Financial Basics for Nonprofit Managers

I’ve had the opportunity to raise, manage, invest and spend a lot of money over the course of my nearly 30-year career, and without patting myself too hard on the back, I’d say that I’m pretty darn good at doing so — despite having little formal training in the financial and accounting disciplines.

I am certainly not alone among nonprofit executives in my lack of textbook-based financial training, in large part because those individuals who choose to pursue such skilled financial degrees are not innately going to be drawn to a professional sector known for its low compensation, high personnel turnover, risks of financial insolvency, governance by unpaid amateurs, and fuzzy wuzzy management practices.

No, it takes a weird, warped and special personality type to purposefully choose such a work environment — and those possessing said personality type are generally more apt to prefer ballet to balance sheets, Renoir to revenues, and punk rock to sunk costs, while also understanding “liquidity” to be a measurement of after-work intoxication resources, and “utility” to be a closet. Note well, though, that I say these things with nary a shred of condescension or disdain, since I am the owner of one of those special personality types myself.

So given this two-strike functional handicap, how did I get to the point where I can confidently create complicated budgets, deftly parse the details of a balance sheet, swap accounting jargon with alpha bean counters, and manage other people’s money in a way that doesn’t embarrass me or them?

It wasn’t easy, and I had to figure most of it out for myself . . . so it recently occurred to me that it might be helpful to others if I created a little primer for up-and-coming nonprofit managers and executives, to help the next wave learn from my own experiences. I’m selfless like that, you know, because that’s the nonprofit way. Huttah!

First and foremost, I followed the best professional advice I’ve ever been given, and I consciously, actively became an expert in the financial workings of my various organizations. I may not have known as much as a marginal first year accounting student much of the time in my early professional days, but if I knew just a little more than most of my colleagues, that was generally enough for them to defer to me when confronted with financial quandaries. If people believe you are an expert, and if you confidently and consistently talk and walk like an expert, then amazingly enough, eventually, you actually really become an expert.

It’s true! Try it!

Another key to my success was making sure that I had a real financial expert available to me for consultation at all times. This was pretty easy, since financial types tend to be somewhat socially awkward, meaning they generally don’t mind if you take credit for their work and expertise, so long as you express gratitude by visiting their cubicles every so often with snacks and/or properly filled-out travel reimbursement forms in hand. Then, once I reached the point of being able to hire my own staff, I always prioritized having an exceptionally talented, scrupulous, and well-trained financial professional on my team, which required me to learn even more of their arcane practices and language, further bolstering my own expertise in the process.

Having those financial language skills is crucial to an up-and-coming nonprofit executive. If you don’t parlez le money vous, then your staff financial professionals and your board treasurer are just going to talk through, around, or over you. You’re going to look lost at staff or board meetings as a result, which does not inspire confidence, even among the kitten-handling types. Conversely, few things are as dazzlingly empowering at a staff meeting as successfully translating and taking decisive action on a jargon-filled statement emerging like squid ink from your accountant’s maw, especially if you can use some cool acronyms and juicy terms of trade in the process, just to keep the non-financial experts in the dark.

To help you in this regard, I’ve compiled a list of ten very important concepts — and the language used to frame them — that you’ll likely need to master in order to convince your staff, colleagues and board that you’re a seasoned nonprofit financial expert, in large part because most of them will have no idea what you’re talking about. Ready? Let’s do this . . .

  • Chart of Accounts and the General Ledger: Your Chart of Accounts is just the listing of all of the buckets (called “accounts” in accounting speak) into which your business transactions can be dumped. While there are some common buckets/accounts that most nonprofits will share, your Chart of Accounts should also be tailored to the unique nature of your own enterprise. Don’t make it too complicated, though, and make sure your buckets’ labels make it clear what gets dumped where, e.g. if your Chart of Accounts has a “Marketing” sub-sub-account under the “Cookie Sale” sub-account under your “Fundraising  Event” account, and it also has a “Cookie Sale” sub-sub-account under the “Marketing” sub-account of your “Office and Administration” account, then which one do you pick when the printing bill for your Cookie Sale Posters arrives? The General Ledger is the official and formal record of your business transactions, classified via the Chart of Accounts for easy access and analysis, if you’re doing it right. Most of us use pre-packaged or off-the-shelf software (e.g. Intuit’s QuickBooks or Blackbaud’s Financial Edge) at this point for our general ledgers, and there are both server and web-based systems available. I prefer the safety of the latter, having once watched one of my employees blow up the former.
  • Profit and Loss Statements and Balance Sheets: Profit and Loss Statements (call them the “P&L” for maximum meeting dazzle) are reports that list your organization’s revenues, then subtract from those revenues the costs of running the business. The bottom line difference between revenues and expenses is called net income (or, sometimes, profit. . . gasp!), and you generally want this to be a positive number. (But wait?!? We are nonprofits?! How can we show a profit on our P&L?!? Hang on, Scooby, we’ll get to that in a minute . . . it’ll be okay, I promise). The Balance Sheet is a statement of the financial worth of your nonprofit that lists all assets (things of value owned by your organization, including both current and fixed assets, more on that below), then balances them with your organization’s liabilities (amounts owed to others) and capital (fixed assets and money invested in the nonprofit, again more on that below). Assets = Liabilities + Capital on the Balance Sheet, always. The P&L Statement covers a period of time (e.g. First Quarter, Fiscal Year 2014), while the Balance Sheet covers a point in time (e.g. March 31, 2014), so don’t trip up while trying to be cute by asking for “the first quarter balance sheet” or the “June 15 P&L.” Your General Ledger software should be able to easily and quickly produce these reports, assuming your financial professional is relatively up-to-date on his or her General Ledger entries, and also considers your needless, last-minute requests for information to be a priority. 
  • Profit for Nonprofits: Why, oh why, do I keep referring to profit?!? We are all nonprofits, so we must lose money every year to have negative net income, by definition, right?!? No! Wrong! Bad wrong! (Insert sound of me rubbing your nose in your P&L here) Bad! Bad nonprofit manager! Here’s the deal: any nonprofit corporation that spent every single penny it earned (or more), as it earned it, would quickly become an ex-nonprofit corporation. The real difference between nonprofit and for-profit corporations is what happens to the positive net income when revenues exceed expenses: in a for-profit corporation, the surpluses are distributed to shareholders as income or dividends; in a nonprofit corporation, the surpluses must (eventually) be applied toward to the nonprofit’s mission. Some amount of running surplus is generally required on a year-to-year basis just to meet basic payroll and operating requirements. Some larger surpluses may support organizational mission by being placed in endowments (say “permanently restricted”), with earnings providing long-term revenue streams. Some surpluses may be ear-marked by your board for specific mission-based needs, and held until such time as the funds may be paid to meet those needs (“board designated” or “temporarily restricted” in the jargon). At bottom line, and over the long term, all nonprofits must make more than they spend, or they will cease to exist as effective entities. You do not want to be the manager who drives a nonprofit organization into insolvency, as that’s one of the very, very, very few things serious enough to keep you from getting another job in our sector. If you’re forced out of our cozy little world, then you will have to jump to the corporate side, where you only get a multi-billion dollar golden parachute for destroying your company’s finances. And who wants that?
  • Current Assets vs Fixed Assets: As noted above, assets are things of value owned by your organization. Current Assets are things that could readily turn into cash within a year or less, e.g. money in a bank account, inventory that can be sold, marketable investments, and accounts receivable (more on receivables below). The ability to turn things into cash quickly is called “liquidity,” even outside of Happy Hour. Fixed Assets are things of value like buildings, land, equipment and long-term investments that can’t readily be turned into cash within a year without having an impact on your nonprofit’s operations, e.g. if you are a museum, you can’t sell your entire collection without seriously degrading your ability to satisfy your nonprofit mission, hence your collections should be considered fixed assets. Most nonprofit managers will spend the lion’s share of their time dealing with current assets, which we need to pay bills and buy lollipops, though most nonprofit organizations will have more of their worth defined by their fixed assets, which seems damnable because we can’t pay the printing bill for the Cookie Sale Posters with them.
  • Cash Basis vs Accrual Basis: Getting your hands around this vast, slobbering bantha of an accounting concept  is the key to advancing from Nonprofit Padewan Noob to Nonprofit Jedi Warrior, for sure. Personally, if I could go back in time to the moment when the first primordial accountant crawled out of the ooze and convinced Executive Director Dimetrodon that accrual based accounting was the wave of the future, I’d redirect a comet to obliterate that exchange, and we’d all happily manage our businesses the same way we manage our personal finances: either we have money in the bank to pay our bills (yay!), or we don’t (uh oh!). That’s cash basis accounting at its most basic, where transactions in the general ledger reflect the point when cash (or equivalent instruments) changes hands: we put five dollars in the bank on Monday, we take three dollars out on Tuesday to pay a bill, we’re still two dollars up, right now, so we could plan on buying a cookie or a cup of coffee on Wednesday if we wanted, so long as we don’t go to Starbucks to get it. But accrual basis? Oh, accrual basis! Bane of board meetings! Destroyer of balance sheets! Sapper of Executive Director souls! I can’t do justice to the horrors here in a single paragraph, but suffice to say that an accrual basis accounting system (under which most of us operate, alas) is one that records revenues and expenses at the time a transaction is said to occur, regardless of whether cash or other current assets change hands or not, while also looking at the life expectancies of fixed assets and only applying pro-rated portions of expenditures for those long-term acquisitions as expenses in any given accounting period. And, yes, I know that all sounds like gobbledegook and is completely alien to anything you encounter in managing your own real world financial affairs, so to spread the confusion out, I cover key accrual basis concepts in their own bullets below. You might want to charge your light saber before reading on.
  • Receivables and Payables: While an annual fund pledge for $10,000 does not change anything for you on a cash basis until the check clears (no matter how much your development director crows about it), it is recorded as a “receivable” on an accrual basis, and increases your organization’s assets on the balance sheet. Conversely, when you receive a bill from Hair Club for Men with a 90-day grace period, nothing changes on a cash basis, though it is recorded as a “payable” on an accrual basis, and decreases your organization’s assets on the balance sheet. If you tally up everything that’s owed to your nonprofit, those are your “accounts receivable” (which the cool accounting kids call “AR”), while the sum of everything your nonprofit owes to others is called your “accounts payable” (repeat after me: “AP”). Unfortunately, you can’t take presumed credit for your organization’s deliverable outcomes and outputs in advance this way, much to your grant writer’s chagrin. 
  • Capital vs Expense: More accrual basis linguistic madness here, where “expense” can be used as a verb, and “capital” has nothing to do with upper and lower case letters. When you expense an item, you post an expenditure against your revenues that reduces your assets — but not all expenditures are expenses. (What?!?) The most common expenditures-that-are-not-expenses for most of us will involve capital investments, which are the fixed assets we acquire that have long-term value and use. For example: let’s say you spend $100,000 to buy a party bus for your clients, and that party bus has a life expectancy of ten years. At the time of the purchase, you convert one asset (cash) into another (party bus), but you have not changed the total value of your assets on your balance sheet, so no expense occurs. How, then, do you actually expense the party bus? Read on!
  • Depreciation: So after one year of riding the party bus with your clients, its value has gone down by ten percent, because it has a ten year life expectancy. How do you mark this anniversary? By expensing ten percent of the purchase price of the party bus in your general ledger, reducing the value of the assets on your balance sheet by $10,000. Then you repeat that annually for the next nine years, until your party bus is fully depreciated, at which point it has no value on your balance sheet, though it may still be fun to ride around in while drinking with your clients. This concept can be tricky to deal with: some assets do not depreciate (e.g. art collections), some assets’ real world value declines far faster than depreciation schedules indicate (probably the case with the party bus), so if you sell them at market price, you still may have to post a loss on your books, etc. If you own a lot of land, building, equipment and other property, your accumulated depreciation numbers may be among the largest figures on your balance sheet, even though 95% of your board members will be rendered immediately glassy-eyed if you try to explain this to them. Better to just jump past it as “one of those accounting things” and get to the kittens and lollipops as quickly as you can accordingly.
  • Materials and Subcontracts vs Labor and Overhead: Gah, enough with this accrual nonsense! Let’s jump back, for a moment, to talk about things that make sense in a lucid world without accountants, and to provide a cautionary note in how to look at — and present — your financial successes and failures. Let’s imagine you run a week-long Clown Academy each summer as a fundraiser toward your charitable mission of terrifying children into avoiding circuses. This year, you raised $20,000 in sponsorships, and 100 aspiring clowns paid $200 each (total of $20,000) to participate in the program, for gross revenues of $40,000. Against these revenues, you spent $10,000 in greasepaint, $10,000 in cream pies, and $10,000 in seltzer water, for total expenses of $30,000. Huttah! You netted $10,000 from the Clown Academy, which you proudly report at your next board meeting . . . neglecting to mention that you and five of your deputy assistant subminions worked for three months to plan and execute this (so called) “fundraising event.” What happens if you factor in the cost of your salaries, your healthcare benefits, your payroll taxes, your paperclips and your bad office coffee? Odds are, the Clown Academy is a big, big loser. Financially, I mean. Nonprofit organizations are utterly notorious for writing budgets and presenting results of fundraising events that focus solely on materials and subcontracts: things we buy, stuff we pay for, checks we write that we wouldn’t buy, pay for, or fund if we didn’t do the event. But it is equally important to plan for and report the costs of your human livestock, too, which you can call “labor and overhead” when talking to your board, since that makes you sound less ruthless and inhuman, which is always good in our business. If you inherit a bunch of fundraising events when you take on a new management position with a nonprofit, the first thing you should do is find out how much staff time is consumed in running each of them, and then quickly kill a few of the ones that are upside down when Materials and Subcontracts and Labor and Overhead costs are factored in, just to show you mean business. You’ll be amazed at what a game changer this can be.
  • Audits and Internal Controls: Once your nonprofit gets big enough to have any real meaningful impact, you’re likely to have to undergo an annual independent financial review, where you will pay an outside agency a lot of money to come in and tell you that you don’t really know what you’re doing. These grouchy outsiders, called “auditors,” will spend a lot of time hunkered down with your financial professional(s), throwing bones around, spilling Diet Coke everywhere, muttering incantations, and frequently popping into your office to wave their hands and moan “GAAP! GAAP! GAAAAAaaaAAAaaAAAAaaaaaP!” What does it all mean? Well, GAAP means “generally accepted accounting principles,” which are a set of standards for financial accounting that we’re all supposed to comply with, because it amuses the auditors and other accountant types to watch us struggle with accruals and depreciation and receivables and whatnots. The auditors will also generally want to look at your internal controls, which are the policies and procedures that you must have to preclude fraud, waste, abuse and mismanagement, or the appearance thereof. Auditors love it when you say “or the appearance thereof,” by the way, so be sure to work that in whenever you can. If all goes well, or the appearance thereof, then the auditors will provide your board with an audited financial statement that essentially says you are in compliance with GAAP, you have sound internal controls, and the papers you gave the auditors when they arrived were accurate and complete to the best of their knowledge. Note well, however, that the auditors will also generally provide 473 carefully-crafted disclaimers, so that if they made a mistake, or the appearance thereof, in their audit, then it is still your fault, not theirs. Also, while getting a “management letter” from your auditor may sound like a good thing — since you’re an important manager, after all — it actually is a bad thing: it’s the way the auditors tell the Board that you’re a knucklehead, or the appearance thereof. Do not want!

And that’s it! If you can master these ten very important concepts and glibly and fluently discuss them, then I guarantee you that your staff and board will consider you to be a financial wizard in no time straight. If you want to go a few levels deeper, then I highly recommend The Jossey-Bass Handbook of Nonprofit Leadership and Management, which is an excellent resource for staying that crucial one step ahead of your board, colleagues, and staff.

Or the appearance thereof.

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