Finance Fundamentals


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Presentation on finance fundamentals for nonprofit organizations. Geared towards non-accountants, this presentation deals with the following:

- Characteristics of nonprofits and responsibility for financial information
- Basic review of accounting principles
- Financial statements
- Different members of the finance team
- Financial policies for nonprofits
- Communicating financial results
- Nonprofit tax

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Finance Fundamentals

  1. 1. FINANCE FUNDAMENTALSFebruary 29, 2012Richard Wolf, CPA
  2. 2. Objectives Characteristics of nonprofits and responsibility for financial information Basic review of accounting principles Financial statements Different members of the finance team Financial policies for nonprofits Communicating financial results Nonprofit tax
  3. 3. Characteristics of NonprofitsVary in their missions but share three characteristicsthat are present in varying degrees and distinguishthem from investor-owned entities:  Receive contributions of resources  Provide goods and services, or both, for reasons other than to make a profit  No ownership interests
  4. 4. Responsibility for Financial Information Management is responsible for the content of the organization’s financial information including adopting sound accounting principles Management should establish and maintain controls over the authorization, recording, processing, and reporting of transactions Board of directors is responsible for management oversight COSO framework
  5. 5. Basic Review of Accounting PrinciplesDefinition of AccountingAccounting is an information and measurement systemthat identifies, records, and communicates relevant,reliable, and comparable information about anorganization’s business activities.(John Wild, Ken Shaw, Barbara Chiappetta. Fundamental Accounting Principles, 19th Edition. 2009.)
  6. 6. Generally Accepted AccountingPrinciples (GAAP) Financial accounting practice is governed by concepts and rules known as generally accepted accounting principles (GAAP) Accounting standards for nonprofits are set by the Financial Accounting Standards Board (FASB) Basis of accounting:  Accrual (GAAP)  Cash basis  Modified cash basis
  7. 7. Accrual Basis Under the accrual basis, revenue is required to be recorded when earned and expenses are recorded when incurred “Earned” revenue includes receipt of a contribution or a promise to receive contributions Accounts receivable Accounts payable and accrued expenses
  8. 8. Cash Basis Under the cash basis, revenue is required to be recorded when received and expenses are recorded when paid No accounts receivable No accounts payable and accrued expenses
  9. 9. Modified Cash Basis Modified cash basis is essentially the cash basis which incorporates “modifications….having substantial support” A modification has substantial support if both the following conditions are met:  It is equivalent to the accrual basis of accounting  It is not illogical
  10. 10. Basic Financial Statements Three or four basic financial statements depending on the type of organization  Statement of Financial Position (Balance Sheet)  Statement of Activities  Statement of Cash Flows  Statement of Functional Expenses (only required for voluntary health and welfare organizations although many other organizations utilize this statement)
  11. 11. Statement of Financial Position Might also be referred to as a “balance sheet” Reports the organization’s assets, liabilities, and net assets at a point in time Focuses on the organization as a whole Assets = Liabilities + Net Assets Three classes of net assets  Unrestricted  Temporarily restricted  Permanently restricted
  12. 12. Temporarily Restricted Net Assets Use is limited by either donor-imposed  Time restrictions, or  Purpose restrictions As the donor-imposed restrictions expire or are removed by actions of the organization, temporarily restricted net assets are reclassified to unrestricted
  13. 13. Permanently Restricted Net Assets Must be maintained by the organization in perpetuity Does not expire with the passage of time and cannot be removed or fulfilled by organization actions Can only be changed by the donor
  14. 14. Unrestricted Net Assets Net assets that are neither temporarily restricted nor permanently restricted All net assets whose use has not been restricted by donors Board designations, which are voluntary board- approved segregations of net assets for specific purposes, projects, or investments, are also part of unrestricted net assets
  15. 15. Statement of Activities Reports the results of operations (revenues and expenses) and change in net assets over a period of time The change in net assets must be presented in total and also by net asset class
  16. 16. Statement of Cash Flows Provides information about the cash receipts and disbursements of the organization over a period of time Cash receipts and disbursements from operating activities, financing activities, and investing activities Statement is a bridge from accrual basis to the flow of cash Two main types:  Direct method  Indirect method
  17. 17. Statement of Functional Expenses Provides information about the organization’s expenses by function and natural classification An organization’s functions are broken out by program services and supporting services Supporting services include:  Management and general  Fund-raising Examples of natural classification are salaries, occupancy, depreciation, and repairs and maintenance
  18. 18. Footnotes To The Financial Statements Footnotes are an integral part of the financial statements Examples of footnotes include:  Description of organization  Summary of accounting policies  Tax exempt status  Detail of investments  Property and equipment  Leases  Debt (loan details including future maturities)  Concentrations
  19. 19. Assets Tangible, intangible, or future benefits to the nonprofit Many nonprofits classify their assets and liabilities as current and noncurrent These designations refer to how quickly they are expected to be converted into cash Current assets are expected to be converted within one year Other nonprofits list their assets in order of liquidity
  20. 20. Assets - Examples Cash – includes highly liquid investments with original maturities of three months or less Accounts Receivable Unconditional Promises to Give – discounted to their net present value Inventories Investments Property and Equipment
  21. 21. Liabilities Reflect organization’s obligations to provide assets, products, or services to others Accounts payable and accrued expenses Notes payable and other long-term debt Deferred revenue – cash received in advance of providing goods or services
  22. 22. Contributions May take the form of cash, investments, goods, services, right to use space, etc. They can be received at the date of donation or may be in the form of a pledge for a future contribution Recorded at fair value at the date of donation In-kind contribution – gift of goods to the nonprofit
  23. 23. Contributed Services Should be recognized as contributions if they create or enhance a nonfinancial asset (such as property or equipment), or They meet all of the following criteria:  The service requires specialized skills  The service is provided by individuals who possess those skills  The service would typically need to be purchased if not contributed
  24. 24. Financial Statement OptionsAudit  Highest level of service provided by CPA  Provides reasonable assurance that the financial statements are free of material misstatement  Auditor seeks to understand the nature of an organization, reviews and evaluates internal control procedures, tests underlying accounting records  May identify weaknesses in internal control system  Does not provide guarantees that no fraud exists
  25. 25. Financial Statement Options, cont. Review  Less assurance than an audit  Typically a lower fee due to less work required  Provides limited assurance that there are no material modifications that should be made to the financial statements Compilation  Does not express an opinion or provide any assurance about the fairness of a set of financial statements
  26. 26. Finance Team Treasurer – Typically the officer of the organization assigned the primary responsibility of overseeing the management and reporting of an organization’s finances. May or may not be a paid employee. CFO Controller Bookkeeper
  27. 27. Finance Team Finance Committee – supports development of annual budget; monitors spending; provides commentary on the “financial health” of the organization to the board Audit Committee – monitors the effectiveness of internal controls; reviews scope of audit; recommends the selection, retention, or termination of auditors to the board; reviews Form 990
  28. 28. Financial Policies Investment Policy Internal Control Procedures Purchasing Practices Unrestricted Current Net Assets (Reserves)
  29. 29. Investment Policy Helps defines the organization’s investment goals and the financial risks the organization is willing to take to achieve those goals Investment policies should include:  Goals of the investment program  Investment objectives, risks and return (target rates)  Investment guidelines and constraints  Allocation of assets  Monitoring and control procedures
  30. 30. Internal Control Procedures Internal control is the plan of an organization and all of the coordinate methods adopted within a business to:  Safeguard its assets;  Check the accuracy and reliability of its accounting data;  Promote operational efficiency; and,  Encourage adherence to prescribed managerial policies.
  31. 31. Internal Control Procedures, cont. Not designed to uncover dishonesty and fraud Internal control system is designed to detect and correct errors (mostly honest mistakes) Internal Control Structure has five components:  Control environment  Risk assessment process  Information controls  Communication controls  Monitoring controls Control Activities
  32. 32. Segregation of Duties Individuals should not be put in situations in which they could both perpetrate and cover up fraudulent activity by manipulating the accounting records The functions of authorizing a transaction, recording the transaction, and taking physical custody of assets related to a transaction should be kept separate For example, the AP department can authorize payment only after a purchase order is obtained from another department
  33. 33. Purchasing Practices Serves as a tool for maximizing available resources of funds, personnel, and time Procedures should be inclusive of different types of purchasing, not just major purchases Consideration must be given to:  Routine purchases of supplies  Major equipment/furniture  Service contracts  Leasing of space  Reimbursement of expenses  Travel  Services (insurance, legal, accounting)  Others
  34. 34. Unrestricted Current Net Assets Formerly known as reserves or reserve funds What are optimal fund levels for the organization? Provides a cushion for the organization in times of need Nonprofit strives to have unrestricted current net assets available for a set amount of time (i.e., 120 days) Having large amounts of unrestricted current net assets on hand is also considered to be a poor management practice
  35. 35. Communicating Financial Results Who is the audience?  Management  Board of Directors  Public  Grantor What level of detail is required? How frequently does it need to be communicated?  Weekly cash report  Monthly financials  Annual financial statements
  36. 36. Communicating Financial Results, cont. Budget vs. Actual – How did the actual results compare with the budget during the period? What are the key metrics that are important to your audience?  Number of members  Museum visitors  Contribution Dollars? # of contributors?  Program Revenue and Expense
  37. 37. Nonprofit Tax Nonprofit is a type of organization, not-for-profit is a type of activity, and tax-exempt is a status granted by the IRS Different types of tax-exempt organizations:  501(c)(3) – religious, educational, charitable, scientific, literary  501(c)(4) – social welfare organizations  501(c)(6) – trade associations, business leagues  501(c)(7) – social and recreational clubs
  38. 38. Unrelated Business Income Tax An organization is subject to tax on certain activities to the extent the activities produce “unrelated business income” Income is unrelated business income if the activity:  Constitutes a trade or business;  Is regularly carried on by the organization; and  Is not substantially related to the performance of the organization’s exempt function
  39. 39. Exceptions to UBIT Convenience exception – primarily for the convenience of its members, employees, customers, etc. Volunteer exception – substantially all work is performed without pay Sales of donated merchandise Qualified sponsorship payments – any payment received by a person engaged in a trade or business to the extent the person does not arrange for or expect to receive a substantial return benefit
  40. 40. Advertising Income Almost always UBIT Special rules to calculate – direct and indirect costs May need to allocate a portion of dues to circulation income
  41. 41. Form 990 Basics Form 990 – “Information Return” Due date of the return – 15th day of the 5th month following the end of the organization’s taxable year Extensions – Automatic 3-month extension and an additional (not automatic) 3-month extension Form 990, 990-EZ (gross receipts < $200k and total assets < $500k) and “e-Postcard” (990-N) (gross receipts $50,000 or less)
  42. 42. Filing Form 990 Consists of a core form with 11 parts and 16 schedules Not all of the schedules will be required for each organization What is the organization’s “story”?
  43. 43. Form 990 Information Requested Financial data Governance policies – heavily scrutinized by the IRS and watchdog agencies (part VI of Form 990) Compensation Relationships Transactions with insiders
  44. 44. QUESTIONS?
  45. 45. Instructor Contact Information Richard L. Wolf, CPA, CGMA Twitter: @richardwolfcpa