Net Asset classifications are unique to nonprofit organizations and frequently management and board members do not have the financial literacy skills to interpret this information. The senior finance staff member is often the only one available to educate the ED and the Board. It can be particularly challenging with board members that only have experience in the for-profit sector. The net asset classifications can provide insight into an organization’s revenue mix, available capital, overall financial condition, and ultimately, stability and sustainability. Ed Mulherin from Ecratchit explained the unrestricted, temporarily restricted, and permanently restricted net asset classifications that appear on nonprofit financial statements, how to interpret this information, and provide some tips on how to explain it all to your Board. Edward M. Mulherin, CPA, Esquire is Founder & CEO of eCratchit. Ed has over 30 years of experience providing accounting and business consulting services to a variety of clients. In 2001, Ed founded eCratchit, which provides web-based bookkeeping and accounting services. Ed has been the Virtual CFO for dozens of companies over the past 10 years providing strategic financial thinking, consulting on issues of cash flow, nonprofit sustainability; short and long term financial planning, banking and financing issues.
It is very important for the Management and Development teams of an organization to have a firm understanding of the concept of what net assets mean and how to explain it to the Board of Directors. Net assets are comprised of Unrestricted Assets, Board Designated Reserves, Temporary Restricted Assets, and Permanently Restricted Assets. When a donor give funds to an agency, those funds will be classified as 1) unrestricted; 2) temporary restricted; or 3) permanently restricted, which can be set up as an endowment. Board designated funds can be restricted or unrestricted. When looking at the Statement of Activities in the Financial Statements, you should focus on the unrestricted column. You should also do a monthly Actual to Budget statement, showing the variance between the two. The Temp Restricted column on this Statement shows funds that are not currently available but it demonstrates strength for future periods. Over time, the temp restricted column will go up or down, depending on whether you receive new funds or bring existing funds into the operating fund. Temporary Restricted Funds are those funds restricted by the donor to spend for a specific purpose or program or restricted to a certain time period. According to Ed Mulherin, a good rule of thumb is to release funds from Temp Restricted “early and often – get it out of Temp Restricted,” otherwise it can get stuck in the category. If you are not sure whether you can bring certain temp restricted funds into operations, ask your auditor. However, another rule of thumb is “don’t release it if you have not received it yet.”
On many occasions, the Development Team and the Finance Team are not aligned on terminology and goals when categorizing and managing funds. The two teams need to be on the same page as to what temp restricted means, how the funds are handled, and when they can be released into operations. Finance and Development should reconcile monthly in the following areas: pledges, temp restricted, and unrestricted operating revenue. As mentioned earlier, Board Designated funds can be restricted or unrestricted. Sometimes it is a matter of form over function – the fact that the funds are Board designated informs the reader of the financial statements that the Board has acted to limit the use of the funds and this might also appeal to certain funders.
Establishing the appropriate level of reserves funds for you agency depends on a number of factors. It depends on the size of the organization, the volatility of your funding, and the ability of your agency to raise funds quickly. A good rule is to have at least 6 months s’ worth of opera ting reserves on hand at all times. You can use temp restricted funds as working capital, but you need to have sufficient funds to cover for its use this way. Finally, it is very important to have a strong balance sheet. When management, the Board, or interested parties look at your balance sheet, they get a good sense of how the organization is doing by looking at the Net Assets line.
Edward M. Mulherin, CPA, Esquire is Founder & CEO of eCratchit. Ed has over 30 years of experience providing accounting and business consulting services to a variety of clients. In 2001, Ed founded eCratchit, which provides web-based bookkeeping and accounting services. Ed has been the Virtual CFO for dozens of companies over the past 10 years providing strategic financial thinking, consulting on issues of cash flow, nonprofit sustainability, short and long term financial planning, banking and financing issues.