The one question that many nonprofits can't answer

That question is…what are your costs?

I do a significant number of business plans and grant applications, and they all require some sort of budget or financial forecasting. For some reason, almost everyone can tell me how much money they think they need for a given program or to start their business. When it comes to filling in the other side, i.e. what costs will that money pay for, less than 50% can provide the information. Added to that is that often they really don't seem to know how to calculate costs. It's almost as though they feel that if they don't think about the costs, they won't have any. If only that were true!

Costs are not just paper plates, postage, and computers. When I ask about things like taxes, the answer is, "We are a nonprofit so we don't pay taxes". Are you sure? What about sales tax, property tax and payroll or self-employment taxes? What about your rent, mortgage and property insurance,  even if your operation is housed in your private home?  If you use your private vehicle in your business or nonprofit, what percentage of its cost of operation can be attributed to business use as transportation costs? Even your internet access fees can be prorated to your operations.

Every single dollar of revenue generates some non-program costs. If you need $5,000 to run a certain program, then you have to know how much of that will truly reach your clients. When you are asked to send in a report on the uses of the funds, it better be accurate.

Donors want to see that you have a grasp on costs and you know where to allocate them. If you don't understand the difference between program costs and administrative costs, there is a good chance that the money the donor thinks is going strictly to programs is actually being used to keep the lights on. Most donors don't like that if they didn't know about it in advance.

Grant applications, loan applications  and business plans always have a section for financial data. Some of them are extremely detailed, while others may just want a total cost figure. Some people try to plug in a number that sounds good, but if pressed for details, they can't provide them. Accurate, detailed financial reporting is important. 

For instance, one grantor followed up on an application with a request for the cost breakdown analysis for a program budget line item. The applicant couldn't provide historical data on the cost to operate a delivery truck, because they had simply never tracked it.

That's why winging it doesn't usually work very well for very long.  More importantly, if you do try to wing it, it is usually pretty obvious to both investors and donors and your funding requests will hit the proverbial round file.

If you aren't sure whether your financial reporting will pass inspection, drop me a line and we'll look it  over together.

Keeping the Tax Man Happy

In "Climbing the Ladder to Nonprofit Success"* I try to emphasize that state and Federal laws governing nonprofits may not be the same. As tax season approaches, one of the areas that differs from state to state is whether or not you must have audited financial statements.

When deciding whether to accept a client requesting grant writing services, I pretty much have two iron-clad rules. You must be a 501(c)(3) and you must have formal accounting procedures in place that are at least capable of producing financial statements. My reasoning behind that is those are the two of the three things virtually every foundation or corporate sponsor requires, with the third being the 990. Without them, your application or entreaties for funding are going nowhere.

More importantly, not having at least the ability to produce audited financial statements can put you in violation of tax reporting laws.

The Council for Nonprofits has a list of states that will help you determine if your state requires audited financials. If you still have questions, the list also links to the specific regulatory reference for each state, or you can contact your state tax commission.

Income doesn't always predict the need for an audit.

While most small or new nonprofits will initially be under the income threshold that requires audited financials, several states require an independent audit if the organization employs "a professional solicitor", regardless of the revenue level, or if the organization receives a significant portion of their income from state funds. In general "professional solicitor" means any employee or paid professional that helps you raise funds, and can and usually does include everything from your CEO to your office manager, to contracted grant writers and  phone solicitors. Also, an independent auditor can't be the person who records or reviews your financial transactions on a regular basis.

Also noteworthy is that varying revenue levels may also require lower-level independent reviews such as an accountant's review or letter of compilation. For instance , Pennsylvania requires an independent auditors review of one form or another if your gross annual income exceeds $50,000, although the full-blown audit requirement doesn't kick in until receipts reach $300,000.

Audits aren't fun.

Last year, one of my former clients contacted me after her first-ever audit and was thoroughly incensed about the "intrusive behavior" of the auditors. The auditors had interviewed several of the staff members regarding how donations were recorded, and when the interviews indicated a somewhat chaotic system, they dinged the organization in their report. She was also angry that they "demanded every single receipt and every single phone message note" to back up expense records, including whether employees had called in or provided doctor's confirmations for sick pay. She wasn't complaining about having to provide the proof, as much as she was about the "inordinate waste of time" required to dig up the records  "to prove a $22.00 expense".

This is what an audit does. It isn't about whether you can add two and two. It's not even just about whether your books are in balance. It also evaluates whether you are exercising sound financial management. It can provide clues regarding the expertise of your staff. Perhaps you are recording expenses under the wrong category, or maybe you are reporting donations as unrestricted when they should have been applied to a specific program's income and spent only for that program. Maybe you are carelessly co-mingling personal and organization funds. It can uncover problems like embezzlement.

Audits should be learning opportunities.

Assuming that your audit problems stem from a lack of knowledge and not outright attempts to deceive, then your audit should be viewed as a chance to improve. You should want to have complete confidence that all the financial controls are in place, and that your financial position is exactly what it appears to be, good or bad. You should  be willing to either provide staff training or replace incompetent staff with people that know the rules and follow them.

Audits provide credibility with donors.

Being able to state that your financial dealings are honest and above-board as evidenced by your audit report reassures donors that their money will be used as they intended it to be when they gave it to you. That level of confidence can greatly impact growth in donations.

Good records mean smooth audits.

Depending on the type of audit or review, there are certain levels of sampling required under GAAP (Generally Accepted Accounting Principles). You are never going to get by without providing some selected source material, i.e. the invoice, receipt, purchase order, payroll check, deposit slip etc. that backs up the journal entry. Written procedures and even minutes of board meetings will also be on the request list.

However, if everything the auditor requests checks out the first time, there is usually no need for the auditor to keep digging. If the auditing firm has been hired on a total fee basis then they want to get done as soon as possible, but they are also required by law to investigate any irregularities. If they find something they don't feel is quite right, they have to keep digging until they have an explanation.

Hiring a proficient bookkeeper or retaining a bookkeeping firm to review your financial records monthly or at least quarterly might seem like an avoidable expense when you are first starting out, but in the long run, it will pay for itself in terms of smooth audits and happy donors. It is far better  to learn to do things properly now, before bad habits turn into bad audits!

© Rebecca L. Baisch 2013

* For your free copy, or to be on the subscriber-only newsletter list, email granthelp@ida.net

Sexy financial statements - Are you kidding!?

On a one to ten scale of what's sexy or exciting, financial statements generally rank at about minus one for most nonprofit board members. Nonprofits still in the early growth phase may not fully understand the relationship of the board's financial or fiduciary responsibility to their overall governance role. There may not even be a formal accounting system in place.

Board members, whether nonprofit or for-profit, typically aren't finance or accounting majors. I can clearly remember sending out the financials to the board members of a small nonprofit in advance of an annual meeting. One of them called and very nicely but sincerely told me that I shouldn't waste postage and paper sending them to him in the future, since it was all "just so much gobbledygook to me". When I explained that I was required to send them because the board was responsible for understanding the financial position of the organization, he asked if I could just tell him where on the papers he could see whether the organization was making or losing money.

This is an all-too-common reaction to the financial portion of a board agenda. In many cases, once the board meeting starts, the chairperson asks if anyone has any questions or comments, and then there is a voice vote to accept all the financial information as written. It's almost a Pavlovian response.

Fiduciary oversight isn't optional.

The problem with that is once you vote to accept the financials, you are effectively saying that you know what's in them. If something is amiss, you can be held responsible for any problems.

For those nonprofits that say they don't need financial statements due to their small revenue streams, or because they are about mission, not money, listen up. If you are a nonprofit corporation, you may be required to use the accrual method of accounting. That means you do need some sort of basic accounting system that can produce financial statements. Leaving the tax man out of it, prospective donors and grantors expect it as well.

Most board members don't intentionally shirk their fiduciary duties, and they are not too lazy or mentally incapable of understanding financials. Financial reporting is simply a foreign language to them. Sometimes they are successful professionals in other fields, but they rely on a staff of accountants to keep the books and synopsize any findings. Other times they are community members whose closest brush with accounting is when they file their taxes. Sometimes they just don't understand the legal impacts of rubber-stamping the financials.

Ignorance isn't bliss.

Not knowing what's contained in the financials is not a defense. Shareholders, members, donors, and the IRS won't accept that as a reason if there is some sort of mismanagement, fraud, or other illegal act discovered. The solution to that is developing a basic ability to understand the financial statements.

There are a number of mini-courses, books and video presentations available that offer financial training for non-financial people. Think of them as sort of a pocket dictionary for another language. When you travel to another country, you may not need or want to know how to carry on an hour-long conversation in another language, but you do need to know how to ask for a doctor or a bathroom.

No degree required.

This isn't about becoming a certified financial professional and to some extent, it isn't even about that much argued-over bottom line. Depending on your board composition, even a one or two-hour presentation can be sufficient to provide all the knowledge most board members need.

Local associations of financial professionals often have seminars that can be scheduled into a retreat or executive training session. In a pinch, you could even have a independent accounting professional or instructor attend a board meeting and explain the financials once a year. The goal is to be sure that everyone has at least a basic understanding of what to look for relative to seeing problems or trends. The purpose of reviewing financials isn't to check the math, it is to obtain operational guidance for the board.

Financials are more than just numbers.

The purpose of this instruction is not to turn the board into bookkeepers or accountants. It is simply to provide a way for the board to recognize problems or trends. For instance, if the depreciation figure is significantly different from last year or the last quarter, does that mean that something new was purchased?  If so, what is it, what did it cost, and is that cost reflected elsewhere in the financials? If not, why was the figure adjusted? If it is significantly lower, does something need to be replaced because it is too old to function properly anymore? Does that affect net worth?

Financial statement training isn't very sexy, but going to jail or watching your organization dissolve in bankruptcy isn't much fun either.

For many organizations, November is approaching the end of the fiscal year. Think about offering financial statement training as a year-end training camp or informational webinar. Some members might even consider it a perk!