Nonprofit Accounting Pressure Points

Where is your nonprofit holding tension?

Like our own bodies hold tension in certain pressure points, nonprofits have several pressure points related to their financial structure. And like in our bodies, being aware of and tending to those accounting pressure points can be a source of relief and increased financial health for an organization.

 For many nonprofits, these recent months of political, economic, and philanthropic chaos have heightened attention to the core financial infrastructure our organization has (or may not have) in place. Having clear, accurate accounting data at hand to gauge where our nonprofit stands financially is crucial when so much is uncertain and rapidly changing. When our organization is reeling from uncertain funding, sudden loss of government grants, impromptu changes in philanthropic priorities, or shifting patterns of individual giving, financial stress may build up in identifiable pressure points within the organization. In this article, we will explore two of these pressure points – cash reserves and restricted revenue – and how to treat them.

Pressure Point – Cash Reserves

One of the most important pressure points involves our financial reserves. Reserves take many forms, but the most important is cash on hand. When funding is uncertain, knowing what resources we have available to withstand immediate funding shortfalls is essential. To get a rough idea of how our cash on hand stacks up against our operating needs, we simply divide our annual operating expense budget by 12. If we have significant noncash items in our budget (for example, large building depreciation expense or large in-kind contributions for rent or donated supplies), we exclude them from the annual operating expense figure. After dividing, this gives us an estimate of the monthly cash outlay needed to run our organization.

Next, we divide our total cash on hand (all the funds in our checking and savings accounts, along with any other readily accessible short-term investment accounts) by the estimated monthly cash outlay to calculate how many months of available cash on hand we have. Before we divide, it is best to subtract out of the cash any amounts that are not available for use within the next twelve months. This means any cash that we have received that we will not be able to use until a year or more in the future. This does not mean that all donor restricted cash must be excluded. We will probably use some of the restricted cash we have on our books for program expenses in the coming year. It is okay to include whatever portion of restricted cash that we expect to use (release) in the next twelve months in our determination of available cash on hand.

Once we know how many months of available cash on hand we have, we need to assess what that means for our organization. There is no universal benchmark for nonprofits. The needed months of cash on hand depends on our specific organization’s receivables cycle – from what sources and when do we regularly receive our revenue?

If we are heavily government funded, we may be submitting invoices or funding requests monthly and getting paid within 30, 60, or 90 days. If so, we need to have cash reserves at least as large as the amount that we are routinely waiting to receive from government payors.

If we rely heavily on traditional year-end giving season contributions, then our cash reserve needs may be much larger. If we receive the majority of our funding in that one season, then our cash reserve needs increase to match nearly a year’s worth of funding.

We can only make sense of this pressure point and treat it accordingly if our accounting system is trustworthy and accurate. Along with trusting the basic numbers, we must be able to clearly see and understand what funds are donor restricted and when those funds will be available for use. Setting up proper accounting for restricted revenue is key to an effective nonprofit accounting function.

Pressure Point – Restricted Revenue

Another pressure point for nonprofits is our understanding and tracking of restricted revenue. Nonprofit accounting is unique in the ability of donors to place restrictions on how and when we use the contributions they give. If we accept a gift from a donor that the donor has stated must be used for only particular programs or purposes, then we must track those funds and their use to ensure that we have complied with the donor’s wishes. Funds are also considered restricted if the donor has specified a future time period when the funds can be used. This is often the case if the donor makes a multi-year pledge or gives an amount this is intended to cover expenses in multiple years.

Receiving restricted money should not burden our organization as long as we are accepting restricted gifts that align with our already planned and budgeted activities. We also need to set up our accounting system and processes to accurately track and report on the use of any restricted gifts.

One effective way to account for restricted revenue is to use a two-column approach in displaying the Statement of Activities (Income Statement) and the Statement of Financial Position (Balance Sheet). In a two-column approach, we show separate columns for funds Without Donor Restriction and funds With Donor Restriction.

Using the two-column approach for displaying restricted revenue gives us better sightlines into how much revenue without restriction we have available for our immediate uses – so that we do not inadvertently consider all our restricted funds as available. We can, of course, plan to use restricted funds for current and upcoming activities that fall within the purposes specified by the donor, or for upcoming activities that fall within the time frame specified by the donor.

In the Statement of Financial Position shown above, we can see that the total cash balance is $345,118. Of that balance, $194,661 is Without Donor Restriction, so immediately available for whatever needs we have. The two-column display also shows that $150,457 of that cash is restricted. But earlier when calculating our months of cash on hand, we estimated that only $75,000 of restricted funds were truly unavailable. The other $75,457 are available for current uses even though those dollars are restricted.

Having this detail available to us and being able to assess how much restricted funding is truly accessible in the current accounting period is extremely useful. Again, we need to have accounting infrastructure (understanding and systems) sufficient to provide this information to make the best choices to fit our financial situation.

Pressure Points – For Diagnosis and Relief            

Knowing our organization’s financial pressure points gives us the ability to diagnosis our current financial realities, assess what may need to be done to change our financial reality, and, hopefully, a method for relieving any stressful pressure that may be building. Making the proper investment in our financial systems and personnel – or seeking outside supports to help us in this area – is the best way to ensure we can accurately assess and successfully treat our nonprofit accounting pressure points.

Post written by Curtis Klotz, CPA, Co-Founder and Chief Learning Officer, Diverge Finance Cooperative