A Comprehensive Guide to Mastering Nonprofit Financial Statements

As a nonprofit organization, your financial statements are the backbone of your operations, serving as both a compliance necessity and a window into your fiscal health. At SSL Associates, we understand the distinct nuances of nonprofit financial statements and are here to guide you in creating, interpreting, and ensuring compliance. Our dedicated CPA services for nonprofits are designed to streamline this process, making it manageable and meaningful.

Nonprofit financial statements may share some similarities with their for-profit counterparts, but they also carry distinct nuances that require specialized expertise. In this comprehensive guide, we'll explore the four primary financial statements that every nonprofit must master.

Why Nonprofits Need Financial Statements

Financial statements are essential for nonprofits, serving both compliance and strategic purposes. First and foremost, they ensure your organization adheres to IRS regulations and follows GAAP (Generally Accepted Accounting Principles) standards. As a tax-exempt entity, maintaining accurate financial statements is crucial for keeping your status intact and avoiding penalties.

Beyond compliance, these statements offer valuable insights into the financial health of your organization. They allow you to make informed decisions on budgeting, resource allocation, and long-term planning. By understanding your revenue sources, expenses, cash flow, and how funds are being spent, you can pinpoint areas for improvement, explore new funding possibilities, and strengthen the sustainability of your operations.

Additionally, financial reporting helps build trust and transparency with donors, grantmakers, and other stakeholders. Sharing detailed information about your income, spending, and overall financial position shows that you are managing resources responsibly. This transparency fosters greater donor confidence, potentially leading to increased contributions and more access to grants, all of which help further your nonprofit’s mission.

The 4 Essential Nonprofit Financial Statements

Here’s a closer look at not-for-profit financial statements and why each of them matters.

#1. Statement of Financial Position (Balance Sheet)

The Statement of Financial Position, often called the balance sheet, offers a snapshot of your nonprofit's financial status at a given moment. It outlines the organization’s assets, liabilities, and net assets, helping you understand what your nonprofit owns, what it owes, and its overall financial strength.

Assets: The assets section details everything your nonprofit owns, from cash and investments to property and equipment. These items are listed in order of liquidity, meaning the most easily converted assets, like cash, are shown first.

Liabilities: The liabilities section shows your nonprofit’s outstanding debts and financial obligations, such as loans, accounts payable, and deferred revenue. These are usually organized by when they are due, with short-term liabilities (like unpaid invoices) appearing before long-term ones (like mortgages).

Net assets: To determine your organization’s net assets, subtract total liabilities from total assets. This calculation represents the value remaining after liabilities are accounted for. Net assets are categorized into two groups: those with donor restrictions, which are earmarked for specific uses defined by donors, and those without donor restrictions, which offer greater flexibility in how they can be applied.

The Statement of Financial Position serves as a vital tool for understanding your nonprofit's financial health, liquidity, and long-term outlook. Analyzing the trends in assets and liabilities over time can help you evaluate your capacity to meet immediate obligations and guide strategic decisions for growth and resource management.

#2. Statement of Activities (Income Statement)

The Statement of Activities, akin to a for-profit income statement, tracks your nonprofit's revenue and expenses over a given reporting period, typically a fiscal year. This report showcases how your financial activities have either increased or decreased your net assets, providing insight into your organization's overall financial performance.

Revenues: The revenue section of the Statement of Activities details the various sources of income your nonprofit has generated, such as donations, grants, program fees, and investment returns. These revenues are often further categorized as either restricted or unrestricted, depending on any donor-imposed limitations on their use.

Expenses: On the expense side, your nonprofit's expenditures are organized by function rather than by their natural classification (e.g., salaries, rent, supplies). The three main functional expense categories are program services, management and general, and fundraising. This breakdown allows you to demonstrate how your spending directly supports your mission-related activities, administrative operations, and revenue-generating efforts.

Net assets: By subtracting your total expenses from your total revenues, you can calculate the change in your net assets over the reporting period. This figure represents the surplus or deficit your organization has experienced, which can then be added to or subtracted from your beginning net assets to arrive at your ending net position.

The Statement of Activities is a critical tool for nonprofit leaders and board members, as it enables you to evaluate the financial sustainability of your organization, identify areas for potential cost savings or revenue growth, and ensure that your spending aligns with your strategic objectives and mission priorities.

#3. Statement of Cash Flows

While the Statement of Financial Position and the Statement of Activities provide a broad view of your nonprofit’s financial health and performance, the Statement of Cash Flows offers a detailed look at how cash moves through the organization.

This statement breaks down cash inflows and outflows into three primary categories:

• Operating activities: This section reflects cash transactions related to your nonprofit’s core operations, such as receiving contributions, paying employee wages, and covering vendor invoices.
• Investing activities: Here, you’ll find cash flows connected to the management of long-term assets, including buying or selling investments, property, or equipment.
• Financing activities: This category tracks cash movements related to financing, such as obtaining loans, paying off debt, or establishing and maintaining endowment funds.

By monitoring your cash flows, you can ensure that your organization maintains sufficient liquidity to meet its short-term obligations, identify opportunities to optimize your cash management practices, and make informed decisions about long-term investments and financing strategies.

#4. Statement of Functional Expenses

The Statement of Functional Expenses is a specialized financial document required for nonprofit organizations. It offers a detailed analysis of spending based on its purpose and how it aligns with the mission of the organization.

In contrast to the Statement of Activities, which categorizes expenses by type — such as wages, rent, or office supplies — this report organizes costs into three primary functional categories:

• Program services: These expenses are directly related to carrying out your nonprofit's mission-driven activities, such as the costs of running your programs, providing services to beneficiaries, and conducting research or advocacy efforts.
• Management and general: These expenses support the overall administration and operational oversight of your organization, including costs for human resources, finance, and information technology.
• Fundraising: These expenses are associated with your nonprofit's efforts to generate revenue, such as the costs of hosting fundraising events, producing marketing materials, and engaging with donors.

By clearly defining expenses within these areas, the Statement of Functional Expenses helps communicate to donors, grantmakers, and other stakeholders how their contributions are advancing the organization’s mission. It also provides a framework for assessing and optimizing resource allocation, ensuring that a significant share of funds goes toward essential programs and services.

Creating a Financial Statement for Your Nonprofit

Financial statements play a vital role in ensuring transparency and compliance for nonprofit organizations. Most of the necessary data can be accessed through your accounting software. You can prepare these reports by either manually entering information into templates, a process that can be complex and time-consuming, or by collaborating with an accounting firm that specializes in nonprofit services. Choosing a nonprofit-focused accounting partner ensures that your statements are precise, fully compliant, and tailored to align with your organization’s unique goals and operations.