Your nonprofit organization has a fiduciary responsibility to report the details of its financial situation to donors and funders every fiscal year-end.
In Canada, that means complying with GAAP (Generally Accepted Accounting Principles) to prepare multiple financial statements that include your:
- Statement of Cash Flows
- Statement of Operations (also known as your income statement)
- Statement of Financial Position (also known as your balance sheet)
- Statement of functional expenses
Since this last provides the most comprehensive picture of your organization’s financial health and stability, it’s important that you become familiar with how to read a balance sheet for a nonprofit.
What’s included in a nonprofit’s balance sheet (Statement of Financial Position)?
A balance sheet provides a snapshot of your nonprofit’s financial position at a particular point in time—like your fiscal year-end.
It does this by itemizing your:
- Assets (what your nonprofit owns)
- Liabilities (what your nonprofit owes)
- Net Assets (also known as your fund balance)
Here’s a brief breakdown of each.
Nonprofit assets include things like cash, investments, equipment, and grants or donor pledges receivable. These are generally listed by order of liquidity (essentially cash convertibility) on your annual balance sheet, beginning with those assets most easily converted to cash.
There are 3 asset categories.
- Current assets: Those convertible to cash within the coming year (like receivables or inventory)
- Non-current assets: Those that will take more than a year to convert to cash (like long-term investments)
- Fixed assets: Non-current operational assets that aren’t easily convertible to cash (like vehicles or buildings)
Just like for-profit organizations, a nonprofit’s liabilities include any debts or other financial obligations.
There are 2 types of liabilities.
- Current liabilities: Those that will be paid off within the year
- Long-term liabilities: Those due to be paid off some time beyond the coming year
Unlike for-profit organizations—where the difference between assets and liabilities reflects retained earnings or owner’s equity—the “bottom line” on your nonprofit’s balance sheet looks like this:
Assets – Liabilities = Net Assets
There are 2 types of nonprofit net assets.
- Unrestricted net assets: Those with no restrictions on how they can be used
- Restricted net assets: Those with specific donor, contributor, or grant-maker imposed stipulations or conditions regarding their use (these may include temporarily restricted or permanently restricted funds)
Key metrics for analyzing a nonprofit’s balance sheet
Your balance sheet is an important tool for analyzing the critical relationship between assets and liabilities.
Using metrics to track and evaluate the liquidity reflected by your balance sheet is especially important since, as a measure of your organization’s financial flexibility, it reflects whether you’ll have sufficient cash to meet your expenses in the coming year.
Here are 4 key metrics that will help you understand how to read a balance sheet for a nonprofit from a liquidity perspective.
Days cash on hand
This ratio reflects your nonprofit’s liquidity by estimating how many days of organizational expenses you can cover with your current cash balances.
Days cash on hand = Cash available ÷ (Annual cash requirements ÷ 365 Days)
This ratio reflects your nonprofit’s future cash flow by measuring assets convertible to cash within the year against liabilities requiring payment during that time.
Current ratio = Current assets ÷ Current liabilities
Note that the higher this ratio, the better your nonprofit’s capacity to pay back its debts. Ideally you should strive for a ratio of 1 or higher, since a ratio of 1 indicates amounts owned as being equal to amounts owed.
Working capital ratio (for nonprofits)
This ratio reflects the value of donor-restriction-free resources available to your nonprofit for current or future use.
Working capital ratio = (Net assets without donor restrictions – Net fixed assets) ÷ (Annual cash requirement ÷ 365 Days)
Note that this ratio gives you a clearer picture of the working capital at your disposal as a nonprofit because it removes both donor-restricted assets—and net fixed assets that are unlikely to convert to cash any time soon—from the equation.
This ratio reflects your nonprofit’s reliance on debt for carrying out its operations.
Leverage ratio = Total liabilities ÷ Total assets
Note that the lower this ratio, the less debt-reliant your nonprofit is likely to be. Ideally you should strive for a ratio of less than 10% (common among top-rated charities) and aim to monitor your results regularly. If you notice this ratio rising over time, it could be a sign of looming financial problems.
Since the statement of financial position is predominantly used to help key stakeholders (like board members, for example) make informed strategic and financial management decisions, if you occupy such a role, it’s essential that you know how to read a balance sheet for a nonprofit.
If you need help preparing your balance sheet or other financial statements meanwhile, Enkel can help! We provide accurate, reliable bookkeeping and financial reporting to nonprofits and charities across Canada.
Contact us today for more information.