Three Steps to Simplify Monitoring the Balance Sheet

Balance sheets are part of standard nonprofit organization financial reporting. However, balance sheets are intimidating to most individuals and often misunderstood. Simplifying the monitoring process is key to improving engagement, enhancing understanding of the balance sheet, and helping individuals to fulfill their financial oversight roles and responsibilities.

Even individuals who have experience and expertise working with balance sheets confront barriers to engagement due to busy schedules and other professional and personal distractions. If a straightforward path is made available, engagement will exponentially increase for the both the experienced and not so experienced user of financial information.

I often find myself in the second group, experienced but busy and distracted. As a result, I have developed this basic three-step approach to tackling a new balance sheet and quickly assessing an organization’s current financial position and trends.

Step 1 – Look for overall discrepancies.

Begin by taking a quick look to determine if the balance sheet is ready for observation and assessment without the existence of obvious errors that need correction. This step focuses on two simple front-end questions:

• Is the Total Balance Sheet for the Current Period in balance (total assets equals total liabilities plus net assets)?

• Is the Total Balance Sheet for the Comparative Prior Period in balance (total assets equals total liabilities plus net assets)?

If the answers to these questions are both yes, proceed to Step 2. If not, inform senior management of the discrepancies and wait for a corrected financial report.

Step 2 – Observe the net assets section.

Next, turn your focus to the net assets section of the balance sheet and observe how the amounts have changed since the prior fiscal year-end:

• Is Total Net Assets increasing since the prior fiscal year-end?

• Is Unrestricted (net assets without donor restrictions) increasing since the prior fiscal year-end?

• Is Restricted (net assets with donor restrictions) increasing while Unrestricted (net assets without donor restrictions) is decreasing since the prior fiscal year-end?

• Is the ratio of Unrestricted (net assets without donor restrictions) to Restricted (net assets with donor restrictions) in a normal range for the organization and aligned with expectations?

Operating reserves are a key element of financial health. Operating reserves reside inside unrestricted net assets. Keeping an eye on unrestricted net asset increasing and decreasing trends will provide you with a quick indication of impact on operating reserve status and the changing financial health of the organization.

Step 3 – Determine the liquid (short-term) cash position compared to accounts payable and accrued expenses.

Now turn your attention to the top of the balance sheet and observe the organization’s current (liquid) cash position as compared to immediate cash out-flow requirements associated with accounts payable and accrued expenses.

• Is Total cash position increasing since the prior fiscal year-end?

• Is Total Accounts Payable and Accrued Expenses decreasing since the prior fiscal year-end?

• Is the current Net Cash Position (cash and cash equivalents less accounts payable and accrued expenses) positive?

• Bonus Question – Is the current Net Cash Position Plus Payroll (cash and cash equivalents less accounts payable, accrued expenses and funds needed to cover the next payroll period) positive?

These questions focus attention on the always important changing net cash position, observing whether the organization’s ability to meet its immediate cash obligations to pay vendors and fund the next payroll cycle is satisfactory (in a normal range) or deficient, which could cause disruptions, late vendor payments, and growing accounts payable.

If any answers to the above questions are “no,” be prepared to make inquiries and forward questions to senior management. Even for “yes” answers, it may be appropriate to contact senior management if results and trends are not in-line with current expectations.

Planning Tip – If an organization normally has deferred income on the balance sheet, carefully observe the impact on liquid cash position. If deferred income is greater than liquid cash, the organization might be partially using cash intended for future programs and activities to cover current cash obligations. This is not always dangerous but could be an indicator of future cash deficiencies. Ask to see cash flow projections to observe if deficit cash positions will appear in future months.

This basic three-step approach will help individuals to improve their understanding of balance sheets with minimal effort, thereby encouraging more active monitoring of financial resources and helping them to fulfill their financial oversight roles and responsibilities.

A modified version of this piece is available to SE4N subscribers as a downloadable PDF checklist.