GAAP compliance in financial statements is an essential underpinning for nonprofits and for-profit businesses alike. It is essential to be in GAAP compliance for audits, funding applications, etc. However, the standard GAAP financial statements may not be enough to ensure your statements will match your cash position at the end of the month. Additional perspectives are required to quickly assess the organization’s financial performance.
GAAP - Generally Accepted Accounting Principles
In the US, the Financial Accounting Standards Board (FASB) sets the standards and oversees improvements to GAAP. GAAP requires you to use accrual basis accounting. If you are going to be audited, your financial records must be GAAP compliant. In 2018, FASB began requiring a new footnote about liquidity in financial statements to provide reassurance that an organization’s statements are inclusive of all aspects of their financial condition.
The Audit
Depending on the size and location of your nonprofit, an audit may be required. An independent audit is not the same as an IRS audit. The IRS does not require nonprofits to obtain audits, but federal and state government agencies do, depending on your nonprofit's size or spending.
Conflict
It’s not about auditable statements when it comes to the day to day management of an organization – it’s about the cash. This need can be a source of conflict between accrual based financial statements and trying to answer the question, “How are we going to pay our bills next month?”
For management purposes you may need another layer - a different dashboard, a cash basis P&L (accrual accounting doesn’t necessarily tell you where your cash goes) or modifications to your existing statements that include debt payments, capital expenditures, pledges receivable, grants receivable, etc. to understand how the cash flows through the organization.
Several common scenarios can cause cash to be “hidden” in a nonprofit’s accrual-based statements.
- Multi-year pledges
- Grant funds awarded but not yet received
- Donations recorded in a prior year
- Stock donations
When combined with a one-time capital expenditure or debt retirement, “Where’s the money?” can become a common question.
Where is the money?
This is a scenario common to many nonprofit clients:
A foundation announces that it will be issuing a $250,000 grant to a nonprofit organization with annual $50,000 contributions over five consecutive years, without any specified conditions. The written issuance of the grant dictates when the revenue will be recognized regardless of when the first check (and subsequent checks) are received. So, if the notification of the grant award was received in 2020, the full $250,000 in revenue would be recognized in that year and booked as a receivable in the same year.
However, the organization did not receive all of the funds in the first year. This can create an "over-representation" of the organization's cash position. To ensure funds are adequate for operational purposes, the organization needs another dashboard for that view into their financial position.
Conclusion:
GAAP compliant financial statements are essential to the ongoing success of your organization. However, they may not be the perfect tool for day-to-day management. Be sure to include the tools you need in your regular financial reporting to understand how the cash flows in support of your mission.
About the Author
Nancy Smith is a high capacity financial manager with success in a wide variety of settings in both the nonprofit and for-profit sectors. She is passionate about engineering process improvement and navigating transitions, resulting in sustainable efficiencies and cost savings. In addition to core accounting competencies, she is experienced at managing other support functions such as IT, Human Resources, and Operations.
Nancy has directed the accounting and finance functions of multiple organizations as a full-time employee and as a consultant. As Chief Financial Officer of World Relief, a $45M international relief and development organization, she led the integration of two finance departments and provided increased visibility and accountability of program operations through improving financial models and analysis. Most recently, she was Director of Accounting at the Evangelical Free Church of America where she acted as controller for a combined $40M budget of the denomination, its US and international programs, and its charitable foundation. Nancy began her career as the Accounting Manager for C&C Paints, and has also worked in public accounting at Ernst and Young, where she directed and participated in consulting projects for telecommunications companies and trade associations.
Nancy is a licensed as a CPA in Washington state. She holds an MBA in Finance/MIS from the University of Washington and a BA in Business from Seattle Pacific University.
