Financial Reporting for Associations 101
While every organization may be required to submit financial reports to the IRS, professional associations and other nonprofits have one more entity to worry about: their board of directors.
For some associations, these reports are some of the only communication the staff will have with their volunteer board. As a result, it’s crucial for an association manager to understand the ins and outs of their financial reporting to ensure the statements accurately represent the financial state of the association.
In this article we discuss the fundamentals of financial reporting for associations, share the four key financial statements you need to have on your radar, and explain what each statement can offer your organization.
Statement of Activity
The Statement of Activity details the funds coming into the association (revenue), the money going out (expenses), and what’s left when the second is subtracted from the first (net profit/loss). More simply, it follows this formula: Revenue - Expenses = Net Income.
On the Statement of Activity, revenue is listed as “Revenues, Gains, and Other Support” and includes the total amounts the association has received from donations, program service fees, membership dues, events, and investment return. Each revenue source has its own line item.
The next component is expenses, which are categorized as either program service expenses or support expenses. Program service expenses are the costs associated with executing programs like continuing education and career training. Support expenses are expenditures related to running the association such as insurance, utilities, and payroll as well as costs incurred for fundraising activities.
Why It’s Important
The Statement of Activity can give you valuable insight into the ROI of your different revenue-generating activities. Taking an objective look at the amount you’ve invested in each activity and the revenue each activity has brought in helps you see how well your association has allocated its budget. If you notice the expenses associated with one activity are considerably higher than the revenue it’s generated, you can reassign that budget to another activity with a better return.
The relationship between expenses and revenue is especially important for board members since they have a fiduciary responsibility to always act in the best interest of the association.Therefore, it’s essential to record and categorize your expenses accurately.
Statement of Financial Position
The next report is the Statement of Financial Position, which is similar to the balance sheet for-profit organizations use. It details what your association owns (assets), what it owes (liabilities), and net assets which shows the difference between the assets and liabilities.
The first section of the Statement of Financial Position lists current and fixed assets in order of liquidity. The first item is cash and cash equivalents followed by accounts receivable and short-term investments. These are all assets that could be converted into cash within 12 months. Following are fixed assets, which include property, equipment, and long-term investments.
In the second section are current and long-term liabilities, which are all the association’s financial commitments. Liabilities are listed in the order they are due, with the soonest at the top. Current liabilities must be repaid within 12 months and include accounts payable, short-term loans, and grants. Examples of long-term liabilities are mortgages, leases, and other long-term debts.
The last section of the Statement of Financial Position is referred to as net assets. It represents the difference between the association’s assets and liabilities and is the equivalent of equity in a for-profit business. The final net assets amount listed on the Statement of Financial Position must agree with the ending net assets value on the Statement of Activities.
Why It’s Important
The Statement of Financial Position is an at-a-glance summary of the financial stability of your association. Unlike the Statement of Activities which describes activities over a period of time (such as the past month, quarter, or year), the Statement of Financial Position is a snapshot of the last day of an accounting period. You and your board members can use the Statement of Financial Position to compare the association’s current performance to previous periods and forecast growth and future financial position.
Statement of Cash Flows
The Statement of Cash Flows illustrates the changes in the association’s cash and cash equivalents during a specific accounting period, usually between two Statement of Financial Position reports. It lists the revenue generated from three sources: operations, investing activities, and financing activities.
The first section, cash from operations, describes how the association uses cash for basic operating activities. If the value is negative, it means the money generated from operating activities isn’t enough to cover the cost of operations. A negative cash flow from operations is acceptable as long as the other cash flows are positive. Otherwise, the association will run out of cash.
The next section is cash from investing activities and includes all cash spent on the purchase of long-term assets such as property or equipment as well as all cash received via the sale of long-term assets. It also includes investments in stocks and bonds and the cash earned on those investments.
The final section is cash from financing, which lists funds the association borrowed from a third party to finance operations. It also includes any funds that have been restricted for reinvestment and other long-term purposes such as future programs or new equipment.
Why It’s Important
As the most liquid of your association’s assets, cash is a crucial part of the association’s financial health. The Statement of Cash Flows gives you a comprehensive picture of how cash is moving through the association and allows you to identify potential issues before they become unfixable. For example, the Statement of Cash Flows will show you if the association’s core operations are generating less cash than they use, which can be catastrophic if not addressed.
Statement of Functional Expenses
Following the release of the FASB’s Accounting Standards Update (ASU) 2016-14, all nonprofit associations are required to present expenses by function and type in one place, either in a Statement of Functional Expenses or in the Notes to Financial Statements. (In this context, “function” refers to an expenditure’s classification as a program service expense or support expense.)
If your association’s expenses are relatively simple, you can opt to include this information in the Notes to Financial Statements. If you go this route, you need to make sure the footnotes and references are as clear as possible so it’s easy to find the line item the note is referring to.
If your association’s expenses are more complex, it’s likely a better idea to create a Statement of Functional Expenses. A Statement of Functional Expenses is a separate report that shows the breakdown of costs by function and category. You can think of it like a more detailed version of the expenses section on the Statement of Activities. Whether your accounting is relatively simple or complex, you must be able to show this functional expense allocation as well as the explanation of the sound methodology employed to get to the final allocations.
This functional expense reporting is required for 501(c)3 Form 990 filings. Although functional expense accounting is not yet required per the IRS for most other 501(c) organizations, a CPA will require this reporting and explanation if she is employed to conduct an audit.
Why It’s Important
The Statement of Functional Expenses allows you to see what percentage of your budget is going to administrative costs and what percentage is spent on supporting your programs and community-facing activities. It also helps you identify expenses that may be taking up more of your resources than they should be. For example, if you see the charges associated with your phone and internet usage are almost as much as the association’s travel expenses, it may be time to revisit your telecom contract.
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