Ever been in a meeting where you’re presented with a stack of financial charts, multiple pages in length and tiny in font size? If so, my informal research suggests you’re in good company; approximately 100% of nonprofit staff and board members have had this experience, give or take 0%.
The sea of data is impressive. Everything appears to be there… somewhere. “Any questions?” usually follows, and the response is also universal: dead silence. There is no better, known way to muzzle an energetic crowd.
If silencing is the purpose, the stack has succeeded. We can move on to the next agenda item…
But let’s step back for a minute. What’s the purpose of data, financial or otherwise?
Unless we’re cynical (and of course we are not), the purpose is to increase, understand and/or stimulate lively discussion. This is true for election results, weather forecasts, baseball box scores and financial reports. And there the stack has fully and completely failed.
With all data, less is more.
I divide data into three types: trivial, interesting and essential. Most data is trivial – fascinating in some way, no doubt, but inconsequential. Some data (not a lot) is interesting, meaning that there’s something of value there, but not earthshaking. A small portion of any dataset is essential to understanding the story we need to know.
What is essential financial data for nonprofits? It’s what will describe your organization’s health, progress and challenges. Just a few select metrics:
Since we’re nonprofits, I’ve been told, we must avoid the forbidden term “profit”. So, I’ll substitute “surplus” and make up a word (which I kind of like). This is, simply, how positive our operating bottom line is over time, both looking backward (historic figures) and forward (projections). I look at surplusability as a percentage of annual operating expenses.
What do I want to see here? Ongoing surpluses of at least 2%. (Less than that, anomalies aside, is often a sign of financial stress.)
This data is derived from the bottom line on your income statement (a.k.a. profit and loss statement). If this seems straightforward, there’s a caveat: Your true operating picture can be distorted if you receive varying amounts of restricted gifts from year to year. What we really want to know is the net funds available to use in each year – this is not what your income statement shows us, even in an audit report. So, we need to make two adjustments; one for past restricted funds used in a given fiscal year, and a second for restricted funds raised in a given year but saved for use in a future year.
With these modifications, we now have the adjusted bottom lines we want. Looking at this metric over multiple years, we can ascertain the organization’s surplusability.
Ever heard the cliché “cash is king”? It’s boring but accurate. There’s no substitute for money in the bank. But, for nonprofits we are especially interested in one kind of money: unrestricted cash (and cash equivalents). I specifically look at unrestricted cash/cash equivalents in the bank as a percentage of annual operating expenses. (If we’re only looking at year-end figures, I like a slightly different metric, unrestricted current assets. Either is fine, as long as we’re consistent.) Again, Iook at the pattern over multiple years, past history and future projections.
The statement of financial position (a.k.a. balance sheet) should, in theory, be helpful here. You can easily find your cash and cash equivalents line item at the end of any month. Unfortunately, this number is incomplete, even in audit reports. It doesn’t tell us how much of that cash is unrestricted. We can’t count unrestricted cash, because it must be saved for its restricted purpose(s). So, we need to make another adjustment, this time subtracting restricted cash from the balance.
Here I want to see at least six-months’ unrestricted cash (or current assets) for most nonprofits (less for organizations with predictable fee-for-service income.)
Now we have the financial position data we need to know.
Let’s add a third metric. Fortunately, this is easy to find. It’s the current ratio, and comes from dividing current assets by current liabilities, both on the balance sheet. This shows how likely we are to run out of working capital in the short-term. It’s not as fundamental as the first two, but helpful as icing on our tiny financial reporting cake. I look for a consistent ratio of 2:1 or higher.
Needles, Not Haystack
Put these three metrics together, as trend lines looking backward and forward, and we have a nice picture of your organization’s financial health. Or, perhaps I should say an accurate picture – it may not look nice to you at all. But enlightenment was our objective, not confirmation, so box checked.
Note that all this discussion has been about just three bits of data at any point in time, not 10, not 50, not multiple pages of charts. All the rest is either trivia or interesting-but-not-essential. Imagine how relaxed the group will be when they know what to focus on?
I want to note something that may have slid past:
Isn’t it surprising that standard financial statements, including audited statements, don’t tell us the two principal things we really need to know? This makes me wonder if nonprofits would perform better if standard reporting formats were more transparent.
While I’m airing this, I’ll also mention another missed opportunity in audited financial statements for U.S. nonprofits: Under revenues, audits have one line, Contributions (or similar), that combines all sorts of things – grants, individual gifts, corporate contributions, etc. Wouldn’t it be helpful to know, at a glance, how these different streams contribute to the organization’s revenue structure and vary, year by year? This is all known information, and it’s a missed opportunity.
A Deeper Dive
When doing financial analysis and modeling as part of consulting projects, there are other data I’m interested in, but they go beyond what financial statements can deliver. Ironically, they’re not even part of the stack of charts in the familiar, hypothetical meeting above! These are: program profitability, income risk indicators, and the drivers of an organization’s business model. This information provides depth needed to make strategic, long-term decisions. I call this the “third dimension” of financial management.
Specialized effort is required to identify this deeper information, but it tells us so much more about the organization, where it needs to go, and what leadership should focus on. My point here is that we shouldn’t rely solely on financial statements, even adjusted ones, to get nonprofit leaders the information needed to make the best decisions. The story may be incomplete.
Ultimately, data is about telling a story. The right financial data tells us the right story. The wrong data silences us.