Special to the Philanthropy Journal
By Sandi Matthews
When the YWCA of the Triangle closed in 2012, nobody saw it coming. Staff was terminated with just one day’s notice. A representative from United Way and several other funders said they were not aware the 110-year old organization was insolvent. Board members inexplicably found out about the possibility of closure just weeks before they shut down. As this report in the Philanthropy Journal revealed, the telltale signals of financial distress were there all along, but missed: declining revenues, increasing expenses and a heavy reliance on grants.
The YWCA of the Triangle is not the only nonprofit organization to close suddenly and leave its constituents in the dark. Consider the eerily similar circumstances at FEGS, formerly the largest social services agency in New York when it shut down suddenly after 80 years in operation. A subsequent report, New York Nonprofits in the Aftermath of FEGS: A Call to Action, identified a pattern of organizations suddenly disappearing, and found that many others are living precariously on the edge of collapse[1].
This problem caught the attention of the FASB[2], the national standard-setting board of the accounting profession. On August 18th, the FASB issued an update that will usher in the biggest change to nonprofit financial statements in over two decades. Enhancing information about liquidity is among the FASB’s key objectives of instating new rules, which are intended to provide a clearer picture of the financial health of nonprofit organizations.
All nonprofits that issue GAAP-basis financial statements will be required to implement the FASB’s new guidance when the rules go into effect. Here are some of the changes I expect to improve financial statements:
- It will be easier to distinguish resources that are available for general use versus those that are tied up (no number crunching needed!). A nonprofit’s resources may be tied up in various ways, for example, if they are invested in property and equipment, are set aside to satisfy a donor or funder’s restriction, are held in endowments or are subject to laws or contractual limitations. Going forward, nonprofits will provide enhanced information regarding limitations on the use of resources. In addition, the new standard eliminates the trichotomy under which all of the entity’s net assets were reported as “unrestricted” “temporarily restricted” or “permanently restricted.” Instead, organizations will now report two classes of net assets: “net assets without donor restrictions” and “net assets with donor restrictions,” as well as the currently required total net assets. This reduction in net asset classifications, coupled with the enhanced information regarding limitations on the use of resources, should make the financial statements easier to interpret.
- You will have a clearer understanding of liquidity and availability of resources through reading the financial statements. A new requirement is that each nonprofit will need to quantify assets that are available to meet the organization’s cash needs for general expenditures for the next year following fiscal year-end. Additionally, each nonprofit will provide a written disclosure that describes the details regarding how it manages liquidity. Some organizations manage unanticipated liquidity risks by arranging to borrow money through a line of credit or by socking away excess cash into an operating reserve or “rainy day fund” they can draw upon later in case of budget shortfall, delays in cost reimbursements from a funder or if a significant grant falls through. Others may have a board-designated endowment set aside to generate interest income, but available for them to spend down in an emergency. The new note disclosures will help us better understand whether a nonprofit is equipped to pay its debts and stay afloat if there are unforeseen events.
- You will see details on what the organization spends its money on, as well as how it allocates expenses. Going forward, all nonprofits will be required to provide a detailed analysis of expenses and show the methods used to allocate expenses to the functional categories of program services and supporting activities (more often referred to as overhead, which includes fundraising activities). Across the nonprofit sector, there are different approaches to expense allocation, which often requires the use of estimates. Many organizations have more than one cost driver. For human service organizations, payroll-related costs are typically an organization’s most significant expense, and approaches to allocation often involve estimating staff time and effort as a basis for expense allocation. Organizations with significant facilities-related costs may allocate expenses according to square footage devoted to programs and supporting activities. Allocation approaches differ from one nonprofit to the next. The enhanced information will shed light on each nonprofit’s cost structure and management’s rationale underlying how spending contributes to providing services in support of the organization’s mission.
The FASB’s new guidance for nonprofits is effective for fiscal years beginning after Dec. 15, 2017. This means that organizations with a calendar year-end will need to implement the new requirements for their fiscal year ending Dec. 31, 2018, and thereafter. For organizations with a June 30 year-end, the requirement will be effective for the year ending June 30, 2019, and thereafter.
What’s next?
Instead of waiting until these changes become mandatory, I encourage nonprofit leaders to start working on an implementation plan with their accountants, making sure that their systems are in place to track the information needed for financial statement preparation. Working together with your executive team and board, review your organization’s policies and practices regarding cash flow management, liquidity and functional expense allocation. Make sure this information is available and can be clearly articulated when the time comes.
In my experience, some nonprofits are hesitant to talk about cash flow problems, fearing that leaving even a trace of uncertainty could deter potential donors. On the contrary, being transparent about liquidity may help an organization rally its supporters around a fundraising goal and may even bolster its appeal for support. Case in point: when the YWCA of the Triangle announced its sudden closure, United Way offered to advance some funds, but at that point, it was too late. Citizens and former employees held vigils, wrote letters and held community meetings to attempt to launch a campaign to compel the organization to reopen. They are still soldiering on; four years later, a recent news article reported that one former employee turned community organizer still hasn’t given up. The organization’s closure left a gap in services for women, youth and elderly citizens in Raleigh that is still felt to this day – a cause worth fighting for.
I can’t help but wonder: If the YWCA of the Triangle had been transparent about its liquidity problems, would concerned citizens have pitched in to save it from collapse? If its financial statements had been prepared under the new accounting rules, would that have revealed some red flags in time to change course?
[1] http://www.humanservicescouncil.org/Commission/HSCCommissionReport.pdf
[2] The Financial Accounting Standards Board (FASB) is the independent nonprofit organization that establishes financial accounting and reporting standards for public and private companies and nonprofit organizations that follow Generally Accepted Accounting Principles (GAAP).
Sandi Matthews, CPA is a Technical Manager at the Not-for-Profit Section of the American Institute of Certified Public Accountants (AICPA). Prior to joining the Institute, she was Controller at North Carolina Community Foundation. She is an alumna of North Carolina State University’s College of Management’s Master of Accounting program and holds a Certificate in Nonprofit Management from Duke University. Follow Sandi on Twitter @SandiRaleigh.
Views expressed are those of the author and do not necessarily reflect an official position by the AICPA.
