If you’ve ever felt that your executive director, program managers, and board members just don’t “get it” when you talk about financial reports, maybe it’s because you gave them the wrong information. I don’t mean that you are using inaccurate financial reports, but that you may be providing the wrong information all together. There is no such thing as one size fits all in financial reports, but most of the advice and guidance on nonprofit financial reports cover the same generic materials – how to read a balance sheet, income statement and audit. Does this mean that reading a financial report is the best preparation for financial decisions? Is that what you need the executive director, program manager and board members to do – to understand how to read the report? Or do you need them to know how to use the information to develop plans, monitor progress and make decisions? If you want the latter, then you need to take a look at what financial information is provided and how it’s provided.
I think there are six distinct steps in using financial information well. Each step is necessary and follows a clear sequence.
1. Produce accurate reports
2. Understand the information
3. Analyze the information through variance review, comparisons and ratio analysis
4. Interpret the information in the context of the organization’s situation, plans and goals
5. Communicate the information
6. Use the information for decisions and planning
Think about how your organization uses financial information – most of us jump directly from step one to step six. Without discounting the importance of the first two steps (a big accomplishment for most small nonprofits), the analysis, interpretation and communication are essential for really wise decisions. So who should be responsible for these different parts of the process? Are you expecting your board members and program managers to complete their own analysis and interpretation? I shared this concept with a CFO the other day and he stopped suddenly and said “what you’re saying is there is a difference between data and information”. Yes – the financial staff should strive to provide valuable information, not just accurate data. Ideally, the financial staff is responsible for the first three steps, and the fourth and fifth are completed in coordination with management and program staff.
If you take the time to really evaluate how you provide and use financial information – and diagram these six steps – you can easily create a better process for providing exactly the financial information needed for the organization. For a longer article about how boards need to use financial information, read Reporting Financial Information to the Board from the Nonprofits Assistance Fund’s financial management resource library.
But what if your nonprofit doesn’t have audited financial reports? Does this item listed in the grant proposal form mean that you should rush out and hire an audit firm – or that without an audit you’ll never get a grant? Probably not – but you should understand what an audit is, why the foundation includes this on the checklist, and what alternatives you have. I’ve been asked this question many times by both nonprofit directors and foundation program officers. The short answer is this – no, you don’t have to have an audit for the majority of grant applications. Most foundations do not want to require a small nonprofit to spend $5,000 or more for an audit just to apply for a grant. In some cases, the cost of the audit would actually exceed the amount of the grant! Requirements for nonprofit audits depend on how funds are raised and various state and federal grant requirements, but the threshold for most nonprofits defined by the Attorney General in Minnesota is $350,000 in income. What the foundation really wants – and needs – is financial information that they can rely on. An audit is the ideal, but there are alternatives.
It’s helpful to first understand what a financial audit is – and what it isn’t. An audit report is a financial report prepared according to accounting standards and an accompanying opinion of a CPA that they have reviewed and tested the information and determined that it is accurate. This is called a “clean” opinion. The reason that funders like to see audits is because of this opinion about the accuracy of financial reports. It’s important to understand that the audit is completed using the financial reports prepared by the organization, not by the auditor. (In fact, the auditor cannot prepare the financial reports and then turn around and issue an opinion letter about them.) An audit is not an assessment by a CPA that the nonprofit is in a good financial position. Making that assessment is up to the organization’s staff and board and any outside users of the financial reports.
So without an audit, how can you provide accurate and reliable financial information that is acceptable to a current or potential funder? Go back to the description of what an audit is: a financial report prepared according to accounting standards. Without an audit you won’t have an opinion letter, but you can provide an accurate year end financial report including an income statement and a balance sheet. In order to do this, the financial manager or treasurer will have to prepare a “final” financial report for the year and have it available in a standard accounting format. It’s great if you create a PDF version that can serve as the definitive version. Along with this report, send your IRS 990 form to demonstrate that you have complied with the requirements for reporting and accountability. The 990 should be accurate, the information reported should agree with the financial report, and it should be timely. The executive director and development staff person or volunteer should be able to read and discuss both of these reports at a site visit or phone call.
I recommend an article in the current issue of Nonprofit Quarterly, “Absent the Audit: How Small Nonprofits Can Demonstrate Accountability Without One”, by Jeanne Bell and Steve Zimmerman. The authors suggest that there are three key functions of an audit for a small nonprofit: generating donor and constituent confidence, ensure compliance with accounting standards, and prevent or catch fraud. They propose a number of ways that small nonprofits can fulfill these same functions with a printed annual report, open communication of a summary version of year end results and the annual budget, and a timely, correctly prepared IRS 990. The article also includes some good advice about using a board treasurer or volunteer to help assure accurate reports and the importance of internal controls for any sized nonprofit.
I’m asking this question in the context of neighborhood and community development planning. In these conversations, nonprofit organizations are usually engaged as providers of services and as advocates. Community development nonprofits, for example, create housing, train entrepreneurs to launch small businesses, and facilitate community planning and participation. But what about the nonprofit organizations themselves – are nonprofits desirable and valuable as neighbors to include in community development planning? Unfortunately, nonprofits are not always viewed as a component of economic development – and sometimes are seen in quite the opposite light. We had an illustrative experience a few years ago. Nonprofits Assistance Fund’s loan funds provide credit to nonprofits for both working capital and facilities. We applied for capital funds in response to an RFP for funding to spur business growth and job creation in some targeted neighborhoods. We are denied funding with the comment that they didn’t want to encourage more nonprofits to locate in these neighborhoods. What they wanted were small businesses like restaurants and retail shops. Nonprofits were viewed as service providers and fundraisers, not as employers and economic entities. Economic development press releases frequently cite how many businesses were started and grew in the last year – but have you ever read a celebration of how many new nonprofits were started or grew in the same year? Why is there a disconnect between nonprofits as essential service providers and nonprofits as community businesses?
We have a case study for this question in Saint Paul and Minneapolis as the light rail transit Central Corridor line is planned and developed. This 11 mile route will link the downtowns of Minneapolis and Saint Paul via the University of Minnesota campus and University Avenue. The corridor along University Avenue has been a magnet for nonprofits for years because of the proximity to both cities, easy access, and affordable rents and real estate – there are about 800 nonprofits currently located in the Central Corridor. The city of Saint Paul has already invested considerable effort in creating a development strategy for the Central Corridor with a framework for “neighborhood revitalization, reinvestment and growth”. Fortunately, many nonprofits are engaged in the process already. I encourage everyone to think of the role of nonprofits as both advocates for the community and as small and medium-sized businesses who have much to offer the community as employers, sources of economic activity, community assets – and as good neighbors.
There has been some research and discussion about the role of nonprofits as both providers and as community development assets. One interesting publication is Tom Borrup’s Creative Community Builder’s Handbook: How to Transform Communities Using Local Assets, Arts, and Culture published by Fieldstone Alliance. Please post a comment or send me an email about other resources on the topic.
