Best Practices for Nonprofit Financial Health, Part One: Top 3 Measures of Financial Health Nonprofit Finance Fund

To illustrate this and other concepts throughout this blog series, I will be using the example of a small performing arts theatre (let’s call it the Drama Queen (DQ) Theatre). DQ Theatre has a $600,000 expense budget, which means that it has about $50,000 in monthly expenses. If this theatre had $100,000 of unrestricted cash on hand, it would have just two months of cash available to support operations.

• When completing Federal Form 900, nonprofits must report expenses functionally, broken down into the categories of Program, Management and General Activities, and Fundraising.
• Organizations typically prefer donations of unrestricted net assets because they allow them maximum flexibility to spend as they see fit, whether for hiring additional personnel or expanding their services.
• For school districts, the highest decisionmaking authority is typically the governing board.
• Or, it requires a transfer be done to show an influx of funds to RNP to bring it to zero.
• The creation of this type of constraint is evidenced by formal governing board actions (e.g., legislation, resolution, or ordinance) that can only be changed by an equivalent action.
• The nonprofit sector is no different; however, some organizations just aren’t there yet.

Regardless of the action that gives rise to a classification of assigned fund balance, formal action is not required to reverse that classification. Again, an assignment does not require any formal action to initiate and will most commonly represent management’s intent of use for resources included within fund balance. Another key difference is the limitations non-profits have in deploying their assets compared to a for-profit company. Most non-profits rely heavily on donations or have strict requirements for how it can use its resources to achieve its stated mission. As a result, within the net assets section of the statement of financial position there are specific accounts that reconcile the varying degrees to which the non-profit can use its money. Specifically, there are the unrestricted net assets and two types of restricted net assets.

Revenues, gains, other support, and releases from donor restrictions

Unrestricted net assets, also known as the operating reserve, represent the cumulative earnings over the life of the organization. A positive operating reserve allows an organization to pay its current obligations and fund future programs or projects through use of unrestricted net assets. Many organizations receive their unrestricted revenue through fee-for-service, https://www.bookstime.com/articles/do-i-need-a-personal-accountant ticket sales or membership income. Other sources of revenue include unrestricted grants/contributions and the release of temporarily restricted net assets through the satisfaction of donor or time restrictions. Whatever their source, they contribute to the overall financial health of the organization as part of its unrestricted net assets.

Just as a fast food chain and an airline are in different businesses with different financial indicators, a specific ratio will mean something different in different types of nonprofits. There are different red flags for arts organizations than there are for human service organizations, and different red flags for organizations that rely on donations than for organizations that rely on individual fee payments. Restricted fund balance primarily represents those resources within fund balance for which constraints exist that cannot be changed or redirected by management. It’s possible for fixed assets to have donor restrictions, for example a building that can only be used for a specific purpose, but in this example fixed assets are not restricted. Even if fixed assets are unrestricted, though, they are still not cash nor are they usually easily converted to cash (liquid). These unrestricted net assets are also referred to as the operating reserves and represent the cumulative earnings over the life of the non-profit organizations.

Statement of Financial Position

This resource helps nonprofit organizations understand and interpret their financial statement by measuring the organization’s efficiency, evaluating the adequacy of financial resources, and identifying significant trends. Nonprofit grantees can learn a great deal about the health of their organization by examining the numerical information presented. Net assets without donor restrictions (unrestricted net assets) is the balance left in net assets after subtracting restricted net assets. In this simple example, you can see that it’s made up of the $50,000 in fixed assets. Unrestricted net assets are donations to nonprofit organizations that have no strings attached.

• Even if fixed assets are unrestricted, though, they are still not cash nor are they usually easily converted to cash (liquid).
• The FDS does not allow negative RNP and requires the booking of a receivable to show that future HAP funds will be provided to cover this difference.
• In any event, months of LUNA may be the metric to follow as it is the more conservative measure of the two.
• A lot of our inquiry is based more on trend analysis than ratio analysis.
• Let’s change our make-believe nonprofit to be a little more realistic.

The amount and nature of the designation should be explained in a separate line of the balance sheet, parenthetical comment, or note to the financial statements. Designations may be related to construction or other capital expenditures, claims and judgments, or self-insurance contingencies. Grants receivable means grant funding that has been committed to the organization but not received. One thing that is clear and certain amidst all this murkiness, is that the number that is used to determine PHA funding comes from the VMS. The amount of HAP expense reported in prior months determines how much HAP income will be disbursed to the PHA as part of the HCV Cash Management rules. The RNP becomes a major factor in funding when the following trends occur.

Statement of Cash Flows

When a donor doesn’t specify exactly where or how the non-profit is to use the given donation, the contribution is considered to be unrestricted. If income is greater than expenses within a given period, say a year, the organization has generated a surplus. If expenses are greater than revenue, the organization experiences a deficit for the period.

• Ask the tough questions, know where the gaps lie and what’s being done to fund them, and have a plan for the next step if funding doesn’t come through.
• However, the account balances will be combined into a few amounts that are presented in the financial statements and IRS Form 990.
• Instead of suggesting that they save six months’ worth of expenses in cash from the outset, I will meet them where they are, suggesting short-term goals of reaching one or two months of cash for starters.
• There is no rule that says organizations should have surpluses, deficits, or break even.
• Timing is critical; a modest budget cut made early on can leave your organization much more viable than a drastic cut made too late.

We love all kinds of net assets, though we have a special place in our hearts for unrestricted net assets. Permanently restricted assets often come in the form of a fund that must be maintained indefinitely, with the income generated by its investment unrestricted net assets to be used for a particular purpose. Organizations typically prefer donations of unrestricted net assets because they allow them maximum flexibility to spend as they see fit, whether for hiring additional personnel or expanding their services.