While updated nonprofit accounting measures have phased in over several years, this year, full compliance is mandated. Implementing the enhancements will take time and resources, but if handled effectively, they’ll be worth the effort. Astute nonprofits can use the opportunity to better tell their financial stories.
Go Beyond the Numbers
The FASB Accounting Standards Update (ASU) 2016-14 includes a number of provisions that may seem burdensome at first glance. To comply, nonprofits must 1) increase disclosure, 2) clarify sources and uses of cash, and 3) allocate expense line items within audited financial statements.
But ASU 2016-14 also offers nonprofits the chance to shift from a system built for compliance to one that can enhance the organization’s mission overall. Historically, regulators have set the boundaries and rules. Yet this update empowers nonprofits to become more proactive and convey their financial status in their own way—a dynamic that makes sense, given that nonprofits remain the best authorities on their own costs, finances, and liquidity.
With enhanced disclosure, savvy nonprofits can pivot to using external financial statements to communicate and educate, rather than merely comply and react. And when deployed successfully, the ASU can also facilitate better use of statements for internal strategic decisions.
Read Between the Lines
We’ve identified three key enhancements that can help nonprofits put their best financial foot forward:
Liquidity: The ASU compels nonprofits to dive deeper into their liquidity status, including reclassifying net assets and “disclosing in notes to financial statements any additional relevant information about the liquidity or maturity of assets and liabilities, including restrictions on the use of particular assets.”1
The good news? Additional disclosures could allow nonprofits to alert donors and creditors to liquidity sources that may not seem readily apparent. For example, nonprofits can outline the nature and amount of donor restrictions on current assets, better explaining how funds are tied up over the next 12 months and showing other potential sources of short-term cash. Sharing new fundraising strategies or offering insight into the expected availability of restricted funds could help nonprofits better demonstrate their financial health and long-term viability—shoring up confidence along the way.
In addition, nonprofits that have underwater donor-restricted funds2 can state how much they are underwater and clarify the trends that led to that situation. This could also be a chance for nonprofits to frame in donors’, lenders’, or creditors’ minds their plans to restore those gifts to solvency.
Expenses (Core Mission Support vs. Total Cost): The rules also require greater disclosure of expenses. As nonprofits seek unrestricted funding to help cover operational costs,3 they can now detail how expenses commonly placed under the umbrella of “operating” are actually directed to project work, or “core mission support.”
Coming into the pandemic, only 7% of nonprofits reported that foundations always cover the full costs of projects,4 suggesting that restrictions may curb nonprofits’ abilities to fulfill their missions. A stronger link between operating or “natural” expenses and project work could help donors to understand the importance of an adequate operating reserve.
Spending Expenses: Today’s landscape makes the ASU even more valuable for several reasons. On one hand, it enables nonprofits to clarify the need for rising expenses. On the other hand, it can also help donors judge how effectively organizations leverage their current spend.
And, while many donors focus on overhead ratios,5 the new updates could put that metric front and center. Nonprofits can now thoroughly account for the denominator—total costs, including direct program costs, overhead, and reserves—and communicate that openly and honestly. This may help donors to better gauge overall costs and appreciate the link between costs and impact (Display).
Self-Auditing Your Financial Status
As nonprofit management teams navigate the updated rules, it is crucial for them to consider their future plans for reining in expenses, boosting liquidity, and stabilizing investments. This starts with a strong 360-degree assessment of liquidity and short-term needs.
Since nonprofits will now convey trends in their financial performance, establishing a baseline and assembling plans for improvement remains vital. And with greater opportunity to discuss financial efficiency, organizations need to develop, execute, and maintain a coherent financial strategy. The steps below can serve as useful prompts:
- First, look closely at liquidity and how it is defined. What does this pool of assets consist of and how much is currently available to deal with obligations coming over the next 12 months?
- Use Bernstein’s Wealth Forecasting Analysis to conduct an in-depth analysis of asset allocation in invested funds and assess whether holdings are aligned with short- and long-term funding needs.
- Revise investment policy statements with new bucketing for reserves that can more easily satisfy disclosure requirements for short-term liquidity.
- Work with investment partners to determine how to improve liquidity over time through sizing reserves, transitioning some restricted funds to unrestricted (if possible)—such as shifting funds from board-designated assets to management reserves—and figuring out the best methods to monitor and measure liquidity.
A key part of this is determining the audience for each organization’s financial reports and then presenting financials that paint a clear picture—one that is controlled by the nonprofit itself. We look forward to ongoing conversations with our clients as they adjust to the current terrain.
1 FASB Accounting Standards Update, No. 2016-14, August 2016, Not-for-Profit Entities (Topic 958).
2 Per the Council on Foundations, underwater is “a phrase used to indicate that the fair market value of the investments in a particular endowment fund is less than the value of the gift that originally created that fund.”
3 Per the CAF America Survey, Volume 2 (2020), two-thirds of the respondents indicated an “acute need for unrestricted funding.”
4Nonprofit Finance Fund’s Annual State of the Nonprofit Sector Survey, 2015.
5 See: https://nonprofitquarterly.org/why-funding-overhead-is-not-the-real-issue-the-case-to-cover-full-costs/.
The views expressed herein do not constitute, and should not be considered to be, legal or tax advice. The tax rules are complicated, and their impact on a particular individual may differ depending on the individual’s specific circumstances. Please consult with your legal or tax advisor regarding your specific situation.