Understanding Finances


Trusted ministries acknowledge the challenges of understanding nonprofit finances.

 

by Dan Busby

 

 

Every ministry would say that the individuals serving on its board are intelligent people. They should be able to understand the financial picture of a nonprofit ministry—right? Sometimes yes; sometimes no.

In the worst case scenario,
clarity of ministry finances
is a key to avoiding financial
shipwreck. In the best case,
clarity prevents a ministry
from becoming an
embarrassment to Christ.

Even the footnotes to financial statements can be difficult to decipher. The following was included in the footnotes to a ministry’s financial statements that came across my desk recently: “During the year ended June 30, Year X, a former employee retained legal counsel regarding an alleged claim in the breach of the employment contract. Subsequent to year end, medication was scheduled.”

This gave me mental whiplash. Perhaps the auditor meant “mediation,” not “medication,” although some personnel issues have left me with an ill feeling!

Why is it important for leaders of a Christ-centered ministry—both the CEO and the board—to have a clear understanding of ministry finances? First and foremost, it is the Godly thing to do.

God is glorified when a ministry:

Every late payment
on obligations by
a Christ-centered
ministry is a
negative witness
for Jesus Christ.
  • Pays its obligations on time. Every late payment on obligations by a Christ-centered ministry is a negative witness for Jesus Christ. When I was the managing partner of a CPA firm I founded, I vividly recall the many times I called on ministry leaders—literally pleading with them to pay invoices that were up to a year old, just so my firm could make its payroll.
  • Has adequate reserves. Obligations can be paid on time when a ministry has adequate reserves. The lack of reserves is often the result of the lack of planning. What is “adequate” is something each ministry must determine. There is no universal rule of thumb.
  • Sets aside funds related to restricted gifts. A ministry that borrows funds from restricted gift accounts for general operating purposes is not honoring its commitment to givers. If the funds have been borrowed, they are not available for expenditure for the restricted purpose(s).

Here are five key myths illustrating the importance of understanding ministry finances:

Myth #1. Nonprofit financial reporting is the same or similar to that of for-profit organizations. Many ministry board members own their own business or work (or have served) in the for-profit world. When they begin serving on their first ministry board, they assume the financial reporting concepts are similar between for-profit and nonprofit organizations. The differences can cause bewilderment.

Consider these examples:

Example #1. Ministry A has annual revenue of $1 million and expenses of $900,000. Are those financial results positive or negative?

The answer is: it depends. If there are no restricted revenues or expenses included in this data, it is positive because the $100,000 excess of revenue over expense increases net assets.

However, if the $1 million of revenue included a $300,000 grant that was not expended at year-end, the data is negative because the grant revenue is not available for general operating expenses. Excluding the grant revenue, expenses exceed revenue by $200,000, reflecting an unrestricted loss for the year.

Example #2. Ministry B has annual revenue of $2 million and expenses of $2.3 million. Are these financial results positive or negative?

The answer again is: it depends. If there are no restricted revenues or expenses included in this data, the data is negative because the $300,000 excess of expense over revenue decreases net assets, using up reserves (if there are any).

However, if the ministry had no restricted revenues but included the expenditure of a $500,000 restricted grant received in an earlier accounting year, the data is positive because excluding the grant data, revenue exceeds expenses by $200,000, reflecting an unrestricted gain for the year.

Myth #2. Ministries should always balance revenue and expenses. Shouldn’t revenue and expenses always balance? After all, a ministry is a “nonprofit” organization. There are a couple of key reasons why ministry revenues and expenses rarely balance:

  • Building reserves. Ministries that are financially viable build adequate reserves. Ministries without reserves lack viability. This is the only way reserves are generated—taking in more revenues than are expended. This sounds so simple, yet it is a principle often overlooked.
  • Impact of restricted funds. Most ministries receive some funds that have been restricted (also called “designated”) by givers for specific purposes and/or to be spent at a specific time in the future (see chapter 17). In most instances, the restricted funds are not all expended in the same accounting year. This creates an excess of revenue over expenses in the year the funds are received and the reverse situation in the year in which the “leftover” funds are expended.
A ministry could be
bankrupt at the same
time it shows a large
unrestricted net assets
balance.

Myth #3. The use of multiple organizational entities does not complicate financial reporting. Wrong. The more subsidiaries or other related entities, the greater the challenge in understanding a ministry’s financial data. There may be very valid reasons to use multiple entities—but the additional entities almost always increase the difficulty in comprehending and communicating the data.

Myth #4. Total unrestricted net assets is a key factor in determining the financial stability of a ministry. This is often an untrue statement.

Total unrestricted net assets includes any property, plant, and equipment, less related debt, that is included on the statement of financial position. A large unrestricted net assets balance might simply mean the ministry has invested significant resources in property, plant, and equipment, and much of the property is debt-free. A ministry could be bankrupt at the same time it shows a large unrestricted net assets balance. How is this possible? With debt-free property, plant, and equipment, the ministry could show a significant total unrestricted net assets balance, while having no cash.

A critical question is
whether there is
adequate cash at the
ministry's lowest
cash point in the year.

Myth #5. As long as revenue always exceeds expenses, the cash balance will take care of itself. Wrong!

A ministry could consistently show an excess of revenue over expense and be bankrupt. How is this possible? This could happen when a ministry has too much cash invested in property, plant, and equipment, inventory, or receivables.

Additionally, even when a ministry is taking in more revenue than it is expending, a ministry can be out of cash because of cash fluctuations during the year.

So what should a board member do who readily admits that nonprofit finances are confusing? Focus on three elements:

  1. Lowest cash point in the year. Cash reserves may be adequate at the end of the ministry’s year (calendar or fiscal). A critical question is whether there is adequate cash at the ministry’s lowest cash point in the year—after setting aside cash related to restricted net assets.
  2. Significant negative variances. Celebrate significant positive operational budget to actual variances and celebrate capital budget to actual variances. Determine if significant negative variances require action.
  3. Significant trends. What financial trends reflect the big picture for a ministry? Generally, only a few data elements tell the story:
Beware of
little expenses.
A small leak will
sink a great ship.
Benjamin Franklin
  1. Trends in total revenue and the key element(s) within total revenue—perhaps contributions, sales, or fees.
  2. Trend of total expenses and the key element(s) within total expenses—this is often salaries and fringe benefits.
  3. Trend of cash and temporary investments.
  4. Trend of debt.
  5. Trend of unrestricted net assets.

When we are doing God’s work, we must count the cost of doing ministry:

Is there anyone here who, planning to build a new house, doesn’t first sit down and figure the cost so you’ll know if you can complete it? If you only get the foundation laid and then run out of money, you’re going to look pretty foolish. Everyone passing by will poke fun at you: “He started something he couldn’t finish” (Luke 14:28–30).

Too often a lack of trust results when ministry leaders fail to understand the fundamentals of nonprofit finances.
 

 

  Questions   for reflection

 

Your Board's Financial Understanding

Check One
  Yes No Not Sure
  1. Is your board aware of the timeliness of payments for ministry obligations

 

 

 

  1. Does your board understand the importance of determining unrestricted reserves after subtracting any net property, plant, and equipment less related debt?

 

 

 

  1. Does your board understand whether and why revenues and expenses are increasing or decreasing?

 

 

 

  1. Is all messaging not only truthful but complete? In other words, is anything omitted in the messaging that, if shared, would provide a different view of a particular matter?

 

 

 

  1. Does your board understand whether and why cash is increasing or decreasing?

 

 

 

  1. Does your board understand how the ministry is using any excess of unrestricted revenue over expenses?

 

 

 

  1. If there is an excess of expenses over revenue, does your board understand why this has occurred?
     

 

From TRUST: The Firm Foundation for Kingdom Fruitfulness, ECFAPress, 2015, www.ECFA.org/KnowledgeCenter.


This text is provided with the understanding that ECFA is not rendering legal, accounting, or other professional advice or service. Professional advice on specific issues should be sought from an accountant, lawyer, or other professional.

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