The Key Financial Reports That We All Need To Understand

by The Montessori Foundation Staff | Administrative Team, Finances, Montessori Administrators, The International Montessori Council

Many of us who end up in school administration or serving on a board would not consider financial planning and analysis to be our strongest skill area.

Despite this, we are all responsible for keeping close tabs on our schools’ finances and for making decisions about the future based on accurate information, as well as intuition. You can accomplish all this, without a sophisticated knowledge of financial planning and analysis if you learn to ask for and use five essential financial reports on a regular basis: your budget versus actual report of income and expenses, your school’s balance sheet, your cash flow projections, aged receivables, and your attrition reports and projections.

These reports provide a snapshot of your school taken from one of several different perspectives, which, when used together, show how the school looked at that given moment in time.

One way to think of these financial reports is to compare them to the instruments and idiot lights on your car’s dashboard. The speedometer tells us how fast you are traveling. The mileage meter tells how far you’ve traveled. The fuel gauge tells us how much fuel you have in your tank. There are idiot lights or gauges that warn us if the engine in overheating or if the alternator is not recharging your car’s battery.

It is important to understand that these reports reflect a moment of time that has already passed by the time you see the data summarized in this form. Therefore, what they reveal has already happened. To be used in managing your school you have to pay attention to the trends and project ahead in time to estimate what this information means. This offers you the opportunity to act accordingly to try to affect the future. If you see that expenses beyond your control are proving to be higher than expected, or if income is falling short, you can choose to rebalance the budget by spending less where you do have control over spending choices, or by finding some ways to generate more income.

Remember, one important aspect of good leadership and sound governance is your commitment and ability to look ahead to see what’s down the road, so you can make adjustments in time to avoid problems before you hit them head on.

So here are the five key financial reports to which you want to pay close attention.

1. Profit and Loss Statement

This report is simple and essential. It summarizes all of the income that your school brought in, along with all expenses that the school incurred, during a given period of time: usually a month, three months (a quarter), or a year. The phrase “bottom line” comes from this report, since its bottom line reveals whether the school made or lost money.

Effective leaders delegate responsibility for specific elements of your school’s overall operation to one member of your team to whom you have given clear-cut responsibility for everything that happens in his or her area. This responsibility can be as broad or limited as you choose, just be sure that every aspect of the school’s operation is someone’s direct responsibility. In some cases, this may be an area where no income is directly earned, like the school office, in which case the person who you put in charge would be responsible for overseeing office equipment, purchasing office supplies as needed, and ensuring that specific tasks are accomplished. In others, the division or department of the school may have both income and expenses, and you may decide to place the responsibility for both (sales) income and expenditures. The key is to get a number of people responsible for managing and overseeing the flow of money into and out of their part of the budget. This gives you a two-level financial planning and control system: school-wide and program-specific. This allows you to break a large overall budget down into more manageable pieces, assigning part of the planning and management responsibilities to a number of other staff members.

The second critical use of the Profit and Loss Report is to compare a budgeted projection of your estimated revenues and expenses for that period of time with the actual amounts that the school brings in and spends. For management purposes, this should be done on a month-by-month basis.

Some schools also compare current revenues and expenses with last year’s actual income and expenses for the same period. I’ve always found this to largely be a waste of time. The time to study last year’s spending is when you are developing this year’s budget. Spend your time studying what happened in the past, consider what you want to change for this new year, and then develop a projected budget for the year. Use it, compare it with actual results, and be sure to understand the reasons for variances.

Having set up an internal control system based in part on the profit and loss statement, the next step is to back off. For ninety days. Monthly blips up or down occur too frequently in most agencies to take them seriously until there is a trend. Reviewing actual versus budgeted performance with those in charge of all Lost Sleep Centers every three months gives a chance for trends and patterns to develop while still leaving enough time to correct problems.

3. Cash Flow Projections

Now we arrive at the reports not ordinarily part of a standard financial accounting package. This one should be. It is hard to overestimate the importance of cash to the entrepreneurial nonprofit manager. In for-profit entities, it’s usually outsiders with some sort of financial stake in the organization—banks, shareholders, owners, etc.—who decide whether and when to fold up and go home. Because nonprofits have no possibility of ownership, and have perhaps more leeway from bankers and suppliers, the impetus to shut them down is more likely to come from within, and the most inescapable way that that happens is when the agency simply runs out of cash. Put positively, the surest way to stick around as a nonprofit is to have enough cash at all times.

The cash flow report should be as much a part of your regular control system as the first two reports. It starts with a cash flow budget for the coming year. For the agency as a whole, the first step is to associate the cash inflow for each month for each type of revenue, then do the same for each type of expense. Computerized spreadsheets make it easier to do this, but in all honesty the chief requirement for doing it correctly is the ability to tolerate a heavy dose of tediousness. Estimating the amount of cash received for each month and the amount paid out for each kind of expense takes persistence, thoughtfulness, and a speck of imagination. Unfortunately, a cash flow projection put together without benefit of all these qualities hovers dangerously close to being useless.

Once you have a projection for the year (consider turning it into a graph for those uncomfortable with seeing endless columns of numbers), take a moment to ponder the implications. I once managed an association heavily dependent on member dues, which came in during the period from December to February. The real problem with this pattern was that it was extremely hard even for the experienced among us to keep from getting positively giddy each winter when we had stored up cash equal to eight or nine months’ expenses. It took constant training and reminders to ourselves that we’d be one hungry pack of squirrels if we didn’t leave some of those acorns for the following November.

Next, apply the exact same comparative structure that you did with your budgets: show where you expected to be each month versus where you actually are. The only differences are that for expenses it’s acceptable to use a single number showing the amount of cash spent during that period, and that you also need to account for cash outflows released for the purpose of acquiring assets.

How often you revisit your cash flow projection will depend on how volatile your cash How is. The more stable the flow, the less frequently projections need to be redone. Generally, quarterly re-projections should be sufficient except in periods of predicted volatility, when monthly or bimonthly would be advisable.

4. Aged Receivables Report

Finally, a report you may never have considered could be the key to organizational health and good fortune—or at least to a better cash flow. Any nonprofit corporation that provides a service for payment at some point in the future by definition has accounts receivable, and the entrepreneurial nonprofit manager knows that accounts receivable can be a fiscal gold mine easily tapped.

To get some idea of how rapidly you are collecting the money owed to you right now, calculate two simple ratios. First, figure out how much revenue you need to receive every day of the year on average. Do this by dividing last year’s total revenue by the 365 days in a year. This ratio gives you one day’s worth of revenue.

Next, locate the line for total accounts receivable on last year’s audited balance sheet. This figure tells you how much money was yet to be received for services rendered as of the last day of the fiscal year, presumably a representative amount. Divide this number by one day’s worth of revenue and check the result. You have just calculated your agency’s collection period, or the average number of days it takes to collect on a bill.

By itself, the collection period will tell you little, although it helps to ask yourself whether the amount of time it takes you to collect seems right for your environment. Generally, the larger the bills or the more complicated the billing mechanism, the longer the collection period. You get the most value from knowing your collection period by comparing it to similar organizations’ ratios. Associations of nonprofits are a good source for this kind of information, and occasionally business-oriented publications contain it as well.

If there is a secret in the collection business, it’s knowing how old each of your uncollected bills is. Naturally, the longer a bill is outstanding, the less chance there is of it being paid. So each month you need a report showing which receivables are outstanding for thirty days or less, which for sixty, which for ninety, and which for more than ninety. A little attention to economics will help you focus on the younger bills that have a greater chance of getting paid than the dusty old ones that have been sitting around for a few months. Of course, the older bills need attention too, just the more concentrated and expensive kind. All the more reason to keep bills from growing old before their time.

What can you do? Entrepreneurial nonprofit executives understand that creative solutions to collection problems are available, often with low price tags and high paybacks. The simplest thing to do is the cheapest and frequently the most potent: state firmly and often that rapid bill collection is important. That ought to be good for, say, a 10 percent improvement in collection period. If that translated into a 10 percent improvement in cash balances, it would mean something like a one-half to one percent improvement in interest earned or an equivalent reduction in interest paid on a cash flow loan.

Timely telephone calls bringing gentle reminders can be effective also. Again, the improvement may only be to get the bill paid two days earlier than it would have been paid otherwise, but this is a game where the little pieces add up. Where payments from third parties are routine, some mental and other health agencies assign staff to make sure that prospective patients arc fully aware of all their legitimate claims on third-party payments, and that those claims are properly processed.

More expensive but potentially high payback methods of improving receivables collection performance include hiring additional staff, investing in computer upgrading, and expanding basic capacities such as telephone systems.

1. Balance Sheet

In addition to being the anchor report of a traditional group of financial statements, the balance sheet can also be a valuable tool for management control. Essentially just a compilation of the things of value that an organization owns set off against outsiders’ claims and “equities,” the balance sheet in many ways is the organization’s monthly report card. You can use it as an implicit check on your management control structure by holding one person ultimately accountable for each line item.

To see how this works, dig out your most recent tax return (IRS form 990) and follow along.

Assets

Cash and Cash Investments In a nonprofit corporation, cash is king. No shareholders are going to storm your annual meeting because you didn’t pay out dividends; suppliers are likely to hear “nonprofit” and automatically assume you’ll have trouble paying your bills; and the IRS may even be a trifle less inclined to play hardball with back taxes. But when you run out of cash, you’ve run out of gas. Cash is so important that it deserves its own special report, detailed below. Assign this one to your highest-ranking business type and check below for what to ask.

Accounts Receivable Second to cash in importance is the amount of money outsiders owe you that you have yet to collect. Accounts receivable also merit a separate report as detailed below, and a full-time business-type person assigned to them if the volume justifies it. To get an idea of how well you are performing right now, calculate this ratio:

Total Accounts Receivable divided by Total of All Assets

If this formula works out to, say, 33 percent or less, you may have a financially sound organization. On the other hand, anything over 50 percent should tell you that your flexibility is severely limited. And if you register over 75 percent, especially if the bulk of the funds receivable are with only one or two funding sources, you don’t own the receivables, they own you.

The next thing you need to find out is how your ratio compares to others’. The percentage of assets carried in the form of receivables will vary according to the type of service you provide, the complexity and sophistication of your agency and funding source, and even the time of year. This is true of every industry, because the economics are unique to specific types of corporations. Grocery stores, for example, will have almost no receivables since their business is largely cash or easily cashed checks. At the other extreme are professional service firms, which can carry receivables for as long as five months or more before they’re paid.

Think about this ratio as an index of how nice you are. A large amount of receivables means you are so nice that you let outside parties—your clients or funding sources—hang onto a large chunk of your agency. Your ability to get access to cash at a moment’s notice is diminished, you have less money available for investment, and you arc effectively at the mercy of the payment policies of whomever owes you the money. Do you really want to be that nice?

Pledges and Grants Receivable These are exactly like accounts receivable except for the obvious difference that they come from philanthropic sources. Whoever writes the grant proposals and oversees the fund-raising campaign gets to worry about this line. In small organizations this will usually be the executive director, in larger ones the director of development. The responsibility is a bit tricky, since zero pledges and grants receivable may mean that the agency’s fund-raising effort is lax, or it could mean that it is uncommonly efficient in collecting donations before allowing them to even become pledges. The time of the year will also affect this line—an end of the fiscal year fund-raising campaign will produce lots more volume here than at most other times of the year.

This is one area to which the entrepreneurial nonprofit manager will pay careful attention in the coming years because standards for handling pledges receivable looked like they were about to change as this book was being written. The Financial Accounting Standards Board (FASB) planned to announce a proposed new policy requiring nonprofit corporations to show pledges as receivable, something most organizations are reluctant to do in order to avoid the kind of experience Princeton University had a few years ago.

A wealthy and well-known businessman told the university that he would donate it $1.5 million. As was their policy, Princeton officials kept the pledge off their balance sheet as an asset, preferring to wait until the money was actually received. This turned out to be a wise decision, for the businessman was Ivan Boesky, and before he could make good on his pledge he was indicted on insider trading charges and suddenly had much more pressing demands on his personal fortune. Pay attention to the opportunities in this accounting change.

Inventories Under ordinary circumstances, inventories are a non issue for most nonprofits. If you have any substantial amount, however, this line is the report card for the person ultimately responsible for using them.

Investments and Securities Don’t try to play where you don’t belong. Any substantial amount of investments and securities calls for professional management. When you hire an adviser you’ll get more regular detailed reports than would appear on your balance sheet, so by the time you see this number it shouldn’t be a surprise.

Land, Buildings and, Equipment In truth, this line may be difficult to use for internal control purposes because it will incorporate such diverse assets as your office building and your shiny new computer system. Still, let it serve as a reminder that tangible assets need routine maintenance and repair prescribed and arranged by some responsible party.

Other Assets Your other assets will vary from zero to a substantial amount, depending on the nature of the organization. Art museums, for example, will ordinarily carry a large percentage of their assets here. In that case, it’s the curator’s scorecard.

Liabilities

Accounts Payable and Accrued Expenses You can benefit from assigning two-level responsibility here. The operational level demands a clerical/bookkeeper-type who can do a repetitive job accurately (consider having identical recurring expenses paid automatically—lease payments, for example). Then be sure that the highest ranking financial type—or you—routinely reviews scheduled payments. In tough times you may be able to stretch some of the non personnel payments, and in good times you only need be sure to pay bills on time (earlier if you get a discount). Good bill paying is a balancing act and demands constant attention.

Mortgages and Other Notes Payable Now we get into top leadership territory. This line measures your agency’s degree of long-term indebtedness. If you would like to know how far into hock you’ve gone, take this number, add it to any other line showing debt that must be paid off for more than a twelve-month period, and divide it by your total unrestricted fund balance. This will give you an approximation of the relationship between your credit commitments and your agency’s ability to pay them off. As with most ratios, there is no absolute standard against which to judge individual performance, but any result approaching or exceeding 1.0 could mean lessened ability to handle additional debt. In turn, this implies that growth will have to be financed through yearly operations, not borrowing, and that your overall ability to maneuver through a fiscal crisis could be limited.

Fund Balances Deep in the heart of leadership country we find this euphemism for net worth. Simplistically, it’s what could be expected to be left over for the outside world to claim were all of the agency’s assets to be used at listed values to satisfy all liabilities (i.e., claims by outsiders). Ordinarily the place where for-profit corporations show owners’ and/or stockholders’ equity, a nonprofit’s fund balance is really “owned” by the public since it can have no shareholders in the legal sense of the term. If the entrepreneurial nonprofit executive has a report card, this line is it. Good program performance and a steadily growing fund balance are the twin peaks of agency achievement.

5. Utilization Report

An indispensable tool for the entrepreneurial nonprofit manager is some form of utilization reporting system. Ideally, it will be linked to the financial accounting system and will generate invoices, make tracking revenue sources easier, and help manage receivables. Designed properly, a utilization reporting system will also generate a respectable database for use in future marketing efforts.

Unlike the previous four reports, the utilization report must be tailored specifically to an individual agency and its array of services. No off-the-shelf products here, although a computerized spreadsheet could be very helpful. As with the profit and loss and cash flow projection, the idea is to compare actual results with projected outcomes, and, more important, to understand the reasons for every major deviance.

While service utilization reporting is especially important for nonprofits that depend on fees and service-based income, all should have some means of documenting levels of service utilization, if only to be able to prove the demand for their services should the occasion ever arise. The entrepreneurial nonprofit manager puts a system in place well before it’s ever needed.

Internal Financial Controls

Read enough audit reports and management letters to nonprofit organizations from public agencies or their own accounting firms and you’ll notice that the most frequently cited area of concern is weak internal controls. What this means is that inherent in the groups’ own processes are opportunities for fraud, duplication of activities, and inadequate control over fiscal resources. It does not mean that any of these things actually occurs, and in fact the fiduciary aspect of the nonprofit executive’s job may actually attract more than its share of people disinclined to perpetrate fraud in the workplace.

Considering the aspect of public trust embedded in the nonprofit manager’s job, it’s a fair question to ask why such a basic matter as adequate internal controls is nevertheless so frequently overlooked. It used to be that one could point to the lack of interest and/or sophistication in financial matters on the part of nonprofits to explain this kind of thing, but I think the real reason was and is much more mundane: lack of administrative staff.

Built into the idea of internal controls is a premise so fundamental that it’s easy to overlook. To establish a traditional system of internal financial controls requires spreading duties among several people. When a nonprofit organization gets along with a volunteer president, an executive director, a part-time bookkeeper who tries to double as a business manager, and a single clerk, there is not a lot of spreading that can happen. It’s not that the average nonprofit manager doesn’t want an adequate system of internal financial controls, it’s just that the resources don’t seem to be there.

Fortunately, there is something most organizations can do. With a little careful organizing and judicious use of staff time, even the smallest of nonprofits can mount a credible set of internal controls.