In each of our chosen fields and careers, there is often some industry-specific language that gets passed around. Nonprofits have their own sets of terminology that can be different and confusing. Whether you’re an accountant, board member, volunteer, or curious potential donor, getting to know the lingo used in non-profit accounting can be important and helpful as you review financial information. Let’s get to know a few of the terms regularly used in the nonprofit financial reporting world.
We’ll start with the Statement of Financial Position. For-profits usually refer to this statement as the Balance Sheet. The Statement of Financial Position shows an organization’s assets, liabilities, and net assets. The statements look at these items at a specific point in time, which is usually captioned at the top of the statement (usually the end of the fiscal year).
Statement of Financial Position
Assets – The items held by the nonprofit with monetary value. Assets would include cash, investments, property, receivables and anything else with value.
Liabilities – What the organization owes other parties in the future that will be transferred from its assets.
Current – Often the Statement of Financial Position shows headings for current assets and current liabilities (this isn’t required but many organizations present this way). When something is classified as current, it means an event that would trigger a conversion to cash or payout of cash could occur within one year. For example, take a loan on a building with monthly payments. The 12 payments that are due in the next year would be classified as a current liability. Anything that isn’t current is classified as long-term. By making the distinction, it’s easier to tell which assets are available for operations, and which liabilities will need to be paid soon.
Net Assets – What’s left when you subtract liabilities from assets? Net assets, or equity as it’s commonly referred to in the for-profit world. Net Assets change all the time as income and expenses affect the assets and liabilities. Net assets are made up of two different classifications, which were updated in 2016 by the Financial Accounting Standards Board and became effective this year.
Net Assets with Donor Restrictions – When a donor makes a gift for a certain purpose, those assets are restricted, until the restriction is met by the organization. For example, if you give a $1,000 check to a nonprofit and tell them it’s for buying a new table for their office, the nonprofit is obligated to use those funds to buy a table. Until they purchase the table, the nonprofit would report $1,000 of net assets with donor restrictions. Once the table is acquired (and the entire gift spent), the restriction is deemed “released” and the asset of the table becomes part of net assets without donor restrictions.
Net Assets without Donor Restrictions – These are net assets that are available for the organization to use for any purpose. They could be used as management sees fit. There is no donor stipulation that mandates use for a certain purpose. Generally, net assets without donor restriction is accumulated income from previous periods. In this way, it is similar to retained earnings on a for-profit balance sheet.
Statement of Activities
Moving on through typical nonprofit financial statements, we come to the Statement of Activities (or Statement of Changes in Net Assets). For-profits refer to this statement as the Income Statement. The Statement of Activities shows the results of the nonprofit’s operations during the year, and also the effects of any non-operating activities. It’s different from the Statement of Financial Position discussed above (which looks at things at a set point in time) since the Statement of Activities looks at what happened during the period presented (usually a year or month).
Revenue – Income received by the nonprofit. Revenue could come from contributions, program revenue, grants, special events, or other sources.
Contributions – Gifts received by the nonprofit from donors. Sometimes organizations will separate by source, and accounting standards require that those gifts with donor restrictions be shown separately. Those with restrictions are typically displayed in a separate column (or in another section) on the statement.
Program Service Fees (or Program Revenue) – Revenue from the nonprofit’s performance of a service. The service is aligned with the nonprofit’s mission, and the nonprofit records revenue once the service has been performed.
Expenses – The costs of providing the services, maintaining operations, and raising money for the nonprofit. Expenses are required to be presented by both natural and functional categories.
Natural expenses – Classification of expenses that correspond to the nature of the expense (salaries, postage, rent, etc.). Typically, natural expenses are presented on the left side of the statement of functional expenses.
Functional expenses – Classification of expenses that correspond to the purpose of the expense. Usually, the functional area is shown as a column on the statement of functional expenses. The main functional classifications are program, management & general, and fundraising; though some organizations present columns to separate different programs.
Other statements typically included in nonprofit financials are the statement of cash flows and the statement of functional expenses. The statement of cash flows presents the cash received or used in operating activities (running the organization and its services), investing activities (capital items or investment transactions), and financing activities (debt and equity transactions to fund operations or expansion). The statement of functional expenses presents expenses by natural and functional categories (discussed above).
Notes to the Financial Statements
Now that we have a feel for the terms used in typical financial statements, most nonprofits usually have a lengthy list of notes attached to the statements, which provide details about some of the items included in the financial statements. Here’s a summary of a few of the common notes relevant to nonprofits that can be useful to understand:
Nature of the organization and significant accounting policies – This note (or notes) describe the organization’s mission and programs, and the accounting policies used in preparing and presenting the financial statements. If there were any sort of option under accounting standards for how to present something, it would be disclosed in this note.
Fair value measurements – Financial assets and liabilities are generally required to be stated at fair value, which is an estimate of the market price. For financial deposit, investment accounts, and certain types of liabilities, accounting standards require this note to disclose the availability and reliability of the valuation of the assets or liabilities. This is accomplished by the fair value hierarchy, which prioritizes the inputs for measuring fair value. It assigns Levels of 1, 2, or 3, with 1 being the most available and reliable (quoted market prices) and Level 3 having inputs that are not observable. The idea is to give the reader a feel for the reliability of the fair value measurement used. You would have confidence a Level 1 asset was valued correctly, but with a Level 3 asset, you wouldn’t be as confident.
Endowments – Many nonprofits have endowments, and there is a required note when they exist. The note lists the nonprofit’s policies and investment objectives for its endowment and also shows the makeup and activity of the endowment assets. – This note became required for most nonprofits in 2018, and discloses the net financial assets that are available for operations, and also the nonprofit’s policy for the amount of financial assets to have on hand at any given time. This can be an important measure to review and use to evaluate the overall health of a nonprofit, and its ability to meet its obligations.
Nonprofit financial statements have a number of other footnotes, such as concentrations, listing of restrictions, detail on long-term debt, detail on promises to give and timing of expected receipts, and others.
At Forge Financial and Management Consulting, we pride ourselves on being able to discuss financial information at a level anyone can understand. If you have any questions about the meaning of these or any other terms, please reach out to us to clarify them.
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