EricYPTC

Nonprofit financial reports are different than for-profit financials.  Here is a short video showing these unique elements.

Comments welcome.

Eric Fraint, President and Founder
Your Part-Time Controller, LLC

Here comes an unsubstantiated assertion:  nonprofit executive directors are underpaid.

I believe I have enough anecdotal evidence to say this based on our work over many years with nonprofits of all types and sizes.  We work closely with the executive directors and we get to know them very well.  Based upon these close working relationships, I can make the following generalizations:

Nonprofit executive directors are smart, knowledgeable people who speak intelligently about the work of their organizations.

They are hardworking and are willing to do whatever it takes to get the work done.

They are very dedicated to the missions of their organizations.

They are resourceful, often accomplishing much with limited resources.

Though they may not have a classical background in finance, they have an intuitive understanding of the finances of their organizations.

They are adroit politically as they must often work with board members who themselves may be less than fully engaged.

They are generally leaders that can inspire staffs and volunteers.

They are people looking to make a difference.

And they are generally underpaid.

What do you think?

Comments welcome.

Eric Fraint, President and Founder
Your Part-Time Controller, LLC.

Show me an organization that cannot do one or more of these 7 basic functions, and I will show you an organization that needs a new accounting department.

At our firm we’ve coined a name for these 7 basic functions: the “Financial Reporting Baseline™” or FRB.

As you read these 7 basic functions, ask yourself if you are getting this minimum level of performance from your accounting department.

(1)    Monthly reporting package:  Your accounting department prepares a monthly financial reporting package consisting of, at the very minimum, a Balance Sheet, a Statement of Activities (commonly called an income statement), and a Cash Flow Statement.

(2)    Timeliness: The monthly financial reporting package is prepared on a “timely” basis.  The definition of timely varies from one organization to the next, but if it takes more than two or three weeks, it is no longer timely.

(3)    Reconciled: Your accounting department reconciles all bank and investment accounts every month.  If this is not done you really do not know how much money you have.

(4)    Restricted funds:  Your accounting department tracks and clearly reports the status of your donor restricted funds.

(5)    Different levels of detail:  Your accounting department is capable of producing financial reports in different levels of detail.  This is sometimes referred to as “vertical” presentations.  Think of your board getting very summary level information, your finance committee getting more detail, and your executive director getting all details.

(6)    Department and program data:  Are you able to easily get your financial information segmented by departments and programs.  We sometimes refer to this as “horizontal” presentations.

(7)    Budgeting:  Does your accounting department budget on both a cash and accrual basis?  The oddities of nonprofit accounting make this particularly important (assuming your organization reports on the accrual basis, which most organizations do).  If you budget only on an accrual basis, you lose information about your cash flows.  If you budget only on a cash basis, your budget may not line up properly with your actual performance which reduces the helpfulness of budget to actual analyses.

These 7 basic FRB functions apply whether your organization has a budget of $500,000, or $500M.  They are in fact so basic that if your accounting department cannot do these things it calls into question the quality of information you are receiving to run your organization.

For a more complete explanation of the FRB, see the article on our website called:  “Don’t Operate Blind: Jump Start Your Accounting Department.”  Find this article, and other articles relating to nonprofit financial management written by me, at:  http://www.yptc.com/NEWSRESOURCES.aspx .

Comments welcome.

Eric Fraint, President and Founder
Your Part-Time Controller, LLC

Here is a troubling observation: many nonprofits, certainly more than half, have problems with their accounting and financial reporting. I would further maintain that the real number of underperforming accounting departments in the nonprofit world is closer to 70% or 80%.

These problems manifest themselves in financial reporting that is often inaccurate, late, or not available at all. The for-profit world has its problems too, but not on this scale.

This is an important issue for the nonprofit sector to address. Most of the data that boards and executive directors rely on to run their organizations comes from their accounting departments. Data that is late, erroneous, or nonexistent will have a deleterious effect on decision-making. It hinders an organization’s ability to operate efficiently and effectively and thwarts the organization’s ability to properly execute and deliver on its nonprofit mission. All of this worries the funders of these organizations too.

Why is this problem so pervasive? In our work with hundreds of nonprofit organizations over the years, we see the following patterns repeat themselves over and over.

(1) Nonprofits have a remarkable propensity for hiring people who do not know accounting to do their accounting.

These nonprofits typically do not have sufficient funds to be able to pay a more qualified employee to get the job done. Or they may skimp when it comes to paying up for a qualified person in order to use these scarce resources elsewhere. But you know the saying: you get what you pay for.

There is also, however, a mistaken belief that all you have to do is sit a non-accountant in front of a computer with some accounting software and he or she can learn what they need to know in a few hours or days. The reality is that no matter what accounting software is used, if the user does not know debits and credits, he or she will not be able to properly support your organization as you try to fulfill your mission. Your accounting software, no matter how good, will not correct for bad data input. There is another saying for this: garbage in, garbage out.

(2) Accounting rules for nonprofits are more complicated to understand and to apply than for-profit accounting rules.

Nonprofit accounting rules regarding the recording of restricted funds and for handling multi-year grants are just two examples of rules with an added degree of complexity for a nonprofit organization. Your accountant or bookkeeper either knows these rules or they don’t. If they don’t know them, their ability to produce accurate financial reports is compromised.

(3) There is, in general, greater demand for financial data in a nonprofit environment, so expectations of your accounting department are greater.

All nonprofit organizations have a board of directors. Most also have some combination of finance committees, executive committees, development committees, audit committees, and investment committees. When these committees meet they need reports to look at, and many of these reports are financial reports that come from your accounting department. In addition, data needs to be provided with some regularity to funders, donors, contributors, lenders, and various government agencies. The organization’s internal department and program managers also need financial reports with comparisons to budget and other metrics with which to run their areas.

In addition, many jurisdictions around the country require nonprofits above certain sizes to have an annual audit. Even in jurisdictions without such requirements, many nonprofits have audits done anyway if their boards or outside funders require it, or because they consider it to be a good practice. If your organization receives federal funding above a certain threshold, it is required to submit to still stricter audit oversight.

In addition to all else, your financial information on Federal Form 990 is required to be publicly available.

Consider the implications of this informational demand on a $2 million nonprofit compared with a $2 million for-profit. The nonprofit has to crank out a high volume of accurate, timely information, usually in various formats and levels of detail, while following more complex accounting rules. The $2M for-profit is probably a single owner without all these committees, needs, and demands. He or she simply gets the information they need to run their business.  As a result, the nonprofit has a much greater need for a skilled accountant, or group of accountants, to keep its books.

Moral of the story: Jim Collins, author of “Good to Great,” says you need to get the right people on the bus. More specifically, if you want your accounting and financial reporting to be done right, you must get the right people with the right skills and the right experience.

Comments welcome.

Eric Fraint, President and Founder
Your Part-Time Controller, LLC

All organizations, from start-up nonprofits to the biggest corporations, need to maintain a “set of books” for recording their financial transactions.  If one set of books is necessary, can multiple sets be better?*

I present here three true stories of nonprofits with two or more sets of books.  These organizations contacted our firm because they were unable to generate timely monthly financial reports and had difficulties preparing for their year-end audits.

In the first organization a staff member was given the responsibility to pay the bills and another staff member the responsibility to record deposits.  These two people got together and decided the best thing to do was to set up two separate files in their accounting software; one company file for bill paying and one company file for deposits.  Both staff members busily went about their work entering their accounting transactions in their separate files.  Lo and behold, not only were they unable to generate a financial report for the organization, they could not even tell how much cash they had in the bank.

Another organization delegated bookkeeping responsibilities for certain programs to several board members, one board member per program.  Each board member had a copy of QuickBooks installed on a computer at their homes where they recorded the receipts and disbursements for their particular program.  When we first met with these very nice people, they told us that they could not generate an organization-wide financial report from QuickBooks.  They thought they might need new software.

In a third example, the executive director was accustomed to maintaining financial records using Quicken.  When the auditors recommended that they switch to a more appropriate accounting package, the organization bought QuickBooks.  The executive director, comfortable with how to find information in Quicken, did not want to discontinue its use.  What was the ED’s solution?  Maintain two sets of books.  Most of the day-to-day transactions continued to be recorded in Quicken, but then the organization had one of their employees rekey all the data each month into QuickBooks.   Month-end journal entries, accruals, and payroll were posted directly to the QuickBooks version.  In neither place was there a complete record of all transactions.

All three organizations were puzzled as to why, if they were using computerized accounting software, they could not just “press a button” and generate month-end financials.  The answer by now is obvious: multiple sets of books made this impossible.  Why did they create multiple sets in the first place?  Because non-accountants were doing the accounting.

Moral of the story: having multiple sets of books is somewhat similar to three people driving a car where one person’s job is to steer the car straight, a second person is in charge of right turns, and a third handles the left turns.  Except in some special situations (see the asterisked comment below), keeping multiple sets of books is not recommended.  More generally, using non-accountants to do your accounting does not typically result in the best outcomes for your organization if your goal is to have timely accurate financial reports.

Comments welcome.

Eric Fraint, President and Founder
Your Part-Time Controller, LLC

* Referring to accounting data as residing in a “set of books” originated in the pre-computer days when organizations maintained their accounting records in an actual set of physical bound paper based ledgers, journals, and registers.  Computerized accounting software programs (for example QuickBooks) have replaced all of this paper, but the terminology remains (at least for now).  For-profit enterprises are sometimes said to keep two sets of books: one for their regular financial reporting, and one for tax purposes.  There are other legal reasons why a for-profit entity might maintain additional sets of books.  Nonprofits might also want to use more than one set of books if, for example, they have more than one legal entity.  Each entity may require its own set.

Most nonprofit organizations have to allocate costs for one reason or another.  If done incorrectly, however, your allocations can impair the quality of your financial information and lead to ruinous decision-making.

Overhead and administrative costs typically need to be allocated to various programs and departments in an attempt to understand the true operating costs of these programs and departments.  This information is usually needed to report to funders.  Executive directors, board members, program managers, and department heads may also find this information helpful when reviewing internally generated financial reports.  It intuitively makes sense, for example, that a portion of the executive director’s salary should be allocated to the various programs even though the ED may not directly work in any of them.

The problem comes when the cost allocations have the unintended effect of obscuring performance. In serious cases the financial information produced by an organization’s accounting department can cause management to make erroneous decisions that may actually undermine their organization!

This is best illustrated with an example.

Presented below is a hypothetical nonprofit that provides afterschool services to children at two different sites.  Site 1 has 100 students, Site 2 has 200 students.

The school earns revenue of $100 per student per month through some combination of parent payments and government support.  The school incurs direct expenses of $80 per student for direct teacher salaries, supplies, and other direct expenses.  The school has certain fixed overhead and administrative costs which are needed to support the programs.  The school’s accountant has determined that $60,000 of these costs should be allocated: half to Site 1 and half to Site 2.  Based on this information, the school is able to produce the following budget:

      Per
Student
per Month         Site 1            Site 2           Total    

Students                                                     100                200                300

Revenue                           $100          $120,000     $240,000      $360,000

Direct costs                      $80             $96,000      $192,000      $288,000
Allocated overhead                             $30,000        $30,000        $60,000
Total costs                                           $126,000      $222,000      $348,000

Net                                                         ( $6,000)        $18,000         $12,000

The board treasurer, worried that Site 1 is expected to lose money, has suggested that it be closed reasoning that the $6,000 loss in Site 1 can be avoided and total net can be increased from $12,000 to $18,000.  Though this would mean serving 100 fewer students, the treasurer feels strongly that this will make the school more financially secure.

What do you think?

The executive director, worried that he/she may lose a third of their program, decides to call our firm, YPTC, to take a look at the numbers.  (Sorry for the shameless plug, but I am after all writing this for free on a Sunday afternoon.)  After analyzing the situation, we put together the following proforma which assumes Site 1 has been closed:

      Per
Student
per Month        Site 1            Site 2           Total    

Students                                                    0                       200                200

Revenue                           $100              $0                $240,000      $240,000

Direct costs                      $80               $0                 $192,000      $192,000
Allocated overhead                               $0                   $60,000        $60,000
Total costs                                              $0                 $252,000       $252,000

Net                                                           $0                 ($12,000)      ($12,000)

The analysis shows the surprising result that instead of producing a larger positive net, the organization’s finances actually get worse resulting in a loss of $12,000, a decrease of $24,000!

A moments examination of the numbers shows why.  While the direct revenue and all the direct costs of Site 1 went away, the fixed overhead did not.  The $30,000 of fixed overhead which had been charged to Site 1 had to go somewhere, and that somewhere in this example was for all of it to get charged to Site 2.  This produced a negative $30,000 swing for Site 2 taking it from a positive $18,000 net to a negative $12,000.

The financial reports of this organization obscured the fact, due to the cost allocations, that Site 1 had a positive contribution margin.  This means that after subtracting the direct costs from Site 1 revenue, Site 1 was contributing $24,000 to the bottom line.  If Site 1 were to close, not only would 100 fewer students be served, but the $24,000 positive contribution margin would be lost.

Moral of the story:  Cost allocations are a fact of life for most nonprofits.  Be careful, though, to perform the necessary financial analysis to understand your cost structure so that your financial reports do not lead you astray.

Comments welcome.

Eric Fraint, President and Founder
Your Part-Time Controller, LLC

There are a number of problems with nonprofit accounting rules.

When I say problems, I mean accounting rules that actually make it more difficult to read and understand a set of nonprofit financial reports.  If you have worked in the nonprofit world long enough, this statement should come as no surprise.

The biggest offender is the rule regarding the timing of revenue recognition with multi-year grants.  This rule says that if your nonprofit organization receives a multi-year grant award, and assuming there are no conditions attached to it, all the revenue is recognized in your financials in the first year.  The revenue may be broken down between restricted and unrestricted, but in total it is all recognized upfront.

This is best shown with an example.

Imagine your organization receives a letter from your favorite foundation awarding you a $300,000 grant to support your main program over the next three years (i.e. $100k per year).  There are no conditions attached to this grant.

Over the three-year term of the grant, your total revenue and expense associated with this grant will look like this:

                       Total      

Revenue      $300,000

Expense      $300,000

Net                            $0

So far, so good.  However, when we break this down year by year, we see the following:

                        Year 1        Year 2         Year 3           Total    
Revenue      $300,000                 $0                   $0     $300,000

Expense      $100,000     $100,000      $100,000     $300,000

Net               $200,000   ($100,000)   ($100,000)                 $0

Note that the totals in both tables above are the same.  However, in Year 1 it looks like the organization has a windfall profit of $200,000.  In years 2 and 3 it looks like the organization has a loss of $100,000 each year.  We know intuitively that the organization is getting $100,000 each year and is spending $100,000 each year, but that is not what the financial reports seem to be saying.

Multi-year grants such as this make it difficult for nonprofit boards and management to understand and interpret their results.  This is further complicated when we consider the impact of the restricted and unrestricted portions of these funds.  (The different types of restrictions will be discussed in a future blog.)

This accounting rule also creates difficulties when budgeting.  How do you prepare your budget for year 2 or year 3?  You will be receiving $100,000 in each of those years from the foundation, but if you put that in your budget, won’t you be double counting revenue that was already recorded in year 1?  But if you don’t include that money, then won’t your budget look like your program is running at a deficit when in fact it is not?

Let me know if you would like me to discuss some solutions to this dilemma in a future blog.

Moral of the story:  almost all nonprofit organizations share this frustration with the accounting rule pertaining to revenue recognition with multi-year grants.  The good news is that there are ways to deal with this when presenting financial information and when budgeting that make your information easier to understand.

Comments welcome.

Eric Fraint, President and Founder
Your Part-Time Controller, LLC

It may be hard to believe, but getting too much money can sometimes destabilize a nonprofit organization.

In my last blog I outlined one such scenario where a grant or contract lacks sufficient funds for infrastructure support. This may strain an organization’s capacity to support the additional programming paid for by the new funds.

Cost reimbursement contracts are another common challenge to a nonprofit. Many contracts require the organization to spend their funds, and then submit an invoice to be repaid. It is up to the organization to be able to fund the float between the time the funds are spent until the time they receive reimbursement.

The following example illustrates this problem. Assume your organization has a $1.2 million government contract to deliver certain program services. Assume the funds are spent evenly during the year resulting in a monthly run rate of $100k.

Further assume your organization may invoice monthly. Your accounting department is able to generate invoices within two weeks after month-end. The government agency is typically able to reimburse you within eight weeks of receipt of your invoice. (Many city, state, and local agencies take longer.)

How long is your organization without the cash?

Assuming disbursements on average occur mid-month, it takes four weeks from date of disbursement to the date of sending the invoice. It then takes the government agency another eight weeks to pay. That is a total of 12 weeks, or approximately three months!

With a three-month turnaround, your organization is effectively forced to finance $300k at any one time (3 months @ $100k each).

Where will this money come from?

Many contracts provide for an advance that is intended to solve this problem. Hopefully you have this type of contract. Other agencies allow a reimbursement to be requested online with funds wired almost immediately to your bank account.

If neither of these options are available, let’s hope your organization is fortunate enough to have sufficient working capital to cover this. If not, you will need to raise the funds from donors who do not mind having their money go toward general operating support.

A line of credit may also be needed. The downside is that a $300k line of credit may cost your organization $15k per year in interest and fees depending on rates.

Further compounding the problem is that the government agencies themselves may experience their own cash flow problems, thus causing them to delay their reimbursements to you. We have seen many organizations, especially during the height of the recession, that had to waste considerable time begging government agencies to pay their invoices.

Moral of the story: taking on too many cost reimbursement contracts can stretch an organization’s ability to fund the float between the dates of disbursement and reimbursement. Before taking on contracts of this nature, perform a financial analysis to be sure that your organization can sustain the additional funding.

Comments welcome.

Eric Fraint, President and Founder
Your Part-Time Controller, LLC

It sounds counterintuitive, but many nonprofit organizations face situations where getting too much money in the form of grant and contract revenue can threaten their ongoing viability.

Take for example a foundation grant that is restricted to the direct costs of operating a program.  Assume the grant, as is often the case, fails to provide any funding, or provides insufficient funding, for general infrastructure and overhead support.   It is quite possible that if the organization gets too much restricted funding of this type that the operating needs of the programs will outpace the ability of the organization to support them.  This could destabilize the organization and, if the situation gets too severe, can cause the organization to collapse.

To illustrate, assume a hypothetical organization that provides after school services for children.  It has a building with classrooms, administrative staff, and teachers to run its programs.  The organization has carefully analyzed all its costs and knows that at its current level of programming it costs 30% of every dollar spent just to keep the doors open.   At the end of the year its financial reports show the following (assume all dollar amounts are in thousands):

The next year a very generous foundation offers a new $1 million grant to expand the after school programs.  The grant stipulates, however, that it will only pay for new direct costs.  It will not pay for any existing or new general infrastructure to support the new programs.  Somehow the organization, which is already operating at its optimum capacity, will need to accommodate a more than doubling of its program activities from $700 to $1,700.

The organization’s accountant prepares a preliminary forecast for the next year with this new grant assuming all else continues unchanged:

The forecast in Table 2 shows that the organization’s support services at 15% of total costs will be woefully inadequate to support the new programs.  30% is a more appropriate level for this organization.  At 15%, the building facilities will not be adequate, and there will not be sufficient support staff, etc.

The accountant does a second forecast in Table 3 of what will be needed to support the new programs and restore the 30% ratio of support service costs to total expenses:

The forecast in Table 3 shows that $730 is needed instead of the $300 already being spent.  That is in an increase of $430.  Where will this money come from?  Not from the foundation providing the additional funding because they specified that their money is only to be spent on new direct costs and not on infrastructure.  One way or another this organization will have to raise an additional $430 in general operating support to allow it to properly run these programs, or risk destabilizing the entire operation.

The situation is somewhat similar to a lifeboat, filled to capacity, adrift in the ocean.  Imagine that the physical boat itself and the crew member operating it represent the support services.  Now along comes a swimmer.  The boat can probably accommodate an additional person without much of a problem.  Now two more swimmers come by.  The boat picks them up but things are starting to get cramped.  Three more swimmers come by.  They scramble aboard.  Now the boat is very unsteady.  If any more swimmers come by and try to get on board, the boat may tip and sink.  Clearly additional support services in the form of a second lifeboat and an additional crew member to operate it is needed.

Moral of the story:  enlightened funders understand the need to provide funds for infrastructure support.  Yet even they may not provide enough.  To combat this, nonprofit organizations need to do their homework by thoroughly understanding their cost structures.  In addition to their program costs, they need to know what their general, administrative, fundraising, and all other infrastructure costs are.  They need to know their fixed and variable costs, and their direct and indirect costs.  This is the starting point of being able to properly manage their finances and to allow them to engage in educated conversations with their funders.

In a future blog I will give another example of a different situation nonprofit organizations commonly face where getting too much of the wrong type of funding can threaten their viability.

Comments welcome.

Eric Fraint, President and Founder
Your Part-Time Controller, LLC