Understanding Financial Statements 101
Board Training Portland Village School
12/19/2013
Overview
As a board member, your fundamental role is to oversee the implementation of
Portland Village School’s mission. This includes exercising your fiduciary duty to
ensure that the organization’s financial resources are effectively managed and
sufficient to assure the organization’s long-term financial viability.
Our finance committee is charged with reviewing the detailed financial statements
in and are tasked with having a deep understanding of our statements. They also
will perform a more detailed review of the various elements of the statements, work
with our auditors/ CPA and report their findings back to the full board.
However as part of our fiduciary responsibility, all board members need to have a
basic understanding of the most important elements of our basic financial
statements and should review the IRS Form 990 prior to filing.
Balance Sheet Basics
The balance sheet (or statement of financial position) summarizes the assets and
liabilities of an organization at a point in time. This is a point in time snapshot of
our financial situation.
Assets = Liabilities + Equity
Contents of the balance sheet
1. fixed assets - long-term (buildings, property, computers, etc.)
2. current assets - short-term (value can change from day to day – cash, money
owed, short term investments, etc.)
3. current liabilities - what we owe and must repay in the short term
4. long-term liabilities – leases, mortgages, etc.
5. equity- permanent, temporary and unrestriced net assets
A balance sheet shows:
 how solvent we are
 how liquid our assets are - how much is in the form of cash or cash
equivalent
 what we owe
 how we’re financed
4 Things You Need To Pay Attention To:
Trends. One of the first places to check for financial issues involves year-to-year trends.
As you compare your current Statement of Financial Position to the one produced for the
previous month or the previous year, you should look for any unusual trends. For
example, does the current ratio seem to be decreasing, or have you had a significant
growth in restricted assets that may affect your operating budget?
Liquidity. Liquidity refers to the organization’s ability to tap into the cash required to
pay immediate and routine obligations. One of the key indicators is the Current Ratio.
The Current Ratio, current assets divided by the current liabilities of the organization,
should be greater than 1.0. In addition, you should know your financial reserve targets
for loans, long-term asset replacement and other uses, and check to make sure you are
meeting these targets.
Debt. Many not-for-profits have a lending relationship with a bank or other financial
institutions. As a board member, you should be familiar enough with the terms of the
loan to understand whether you can access the capital required to cover emergencies. You
should also review the Statement of Financial Position to ensure the loan balances are
consistent with expectations. Rapid growth in debt might foretell an impending financial
crisis.
Unrestricted Net Assets. Planning for a significant economic downturn, natural disaster
or other crisis is an important board function. As a part of that planning, you should
anticipate the financial demands that could result from such a situation and ask whether
or not your organization has enough liquid unrestricted net assets, and/or access to credit
to protect the organization.
Yellow flags are on the statement of activities, red flags are on the balance sheet!
Statement of Activities (aka Income Statement & Profit and Loss)
The Statement of Activities is similar to the Income Statement prepared by for- profit
entities. Not-for-profits have two key sources of income: revenue and support. Revenue
includes resources that resulted from an exchange trans- action, such as program or
service fees, grants and contracts from governmental agencies or other sources, ticket
sales or event income, and investment return. Support includes resources for which no
services, goods, or reciprocity is received by the donor/funder. This includes
contributions, private grants and in-kind donations.
The Statement of Activities shows the results of the organization’s financial operations
for a period of time. Not-for-profits have many of the same expense categories that other
entities do, but they must also show expenses by their functional classification: Program
Services, Administrative and Fundraising.
Change in Net Assets, like the net income in for-profit statements, is the difference
between revenue (including support), and expenses.
As a board member reviewing the Statement of Activities, you should consider these four
critical areas:
Budget versus Actual. Throughout your term, you will often have access to
management’s internal Statement of Activities, outlining budget versus actual expenses.
As you review the document, look for significant variances, especially those that
negatively impact the organization, and ask questions so that you better understand both
the cause and the effect. One real quick way to do this is to scan the percentages to see
where each line item is significantly over/ under budget. If there are large variances, you
should understand the reasons for the variances and what management's plans are for
addressing the variances to determine whether you feel confident that management's plan
will be effective.
Revenue & Support. While the Statement of Activities identifies revenue or support, it
may not always indicate how dependent the organization is on any one source. Heavy
reliance on a single source can be risky. For example, if the organization receives 80% of
its funding from a single donor or foundation, the organization could be at significant risk
if that funding is decreased or discontinued.
Trends. When reviewing actual expenses, look for expenses that are rising more rapidly
than the corresponding revenue or support source. Also, look for longer-term trends in
both revenue and expenses. Such trends may signal a need for increased attention to fund
development or tighter expense management.
The Bottom Line (Net Income or Loss). The bottom line is just as important to a notfor-profit as it is to a for-profit organization. The audited format of the Statement of
Activities shows not only the total change in net assets for the year, but also how the
change is distributed between restricted and unrestricted net assets.
IRS 990 Form
The Form 990 is a not-for-profit organization’s required annual IRS tax filing. It is a
public document available for anyone to review. As a board member you should review
the Form 990 before it is submitted. Even though you may not be asked to sign the
document, it is important for each board member to review the Form 990 before it is
submitted.
Pay close attention to the snapshot on the first page and accomplishments. It is also
important to review the attached schedules and disclosures.
Questions to Ask about the Form 990
o Does the Form 990 accurately reflect our financial position?
o Does the document present any red flags to prospective donors or governmental
agencies?
4 Things to do when you get the financial statements
1. Review the balance sheet
o How solvent are we? AKA, Are our assets greater than our liabilities?
o Did we have a financial gain or loss this period?
o Can we access capital in an emergency?
o Are we prepared for a significant economic crisis?
2. Review the Statement of Activities (aka Profit & Loss, Income Statement):
o Are there budget lines where we are significantly over budget?
o How are we addressing any large variances between budget and actual?
o Are we overly dependent on a single funding source? (In our case, it kind of goes
with the territory, however we want to look at the other revenue sources outside
of PPS)
o Is revenue increasing at least as fast as expenses?
o Did our bottom line meet expectations?
3. Check to see how many days of cash we have on hand
1. Divide the annual expense budget by 365 days. This is the amount of cash we
need per day.
2. Calculate our cash and cash equivalents on the balance sheet.
3. Divide cash by amount of cash we need per day
4. If this number is less than 60-90 days, what’s our plan to cover expenses?
4. Look for trends
o Are expenses rising faster than revenues?
o How do are statements compare with prior year financial data?
o Have we had significant increases in restricted assets?
Glossary of Not-For-Profit Financial and Accounting Terms
Accounts Payable: The amount owed to others (e.g., vendors) for services or merchandise
received by the organization.
Accounts Receivable: The amount owed to the organization for services or merchandise
provided to others (e.g., customers).
Accrual-Basis Accounting: A system of financial recordkeeping in which transactions are
recorded as expenses when they are incurred and as income when it is earned, rather than
when cash is paid or received. The alternative is cash- basis accounting. Accrual-basis
accounting is more precise but also more complex.
Accrued Expenses: Expenses that have been incurred but have not been paid (e.g.,
salaries, benefits)
Accrued Interest: Interest costs that have accumulated but have not been paid.
Allocation: A method of dividing expenses among different program, administrative and
fundraising categories using a reasonable and consistent basis (common bases include
staff time, number of employees and square footage).
Assets: What the organization owns or has a right to use.
Audit: An examination, conducted by CPAs retained by the organization’s Board of
Directors, that provides assurance to internal and external users of the organization’s
financial statements that the statements are presented in accordance with generally
accepted accounting principles (GAAP). The audit results are presented to the Board in
the form of an opinion from the CPA.
Balance Sheet: A report showing a snapshot of the financial condition of the organization
at a particular moment in time. Also referred to as the Statement of Financial Position.
Board-Designated Funds: Funds earmarked by an organization's Board of Directors for a
specific purpose, such as Operating Reserves. For accounting purposes these funds are
still considered unrestricted because the condition was not specified by a donor.
Cash and Cash Equivalents: Funds that can be quickly and easily converted to cash
(usually bank accounts, money market funds and other investments that mature within 90
days).
Cash Flow Statement: A report showing cash inflows and outflows for a specific period
of time.
Chart of Accounts: A list of all accounts used in an accounting system, including assets,
liabilities, equity, income and expenses.
Contribution: A donation, gift, or transfer of cash or other assets.
Current Assets: Cash,
investments, receivables and other assets that are expected to be available as cash within
the next 12 months.
Current Liabilities: Those liabilities due to be paid within the next 12 months including
the Current Portion of Long-Term Debt (loan principal payments that are due and
payable within the next 12 months).
Deferred Revenue/Deferred Income: Income for which payment has been received before
it has been earned. It is reflected as a liability on the Balance Sheet until it is earned and
can be recognized as income.
Deficit: Expenses in excess of income. Also referred to as Net Loss or a negative Change
in Net Assets.
Depreciation: The recognition of the decrease in value of a fixed asset over its expected
physical or economic life. This is recorded as an expense each year.
Fixed Assets: Tangible assets that have a useful life in excess of one year such as land,
buildings, furniture and equipment.
Fiscal Year: A 12-month period which the organization uses for accounting and Form
990 purposes. This period may be a calendar year but can also be any other 12-month
period. A fiscal year accounting period should normally coincide with the natural
operating cycle of the organization.
Form 990: IRS Form 990 (Return of Organization Exempt from Income Tax) is the
annual tax return document used by most tax-exempt organizations
to report
information about their finances and operations to the federal government.
Functional Expenses: Categories of expense delineated by the type of expense: program
services, management and general, and fundraising. Required for IRS Form 990 and
audited financial statements.
Fundraising Expense: Expenses incurred in soliciting contributions, gifts, grants and
other funding sources, including volunteer time.
Generally Accepted Accounting Principles (GAAP): The standard framework of
guidelines for financial accounting established by the Financial Accounting Standards
Board (FASB) to help ensure the accuracy and consistency of financial records and
reports.
Income Statement: A report that summarizes the organization’s activity (revenues and
expenses) during a specific period of time. Also referred to as the Statement of Activities,
Statement of Changes in Net Assets or Profit and Loss (P&L).
In-kind Contribution: A contribution made of goods or services rather than cash.
Liabilities: What the organization owes to others.
Management and General Expense: Expenses for the general functioning of the
organization, but not related to a specific fundraising or program activity.
Net Assets: The difference between the organization's total assets and its
total liabilities
on the Balance Sheet indicating the net financial worth for the organization (similar to
equity in for-profit organizations). Divided into unrestricted, temporarily restricted and
permanently restricted net assets, depending on donor-imposed restrictions.
Permanently Restricted Funds: Contributions that are to be retained, rather than spent, by
the organization. The most common are endowment gifts which are invested and produce
income that can be spent each year.
Pledge: A formal commitment to make a contribution of a specific amount. Also called,
"promise to give" or "unconditional promise to give."
Prepaid Expense: An expense that is paid before use of the good or service such as
insurance paid in advance.
Release from Restrictions: Transfer of temporarily restricted funds into the organization's
unrestricted accounts when the restriction has been satisfied.
Reserves: An amount set aside by the organization to be used in case of losses,
unexpected expense, emergency or planned future events, such as purchase of a building.
Restricted Funds: Contributions restricted by the donor for a specific use. These
restrictions can be temporary or permanent in nature.
Temporarily Restricted Funds: Contributions given for a specific use or for use during a
specific period of time. Once funds have been spent for the specified purpose or the
period of time has lapsed the funds are released from restric- tion.
Unrestricted Funds: Contributions with no donor restrictions or limitations as to their use,
as well as all other revenue sources.