Frequently Asked Questions about Nonprofit Finances

An Excerpt from the Center's Nonprofit Answer Book: An Executive Director's Guide to Frequently Asked Questions printed in 1998. Our goal is to provide nonprofit managers and directors with a useful reference for spotting potential problems and enable further research.

FAQ #1. How should a nonprofit organization develop a budget?

Answer currently undergoing revision.                                  

FAQ #2. Are there resources for learning about accounting for non-professionals?

Answer currently undergoing revision.

FAQ #3. How can we find accountants who know nonprofits and charge reasonable rates?  

Answer currently undergoing revision.

FAQ #4. What are differences between accounting for nonprofit and for-profit businesses? 

Answer currently undergoing revision.

FAQ #5. What are the basic financial reports issued by nonprofit organizations?

The basic financial reports of a nonprofit organization include: 

• ·         Statement of financial position (sometimes referred to as a balance sheet).
• ·         Statement of activity.
• ·         Statement of cash flows.
• ·         Statement of functional expenses. 

Other reports, depending on your organization’s needs, are: government information returns, tax returns, reports to funders, management reports, budget monitoring reports, cash flow reports, analysis of statements and investment reports.

The Statement of Financial Position summarizes the assets, liabilities and net assets of the organization at a specified date.  The Statement of Financial Position is a picture of the organization’s financial position on that date.

The Statement of Activities reports the organization’s financial activity over a period of time.  It shows the types and amounts of revenue and expense and the net revenue or difference between revenue and expenses.

The Statement of Cash Flows summarizes the resources that become available to the organization during the reporting period and the uses made of such resources.

The Statement of Functional Expenses reports all expenses as related either to program services or to supporting services.  Expenses under program services are shown divided among the various programs.  Expenses under supporting services are generally divided between (1) management and general expenses and (2) fundraising expenses. 

Government Information Returns: Nonprofit organizations are required by federal and state governments to file various reports to maintain their tax-exempt status and document tax compliance.   The primary federal reports are the annual Form 990 and Schedule A to the 990.  State governments may require additional reports, such as the 199 and Registration/Renewal Fee Report (RRF-1) in California.

Tax Returns:  If you have employees, payroll tax returns are required by federal and state agencies, and by some cities as well.  Organizations also must report taxable income from business activities unrelated to their tax-exempt purposes (unrelated business income).  If an organization engages in sales, state sales tax regulations may be applicable. If you hire independent contractors, you may have to file Forms 1099.

Reports to Funders are based on the terms of the grants.  In some cases, periodic statements report to the funder the ways grant funds were spent.  Another report to a funder is a “reimbursement request” in which the funder is billed for the amount spent by the organization on a program established through a contract arrangement.  Some reports to funders focus almost exclusively on program output, such as numbers of clients served, and may report only the organization’s consolidated financial activity.

Management Reports are for internal use by the organization.  They are selected and formatted to answer specific concerns of management.

Adapted from: The Finance Manual, by Jan Masaoka and Jude Kaye.

Links:

Analysis of FASB117

IRS Publication 4221, Compliance Guide for 501 (c)(3) Tax-Exempt Organizations

California Franchise Tax Board, Exempt Organizations Filing Requirements

California Franchise Tax Board, Overview of Exemption and Filing

FAQ #6. How can we prepare for an audit?

Two keys to audit preparation are:  (1) choice of an auditor with extensive experience working with nonprofit organizations, and (2) being prepared. 

Be sure your staff understands that your organization has chosen to conduct an independent audit to provide assurance to the board of directors and outside parties, such as donors, that the organization properly manages its finances. Pulling documentation and anticipating questions in advance will make the audit go much more smoothly.  Being prepared increases the likelihood that with any questions asked, you and your staff can easily produce the necessary information and this should reduce your anxiety.

Ask the auditors for a list of the information they will need before you spend time producing reports that the auditors do not need. Clarify any items that you are not certain about, including documentation. Arrange for space for the auditors to do their work and notify the staff members that may need to meet with the auditors.  The executive director or designated staff member should be familiar with data from all staff members and know who is responsible for the following information:

• ·         Most recent interim financial statement.
• ·         Journals and ledgers.
• ·         Chart of accounts.
• ·         Checkbooks, bank statements, bank account reconciliation’s and canceled checks.
• ·         Resource documents such as paid bills and receipts, including petty cash.
• ·         Payroll records (including documentation for new hires and terminations, tax returns, state payroll taxes).
• ·         Employee vacation records, including unused vacation.
• ·         Organizational documents such as tax exemption letters and board or committee meeting minutes.
• ·         Grant contracts and supporting documents.
• ·         Letters designating restricted use of funds.
• ·         Lease and maintenance agreements.
• ·         Insurance policies.
• ·         Unpaid invoices.
• ·         Tax returns such as Form 990 and state filings.
• ·         Trail balance.
• ·         Pledges and accounts receivable listing.
• ·         Accounts payable.
• ·         Depreciation schedule.
• ·         Fixed asset additions and deletions.
• ·         List of any prepaid expenses.
• ·         Record of investment activities.
• ·         Documentation for donated supplies, equipment, and volunteer services.
• ·         Information on affiliated organizations.

FAQ #7. Should we have an audit? 

While the term “audit” is sometimes used to refer to other types of review (e.g. contract monitoring, internal review, external management review, etc.), an audit most commonly refers to an independent financial audit conducted on an annual basis.  This response addresses the need for an audit or other independent review of the organization’s financial condition.

An annual financial audit is not a legal requirement in California for nonprofit organizations.

Requirements of Funding Sources

The federal government requires an independent audit for organizations that have expended more than $500,000 in federal grants within a year.  (See OMB Circular A-133, http://www.whitehouse.gov/omb/circulars/a133/a133.html.)  Certain donors may require an independent audit as a requirement of funding.)

Benefits to the Organization

An audit provides the board of directors with an external review of the accounting practices and financial reporting functions.

Preparation of the Audit 

An audit must be prepared by a licensed independent certified public accountant (CPA).  The auditor performs a series of selective tests that provide a basis for judging whether the financial reports can be relied upon.  Auditors will examine, among other things, bank reconciliation; selected restricted donations, (to see that they were handled and recorded properly); grant letters (to see that receivable are accurately stated). In addition, the auditor reviews physical assets, journals and ledgers and board minutes.   Based on this investigation, the auditor issues a formal opinion about the accuracy of the financial reports. 

Other Types of Financial Reports

Certified public accountants (CPAs) can prepare three basic types of reports: compilations, reviews and audits (discussed above and in Finance FAQ #5).  Each report involves a different level of review and certification of the accuracy of the financial information presented in the statements.

In a compilation report, the accountant takes the financial data supplied by the agency and organizes it into standard financial reporting formats.  The accountant does not review the numbers for accuracy, nor state an opinion regarding the accuracy of the information.

A review is a limited examination of the information prepared by the organization.  A review offers limited assurance that the organization’s true financial picture does not significantly vary from the information presented.

Adapted from: The Finance Manual, by Jan Masaoka and Jude Kaye.

FAQ # 8. Where do we find reputable auditors who specialize in nonprofit organizations?

Answer currently undergoing revision.

FAQ #9. What are tax and reporting compliance requirements for nonprofit organizations?

Answer currently undergoing revision.

FAQ #10. Are there any resources for securing a cash flow loan?

Answer currently undergoing revision.

FAQ #11. How large should our cash reserve be?

It is good practice to have a cash reserve equal to three to six months of the organization’s annual operating budget.  This is easier said than done.  If an organization retains more than one year’s operating expenses in reserve, the organization should have a sound rationale for keeping this much cash on hand.  Otherwise, the board, funders, and constituents may begin to ask if the organization is utilizing its available financial resources in a manner that will have the greatest impact in achieving its mission.

FAQ #12. What should be our organization’s investment policy?

At the heart of setting investment policies is the tension faced by nonprofit organizations to meet the operating needs of today and building an endowment fund to meet the needs of tomorrow.  The board of directors needs to make two critical decisions in regard to investment policies: asset allocation and spending parameters.  These decisions will determine the ability of a nonprofit organization to maintain and develop its programs and to keep its physical plant adequate. These questions will provide insights into an organization’s investment practices, its historical return on the investments, its asset allocation and its compliance with the Uniform Prudent Investor’s Act.

Questions which the board of directors should answer in setting its investment policies include:

• ·         Does your organization have an investment policy statement?  If so, when was it last updated?  Does it meet your objectives and needs?  Is it consistent with the California Institutional Funds Act?
• ·         What is your return goal over the period of your plan?
• ·         What is your current spending rate (percentage of endowment transferred to operating fund)?
• ·         What is your projected contribution level?
• ·         Do you project an increase in your spending level each year to cover inflation?
• ·         What are the liquidity needs?
• ·         Have management letters from external (or internal) auditors addressed issues related to investments?  Is so, what are the recommendations?
• ·         How much does the organization rely upon endowments, grants and other contributions?
• ·         From whom has the organization received endowments, grants and contributions?
• ·         Is there a board committee responsible for investments?  How often does it meet?
• ·         What information do board members receive with regard to the organization’s investments?  How regularly do they receive it?
• ·         How do you currently monitor investment performance?  What investment performance benchmarks are used?

• Have you evaluated the cost of your investment managers?
• What is your current asset allocation in the organization’s portfolio?
• Do you feel that there are adequate investment monitoring systems in place?
• What are the organization’s attitudes toward risk within the portfolio?
• What are the organization’s objectives with regard to returns from the investment portfolio?
• Are you getting the advice you need on investments?
• Are your investments subject to any unusual regulations?
• Has the organization transferred cash and investments to any related organizations?

FAQ #13. What internal financial controls should we have?

Answer currently undergoing revision.

FAQ #14. How should we handle our petty cash?

Some nonprofit organizations find it helpful to have a petty cash fund.  A petty cash fund is primarily used for expenses that, because of their unpredictable timing and small monetary amounts, make it inefficient to go through the organization’s regular check authorization and issuing process.  These expenses may include overdue postage, an urgent office supply need, or covering beverages for a meeting.  The practice is also common in remote sites and branches of an organization. 

Because a petty cash fund involves employees having direct access to cash, it is important that there be clear policies and procedures to provide a real deterrent to fraud.

Procedures, which should exist for the petty cash fund, include:

• ·         A fixed amount for the fund.
• ·         A ledger that outlines funds in and expenses out.  Each withdrawal must be documented by the reason for withdrawal, program, person, amount and date.  Where possible, receipts should be attached to the ledger.
• ·         Funds should be kept in a locked drawer.
• ·         Access to the petty cash should be limited to one person who is accountable for balancing the account on a monthly basis.
• ·         At least on an annual basis, an unannounced audit of the petty cash fund should be conducted.

DISCLAIMER:

The answers provided can deal with complicated and sensitive legal issues. These answers are only intended to give general guidance and does not contitute legal advice. The law is constantly changing and its application always depends on the particular circumstances involved. We strongly urge readers to seek legal counsel in the event they are confronted with a possible legal problem.