Understanding Financial Statements
Understanding and interpreting financial statements can seem intimidating for non-financial people. Knowing a few concepts, however, can lead to a much better understanding of how an organization is doing. The three major financial statements - Balance Sheet, Income Statement and Cash Flow Statement - together provide insights into the financial health of an organization. Nonprofit organizations use the same statements, albeit with different names. Nonprofits use a Statement of Financial Position instead of a Balance Sheet, and they refer to a Statement of Activities rather than an Income statement. The purposes are the same, however.
Balance Sheet (Statement of Financial Position) - This statement provides a snapshot of the organization’s financial position as of a particular date, typically the fiscal year end or the most recent month end. It is broken into three components: Assets (what the organization owns); Liabilities (what it owes) a company’s financial position at a specific point in time. As its name implies, a Balance Sheet has to “balance” according to the formula: Assets = Liabilities + Equity (also known as Net Assets in the nonprofit world). Equity is effectively the net worth of the organization - what is left after all liabilities have been paid.
A couple of trends are helpful to look at - are Assets increasing from year to year (good), or are Liabilities increasing (cause for concern). Equity should increase from year to year in successful organizations.
Income Statement (Statement of Activities) - Also known as a Profit and Loss (P&L) statement, this report reflects revenues, expenses and profit (or loss) over a period of time, typically a fiscal year, month, or group of months within a particular year. The formula here is Revenue - Expenses = Net Income (or Loss).
It’s helpful to look at two Income Statements for different periods, such as the last fiscal year versus the previous one, or the most recent month versus that same month in the prior year. Is the organization showing a profit? When looking at two periods side by side, are the trends positive or negative? In other words, is Net Income increasing between the two periods? Are revenues increasing?
Cash Flow Statement - This statement tracks the flows of cash in and out of the organization. Positive cash flow is essential. If there are periods when cash flow is negative, the organization might need to rely on loans, or find ways to cut expenses during those periods.
For more detailed analyses, leaders can rely on their financial team, or their accountant. This isn’t necessary to get a high-level overview of the organization’s health, however. Evaluating trends in revenues, expenses, and net worth can give the layperson a good overview of the organization’s overall financial health.
