The Overlooked Effects of Changing a Fiscal Year-End
“Should we change our fiscal year-end?” This an interesting question that will naturally pop up over time for many nonprofit organizations. As with most complicated, multi-layered questions, the highly visible positive aspects need to be balanced against potential negative outcomes that are often hidden or ignored. One often-overlooked downside of a change in fiscal year-end (FYE) is the impact on an organization’s operating reserves.
The main reason why a nonprofit organization might want to change its FYE is usually because the current FYE is not optimally aligned with funding, operations, mission, programs, and/or collaborations with other organizations. Poor alignment of a FYE can occur when operational and funding patterns change over time or can sometimes be the result of an unintended bad choice of FYE when the organization was formed.
Regardless of the reason for FYE change, the transition period from an old FYE to the new FYE is where potential hidden problems lurk.
Consider this transition period example, an organization whose annual meeting, the largest generator of net revenue for the organization, is scheduled for September each year. If this organization changes its FYE from December 31 to June 30, the annual meeting will “shift” from the 3rd quarter to the 1st quarter repositioning this key revenue generator near the beginning of the fiscal year which will improve budgeting, resource allocation, and planning.
A “short-period” transition year is required to change a FYE. Shifting from a December 31 to a June 30 FYE, a short-period year of 6 months is necessary (January 1 to June 30). An 18-month transition year is not allowed. The transition year must be less than 12 months.
The short-period transition year can create financial hurdles that are so significant that they may make the change of FYE unfeasible. Significant hurdles include preparing a short-period Form 990 and other tax filings, requesting a change of FYE from the IRS, preparing a short-period budget, preparing for an additional short-period FYE closing and financial statement audit, and being unable to present comparable financial results for two years.
However, the most significant overlooked effect is the short-period impact on operating reserves.
Referring to the example above, this change in FYE will trigger a 6-month short-period fiscal year without an annual meeting and the corresponding net revenue. Now suppose that in a normal budget year this organization counts on a $200K surplus from the annual meeting to produce a bottom-line surplus of $40K. Without an annual meeting the organization will have a large deficit. The bottom line for the short-period year will be in a deficit position and could be even worse based on other seasonal timing issues.
Most short-period transition years result in substantial losses which will directly deplete operating reserves and weaken balance sheet financial health.
Now for the bad news. The short-period large operating deficit will not reverse in the first year after the FYE change. Often the recovery period will take many years. In preparing financial forecasts, plan to show a recovery period of at least 5 years and maybe as many as 10 years to recoup the large, short-period transition deficit.
Planning Tip – Changing your organization’s fiscal year end (FYE) can seem like a sure win, but the consideration and planning process must be comprehensive to avoid significant missteps. Assign a diverse and experienced working group to explore and assess the consequences of the FYE change, both positive and negative. Require them to prepare a work plan with detailed action steps that describe financial effects (costs, impact on operating reserves, etc.) as well as non-financial effects (staff capacity, disruption, etc.). This work plan should also highlight the pros and cons for each step in the transition process and expected long-term benefits and outcomes.
The short-term impact on operating reserves could make the consideration of changing FYE a real challenge. When you factor in other financial considerations such as additional year-end closing, tax filings, financial audit, etc., the total financial impact and time commitment could outweigh the potential long-term benefits. For these reasons, it is important to be open-minded and thorough when considering and planning for a change in FYE.
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