FINANCIAL REPORTING

The Income Statement

Accurate, concise, and readable financial statements are a must-have for decision making in both the nonprofit and for-profit worlds. The financial statements of a nonprofit answer the questions that are pretty much always on the minds of executive management and the board:

  • How are we doing?
  • How will we end the year?
  • What is our financial position?
  • What is our long-term financial outlook?

The CFO lives and breathes the income statement and balance sheet reports because they are the tip of a very large iceberg. They are inseparable from a carefully designed and maintained general ledger (GL) system. Every decision about the accounting for revenues, expenses, cash, receivables, etc., is about general ledger architecture, which is ultimately about financial statement reporting.

Here we are going to talk about the income statement. We will cover the balance sheet in Balance Sheet Part 1 and Part 2.

WHAT AN INCOME STATEMENT LOOKS LIKE

Most nonprofit managers and board members know that the income statement is money in (revenues), money out (expenses), and the difference between the two is surplus or deficit. Ironically, many accountants use the term “profit and loss” or “P&L” report for a nonprofit income statement, on which you will never see the word “profit.” In our examples you will see both surpluses and deficits.

There are several types of income statements:

  • Annual internal—The year-end income statement reports financial activity for the entire year, whether it be calendar or fiscal year. Used by management and board for budgeting and strategic planning, it can be consolidated or broken down by function.
  • Functional income statement—An income statement for the organization as a whole, it is broken down by program, management and general (M&G), and fundraising. On the 990 only expenses are reported but we will show revenues and expenses in our example.
  • Ongoing budget-to-actual—The monthly and quarterly income statements act as performance reports, comparing budget to actual; these are invaluable for decision-making throughout the year.
  • Statement of activities—This is included in the annual audit report. It’s the year-end income statement dressed up with all of the applicable features of Generally Accepted Accounting Principles (GAAP).

ANNUAL INTERNAL INCOME STATEMENT EXAMPLE

Let’s dig a little deeper and review the finances of a fictional nonprofit, Farm Haven Animal Refuge (FH). FH leases a five-hundred acre property on which it provides a home for rescue animals such as pigs, cows, sheep, etc. It is open to the public and provides educational programs for adults and children. This example of a year-end income statement is formatted for presentation to Farm Haven’s board of directors:

Here you see FH’s activities for the year 20×1. This income statement is presented on a consolidated basis, rolling all program and administrative functions together into one dataset. The financial result: an organization-wide deficit of $27,200.

Other information to be gleaned:

  • FH had a fairly diverse funding mix with grants and donations making up 78% of income.
  • Personnel costs were 55% of total expense.
  • FH had no loan interest expense.
  • Non-personnel direct service costs (animal care supplies and veterinary services) were 21% of expense.

While this report gives the reader a 30,000-foot view, questions remain.

  • What are the causes of the deficit?
  • How do the numbers break down between programs?
  • What percentage of expense is administrative overhead?
  • How effective are fundraising and development efforts?

ENTER THE FUNCTIONAL INCOME STATEMENT

The functional income statement tells a more detailed story about FH’s activities during the reporting period. Here we report the individual programs along with management and general (M&G, also called administrative overhead) and fundraising, each in a separate column. The GL is organized so that this breakdown is available for:

  • Management and board
  • The annual IRS 990 report (expenses only), required for nonprofits with revenues of $200,000 and over.
  • The annual audit report

(Note: only expenses need to be broken down by function for the 990 and annual audit report.)

The functional income statement allocates M&G expense to the programs according to the size of the program, providing a complete picture of each program’s financial health.

Now we can see:

  • M&G payroll was 34% of total payroll.
  • M&G expense was 28.7% of total program expense.
  • Fundraising activities netted $89,000.
  • The animal care program’s funding did not cover its costs.
  • FH relied on education/outreach and fundraising/development to cover a good portion of the animal care program deficit.

There are many ways to present an income statement by function, depending on the number of programs and the purpose of the presentation. You will want your GL to be granular so that you can run an income statement report for every individual program or roll up individual programs into larger groups such as departments or divisions.

BUDGET-TO-ACTUAL INCOME STATEMENTS

Some Budgeting Philosophy

Comparative reports start with an anchor that provides trustworthy comparative data. The budget is an excellent anchor because the board reviews and approves the budget before the year begins. Throughout the year board members are looking for assurance that the budget is being followed.

You might ask “Why did the board approve a deficit budget?” The array of answers to this question could comprise a separate essay. In brief, while many boards demand a balanced budget, others prefer to see a budget that tells the real story. I am in the latter camp. FH, like many nonprofits, runs a program central to its mission that cannot cover its costs and makes up for the losses with other activities. The animal care budget ended the year with a somewhat frightening deficit of $172,610, but the consolidated bottom line was a deficit of $27,200—slightly better than the budgeted deficit of $34,000 as seen in example 3, below. A realistic budget gives management and board a meaningful target to aim for throughout the year. Can FH sustain deficits year after year? Probably not, but for this year they may have reserves to draw on, or they may be working on a five-year grant application that will take them out of negative territory in the future.

The budget-to-actual income statement report follows the standard format with the addition of total budget, year-to-date (YTD) budget, variance, and explanation columns. It is a performance report, showing the reader how well the organization is following the budget and thus opening the way for midcourse corrections as needed.

Budget-to-actual reports are usually prepared for a single individual program or at the consolidated level. The functional income statement does not lend itself to this format because there are too many columns. Information overload is always a consideration in preparing financial statements.

The presentation for the board is often a consolidated statement with explanations for significant variances between actual and budget for the organization as a whole. You might use a narrative to address the programs deemed to be a problem from a financial standpoint. Some boards may wish to see more of a breakdown; others may not. For more about board reporting click here.

Here is FH’s consolidated mid-year budget-to-actual report:

This report aims to answer the questions “How are we doing?” and, “How will we end the year?” As of 6/30/x1 FH has a YTD deficit of $68,400 compared to a YTD budgeted deficit of $17,000. The board needs to know whether FH is in trouble, or on track to end the year close to budget.

The explanations tell us that some of the revenue variances are due to timing, and hence may not be of concern. The loss in grant revenue is potentially offset for now by salary savings from staff turnover. The increase in the cost of animal care supplies is troubling because it is an on-going expense at the heart of the organization’s mission.

To get a better picture of how FH will end the year, board members might ask these questions:

  • Are the midyear donation revenues about the same as prior years?
  • What is the track record for the fundraising event scheduled for September?
  • Are alternative revenue streams being sought to replace the reduction in grant revenue?
  • Will the salary savings continue to grow? Are the positions being filled? Are more staff expected to resign?
  • Are there viable measures we can take to reduce the costs of animal care supplies?

The consolidated budget-to-actual report tells the board a lot about FH’s financial picture from a governance standpoint. From a managerial standpoint, executive and program managers will need to see income and expense for every program, with detailed explanations for significant variances between budget and actual.

YEAR-END STATEMENT OF ACTIVITIES

Foundation funders, government entities, and lenders are the targeted readers of the statement of activities. GAAP rules make it possible for a banker considering your loan application to compare your results with those of any other organization, for-profit or not. Similarly, a government funder will want all grant recipients’ reports to conform to the same set of rules. Your bank may require audited financial statements every year during the life of your loan so that it can monitor your financial performance.

If you are required by your local or state government, funders, or bank to provide audited financial statements, the auditors will take the lead in preparation of the statement of activities. There are several GAAP standards that you may or may not observe when preparing your internal monthly statements, such as depreciation, unrealized investment income, release of revenue restrictions, or even full accrual of revenue and expense. The auditors will show you the adjustments needed to bring your revenues and expenses into compliance with GAAP.

TO CONCLUDE

Communication of money in/money out, and the difference between the two is an age-old endeavor. A well-designed income statement will provide the key to understanding an entity’s activities and performance, whether it be one program with a $10,000 budget or a multi-million-dollar organization with many divisions and hundreds of individual programs. Success is achieved with the right GL software and structure, accurate data entry, and a well-thought-out report design.