by John F Heveron, Jr. Principal, Heveron and Company CPAs, Rochester NY
Here is a quick overview of audited financial statements and what to look for when reading them.
Auditors Cover Letter/Opinion
This is addressed to the board and is dated when the audit was completed and accepted by management.
This report has headings, and one of the headings is “opinion”. If what follows is anything other than the standard language “in our opinion the financial statements described above present fairly …..”, That is cause for concern, and you should investigate what led to that modified opinion.
Income Statement or Statement of Activities
This will include all income earned by the organization and all contributions that are not subject to uncertainties (conditions).
Income earned isn’t the same as income collected. Some amounts get paid in advance, sometimes amounts are earned but not yet paid.
There may be contributions of in-kind items that don’t include any cash. The financial statement should include a Statement of Cash Flows that attempts to explain the differences between what was earned and what was collected, but it is a difficult, often confusing statement to read.
The income statement or statement of activities often includes the prior year as well as the current year, or at least totals for the prior year, so you can tell whether revenue went up or down.
The different categories of income tell you how diverse the funding is and whether funding from specific sources is up or down. Diverse funding is considered a sign of financial stability.
The board may request five or even 10 years of income by source and expense by type in order to see longer-term trends. This is also helpful for budgeting.
When you look at expenses consider where the organization is spending their money. Is the great majority of it spent directly on program services? How do salaries compare to similar organizations?
Balance Sheet or Statement of Financial Position
This statement lists assets (what the organization owns) and liabilities (what the organization owes) on a specific date, most commonly your fiscal year-end. The difference between assets and liabilities is your equity or net assets. Net assets are generally broken down into unrestricted net assets, temporarily restricted net assets, and permanently restricted net assets. Nonprofit financial statements are all being changed in the near future to have just two categories of net assets, which are “net assets without donor restrictions” and “net assets with donor restrictions”, although organizations will be able to include subcategories within each of those categories.
Our CILs don’t typically have a lot of assets, so this statement may be more meaningful for those with property and equipment than others.
This statement will also show debt such as lines of credit, installment loans, building loans, accounts payable, and payroll and payroll taxes that have not been paid yet. Be alert if accounts payable, unpaid payroll or taxes get larger from year to year. That might signal a cash flow problem.
This is a good statement for the board to review but should not be the only report they review. The income statement or statement of activities is also very important.
If you want to understand your CIL’s financial statements, boardsource.org publishes many helpful resources for board members, including a book called Understanding Nonprofit Financial Statements. This is available on Amazon or directly from BoardSource.