities Associations Quick Ratio 1.42 1.27 Current Ratio 2.97 2.36 19
  • 20. Sample RatioTOTAL CURRENT ASSETS $ 1,004,668 = 1.37TOTAL CURRENT LIABILITIES $ 735,797
  • 21. Sample RatioTOTAL CURRENT ASSETS $ 1,004,668LESS: Prepaid expenses 59,379TOTAL QUICK ASSETS $ 945,289 = 1.28TOTAL CURRENT LIABILITIES $ 735,797
  • 22. Many Excel templates are available online, likeUse Templates As Tools! this one available from Microsoft at http://office.microsoft.com/ [templates]YOUR Balance Sheet For the Period Ending [End Date]Current ratio [A/B] - Working capital [A-B] $ -Quick ratio [(A-C)/B] - Debt-to-equity ratio [(G+H)/F] -Cash ratio [D/B] - Debt ratio [(G+H)/E] - Stated in 000sASSETS % of ASSETS LIABILITIES & OWNERS EQUITY % of ASSETSCurrent assets Current liabilitiesCash and cash equivalents [D] - Loans payable and current portion long-term debt [H] -Short-term investments - Accounts payable and accrued expenses -Accounts receivable [I] - Income taxes payable -Inventories [C] - Accrued retirement and profit-sharing contributions -Deferred income taxes -Prepaid expenses and other current assets -Total current assets [A] $ - - Total current liabilities [B] $ - -Fixed assets Other liabilitiesProperty, plant and equipment at cost - Long-term debt [G] -Less accumulated depreciation - Accrued retirement costs -Total fixed assets $ - - Deferred income taxes - Deferred credits and other liabilities -Other assetsLong-term cash investments -Equity investments -Deferred income taxes -Other assets -Total other assets $ - - Total other liabilities $ - -Total assets [E] $ - - Total liabilities $ - - Total owners equity [F] $ - - 22 Total liabilities + owners equity $ - -
  • 23. Statement of Activities • Nonprofit equivalent of the Income Statement • Shows how the organization performed during the period • “Change in Net Assets” is nonprofit equivalent of “Net Income” • Nonprofits are measured differently • Negative change in net assets isn’t necessarily bad 23
  • 24. Statement of Activities Temporarily Unrestricted Restricted TotalREVENUE AND SUPPORT Grants and contributions $ 1,209,176 $ 441,269 $ 1,650,445 Conferences 1,137,432 - 1,137,432 Publications 1,222,682 - 1,222,682 Rental income 67,943 - 67,943 Investment income 35,482 - 35,482 Miscellaneous income 5,914 - 5,914 Net assets released from restrictions: - - Satisfaction of purpose restrictions 324,615 (324,615) - TOTAL REVENUE AND SUPPORT $ 4,003,244 $ 116,654 $ 4,119,898EXPENSES Program services: Research 2,125,836 - 2,125,836 Student Services 136,920 - 136,920 Government Affairs 167,976 - 167,976 Communications 261,630 - 261,630 Conferences 250,971 - 250,971 Total program services 2,943,333 - 2,943,333 Management and general 602,073 - 602,073 Fundraising 412,639 412,639 TOTAL EXPENSES 3,958,045 - 3,958,045 CHANGE IN NET ASSETS 45,199 116,654 161,853 24
  • 25. Revenue Considerations • Contributions/Grants • Membership Dues • Special Events • Investment Income • Unrelated Business Income Tax (UBIT) 25
  • 26. Contributions/Grants • Restricted vs. Unrestricted – Unrestricted • Provides more flexibility • Can be more difficult to raise – Restricted • Can engage donors more than unrestricted • No disputes over usage • Potential for being “painted into a corner” 26
  • 27. Contributions/Grants • Corporate grants – One can lead to more – Can be unreliable long-term • Foundation grants – Can be more reliable than corporate – May have more reporting requirements • Government grants – Need proper controls in place – State grants may be risky – Single Audit considerations for federal grants 27
  • 28. Membership Dues • More predictable – less dynamic • Raising dues rates • Determining proper dues rates – Cost of soliciting new members (direct mail, telephone solicitation, new member kits,etc) – Cost of retaining the member (newsletters, other member benefits) – Dues rates should cover costs per member 28
  • 29. Membership Dues • Additional Considerations – Tiered dues structure • Based on Benefits • Based on Size • Student memberships 29
  • 30. Special Events • Can provide visibility • Large upfront costs • How confident are you regarding the revenue? • Consider lower cost alternatives • Consider partnering 30
  • 31. Investment Income • Record reinvested interest and dividends • Don’t forget to record unrealized gains and losses (especially in today’s economy) • Know what have! 31
  • 32. Unrelated Business Income Tax (UBIT) • Represents taxable income • Reportable on Form 990T • Considerations: – Advertising in magazines or newsletters – Corporate sponsorship 32
  • 33. Ratios AIP BenchmarkOperating Efficiency:Indicates percentage of each dollar spent on programs. Program related expenses 75% Total expenses 33
  • 34. Ratios AIP Benchmark Fundraising Efficiency: A measure of the cost of raising money. Fundraising Expenses Ideally 25% Related Contributions (no more than 35%)
  • 35. Sample Ratio Operating Efficiency Program services $ 2,943,333 Management and general 602,073 Fundraising 412,639 Total Expenses $ 3,958,045 Program services $ 2,943,333 = 74% Total Expenses $ 3,958,045
  • 36. Sample RatioFundraising EfficiencyFundraising expenses $ 412,639 = 25%Grants and contributions $ 1,650,445
  • 37. Cash Flow Statement • Equally important, but frequently ignored • Reconciles change in net assets to change in cash • Answers the question: “We made money - where did it go?” 37
  • 38. Cash Flow Statement CASH FLOWS FROM OPERATING ACTIVITIES Change in net assets $ 161,853 Adjustments to reconcile change in net assets to net cash flows from operating activities Depreciation and amortization 5,144 Net unrealized and realized gains on investments (3,058) (Increase) decrease in operating assets Receivables (107,401) Prepaid expenses 48,209 Increase (decrease) in operating liabilities Accounts payable and accrued expenses (127,530) Deferred revenue (39,195) NET CASH FLOWS FROM OPERATING ACTIVITIES $ (61,978) CASH FLOWS FROM INVESTING ACTIVITIES Purchases of investments (281,871) Proceeds from sales of investments 450,000 NET CASH FLOWS FROM INVESTING ACTIVITIES 168,129 CASH FLOWS FROM FINANCING ACTIVITIES Repayments on line of credit (50,000) NET CASH FLOWS FROM INVESTING ACTIVITIES (50,000) NET DECREASE IN CASH 56,151 CASH, BEGINNING OF YEAR 483,901 CASH, END OF YEAR $ 540,052
  • 39. Statement of Cash Flows • Cash Flows from Operations – Shows cash provided by (or used in) operations – Ideally this number should be positive – Items which affect operating cash flow • Depreciation • Collection of receivables • Paying of accounts payable 39
  • 40. Statement of Cash Flows • Cash Flows from Investment – Shows cash provided by (or used in) investing activities – Items which affect investing cash flow • Buying and selling marketable securities • Buying and selling of property and equipment – Not bad if this number is negative • Similar to your personal finances 40
  • 41. Statement of Cash Flows • Cash Flows from Financing – Shows cash provided by (or used in) financing activities – Items which affect financing cash flow • Bank loans • Lines of credit • Equipment leases – Not bad if this number is negative • Similar to your personal finances 41
  • 42. Cash Flow StatementCASH FLOWS FROM OPERATING ACTIVITIES Change in net assets $ 161,853 Adjustments to reconcile change in net assets to net cash flows from operating activities Depreciation and amortization 5,144 Net unrealized and realized gains on investments (3,058) (Increase) decrease in operating assets Receivables (107,401) Prepaid expenses 48,209 Increase (decrease) in operating liabilities Accounts payable and accrued expenses (127,530) Deferred revenue (39,195) NET CASH FLOWS FROM OPERATING ACTIVITIES $ (61,978)
  • 43. Cash Flow StatementCASH FLOWS FROM INVESTING ACTIVITIES Purchases of investments (281,871) Proceeds from sales of investments 450,000 NET CASH FLOWS FROM INVESTING ACTIVITIES 168,129CASH FLOWS FROM FINANCING ACTIVITIES Repayments on line of credit (50,000) NET CASH FLOWS FROM INVESTING ACTIVITIES (50,000) NET DECREASE IN CASH 56,151 CASH, BEGINNING OF YEAR 483,901 CASH, END OF YEAR $ 540,052
  • 44. Specialized software programscan help you “goal seek”and consider “what if” scenarios. 44
  • 45. Operating Reserves • What is an appropriate level of operating reserves? • Using the Statement of Cash Flows to evaluate cash flow performance. • Preparing cash budgets and cash projections • Building and maintaining an appropriate level of operating reserves 45
  • 46. Operating Reserves How do you calculate operating reserves? • Unrestricted net assets – Fixed assets = Operating reserve • Total expenses – Depreciation = Operating expenses • Operating reserve divided by operating expenses 46
  • 47. Sample CalculationUnrestricted net assets $ 997,049Less: Fixed assets 15,293Operating reserve $ 981,756Total expenses $ 3,958,045Less: Depreciation expense 5,144Operating expenses $ 3,952,901Operating reserve $ 981,756 = 25%Operating expenses $ 3,952,901This means 25% (or 3 months) of their annual expenses
  • 48. Operating Reserves What is an appropriate level? • Minimum of 25%, or 3 months, of operating expenses • Other factors to consider: – Type of organization – Types and diversity of revenue streams – Peaks and valleys in expenses – How susceptible the organization is to economic downturns – Large outlays of cash projected in future? 48
  • 49. Type of Organization • Type of revenue stream – How predictable is it? • Grant driven (Recurring or non- recurring?) • Membership dues • Special Events – Less predictable – higher reserve 49
  • 50. Diversity of Revenue Streams • How dependent are you upon one or a few donors? • How reliable are those donors? • Less diversity – higher reserve 50
  • 51. Peaks and Valleys in Expenses • Quarterly or annual publications? • Annual conference or fundraiser? • Less predictable – higher reserve 51
  • 52. Susceptibility to economic downturns • Dependent upon contributions – Individual, Corporate, Foundation • Dependent upon membership dues – How strong is the industry (small business, oil, medical, etc.) • More susceptible – higher reserve 52
  • 53. Large Outlays of Cash Projected • Upgrading computers or database • Implementation of new program or service • Moving to larger facility • Trade show or conference • Expanding membership base 53
  • 54. Operating ReservesDetermining the appropriate level for your organization Your Board should be involved in these discussions: • Determine how your organization will define “operating reserves” – Include Prepaid expenses, Deposits, etc? • Determine what level your organization wants to maintain 54
  • 55. Operating Reserves -Determining the appropriate level for your organization Your Board should be involved in these discussions: • Establish a minimum level that must be kept intact and how it will be replenished if used • Develop a policy as to how the reserves will be invested – Safety – no big risk • Establish how often the reserves will be evaluated (monthly?, quarterly?) – Financial statements, investment statements 55
  • 56. Budgets & Projections Preparing cash budgets and cash projections • Use operating budget as a starting point • Convert accrual basis items to cash basis • Back out noncash expense (depreciation and amortization) • Add in non-expense outlays, such as loan repayments or equipment purchases • Add in line items for additions to operating or other reserves 56
  • 57. TEXT XYX Organization BOX Cash Flow Budget Worksheet WHITE Year ending December 31, 20XX AdjustmentsSUPPORT AND REVENUE CASH INFLOWSContributions $ 1,404,125 $ 36,000 a Contributions $ 1,440,125Interest and dividend income 52,525 2,932 a Interest and dividend income 55,457TOTAL SUPPORT AND REVENUE 1,456,650 38,932 TOTAL CASH INFLOWS 1,495,582EXPENSES CASH OUTFLOWSAdministrative fees 7,200 Administrative fees 7,200Board expenses 1,050 Board expenses 1,050Cleaning 26,706 Cleaning 26,706Commission - rentals 4,752 (4,752) a Commission - rentals -Depreciation 80,436 (80,436) b Depreciation -Insurance 9,023 2,904 a Insurance 11,927Miscellaneous expenses 173 (4) a Miscellaneous expenses 169Office expense 1,300 Office expense 1,300Personnel expenses 1,005,455 Personnel expenses 1,005,455Property taxes 97,250 Property taxes 97,250 150,000 c Transfer to reserve 150,000 28,477 c Purchases of property and equipment 28,477 39,618 c Repayment of notes payable 39,618Repairs and maintenance 32,042 3,934 a Repairs and maintenance 35,976Security 2,701 Security 2,701Trash and hauling 4,683 Trash and hauling 4,683Travel 551 Travel 551Utilities 51,503 Utilities 51,503TOTAL EXPENSES 1,324,825 139,741 TOTAL CASH OUTFLOWS 1,464,566 CHANGE IN NET ASSETS 131,825 NET CASH FLOWS $ 31,016 a Adjustments to reverse out accruals b Elimination of non-cash expenses c Inclusion of cash outflows not recognized as expenses
  • 58. TEXT XYX Organization BOX Quarterly Cash Flow Budget Worksheet WHITE Year ending December 31, 20XX 1st Qtr 2nd Qtr 3rd Qtr 4th Qtr TotalBEGINNING CASH $ 150,469 $ 117,249 $ 189 $ 365,117 $ 150,469CASH INFLOWSContributions 250,125 166,286 774,000 249,714 1,440,125Interest and dividend income 13,864 13,864 13,864 13,864 55,457TOTAL CASH INFLOWS 263,989 180,150 787,864 263,578 1,495,582CASH OUTFLOWSAdministrative fees 1,800 1,800 1,800 1,800 7,200Board expenses 263 263 263 263 1,050Cleaning 6,677 6,677 6,677 6,677 26,706Insurance 2,982 2,982 2,982 2,982 11,927Miscellaneous expenses 42 42 42 42 169Office expense 325 325 325 325 1,300Personnel expenses 251,364 251,364 251,364 251,364 1,005,455Property taxes - - 97,250 - 97,250Transfer to reserve - - - 150,000 150,000Purchases of property and equipment - - 28,477 - 28,477Repayment of notes payable 9,905 9,905 9,905 9,905 39,618Repairs and maintenance 8,994 8,994 8,994 8,994 35,976Security 675 675 675 675 2,701Trash and hauling 1,171 1,171 1,171 1,171 4,683Travel 138 138 138 138 551Utilities 12,876 12,876 12,876 12,876 51,503 TOTAL CASH OUTFLOWS 297,210 297,210 422,937 447,210 1,464,566 NET CASH FLOWS (33,221) (117,060) 364,928 (183,632) 31,016ENDING CASH $ 117,249 $ 189 $ 365,117 $ 181,485 $ 181,485
  • 59. Breakeven Cash FlowMonthly fixed costs: Rent & Utilities Payroll & Benefits Loan/equipment lease payments Other monthly costsBreakeven cash flow refers to the nondiscretionary coststhat you must cover each month - it is the amount of cashyou must have on hand (not revenue on the books). 59
  • 60. Operating Reserves Building and maintaining an appropriate level of operating reserves - additional considerations: • What types of reserves (emergency, expansion, equipment, etc.) • Determine time frame for building up reserves 60
  • 61. Operating Reserves To borrow or not to borrow • Lines of credit – How will the organization pay it back? – Specific purpose vs Operating expenses – Trade show, fundraiser – How confident are you regarding revenues • Term Loans • How will the organization pay it back? • Consider building an intermediate reserve 61
  • 62. Potential Obstacles • Donors • Staff • Board • Desire to fulfill mission Importance of communication! Effective communication can help navigate obstacles. 62
  • 63. Communication with Donors(recognizing/navigating obstacles) • Doesn’t energize donors • Reserves can be viewed as waste or abuse • Communicate need for long-term reserves 63
  • 64. Communication with Staff(recognizing/navigating obstacles) • May not be understand finances • May be viewed as robbing programs • Communicate need for long-term reserves • Engage certain staff in budget process 64
  • 65. Communication with Board(recognizing/navigating obstacles) • Same issues as both donors and staff • Importance of monthly/quarterly review of financial statements • Communicate need for long-term reserves 65
  • 66. If you have questions . . .Contact: Mr. Denlinger designs and manages outsourced CFO and accounting engagements serving both for- J. Scott Denlinger, CPA, profit and nonprofit organizations. He also performs Director and Practice Lead CFO duties for several organizations, assisting in Outsourced Financial Services the preparation of internal financial statements and Scott has more than 20 presentation to their Boards. With his extensive auditing experience, Mr. Denlinger is able to assist years experience in our outsourcing clients in preparing for their year- accounting, tax, consulting end audits. Combining his communication skills and and auditing. ability to translate difficult accounting concepts into laymen’s terms, as well as his penchant for CBIZ MHM, LLC – Bethesda, MD teaching, Mr. Denlinger is frequently asked to lead seminars and workshops by various organizations (301) 951-3636 on a broad range of financial management and sdenlinger@cbiz.com reporting topics. He is a member of the MACPA Government and Nonprofit Conference Committee and serves on the Board of Family and Children Services of Central Maryland. 66

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