Critical Financial Issues: Strengthening Your Not for Profit Sikich LLP Certified Public Accountants Business Advisors

2. Critical Financial Issues:Strengthening Your Not for Profit Overview of the Not for Profit (NFP) Sector In 1998 there were only 1,158,031 tax-exempt organizations registered with the IRS, including: 596,160 public charities 70,480 private foundations 491,391 other types of nonprofit organizations, including chambers of commerce, fraternal organizations and civic leagues In 2008, there were 1,536,134 tax-exempt organizations registered with the IRS, including: 974,337 public charities 115,340 private foundations 446,457 other types of nonprofit organizations, including chambers of commerce, fraternal organizations and civic leagues 63.4% growth in public charities between 1998 and 2008

3. Overview of the Not for Profit (NFP) Sector (cont’d) In 2007, public charities reported over $1.4 trillion in total revenues and nearly $1.3 trillion in total expenses.  Of the revenue: 22% came from contributions, gifts and grants. 67% came from program service revenues, which include government fees and contracts. 11% came from "other" sources including dues, rental income, special event income, and gains or losses from goods sold. Critical Financial Issues:Strengthening Your Not for Profit

4. Overview of the Not for Profit (NFP) Sector (cont’d) Charitable contributions by individuals, foundations and corporations reached $284.99 billion in 2008, a decrease of 5.6% from 2007 after adjusting for inflation. Of these charitable contributions: Religious organizations received the largest share, with 34.7% of total estimated contributions. Educational institutions received the second largest share, with 13.3% of total estimated contributions. Gifts to foundations were the third largest or 10.6% Human service organizations accounted for 8.4% of total estimated contributions in 2008, the fourth largest share. Critical Financial Issues:Strengthening Your Not for Profit

5. Overview of the Not for Profit (NFP) Sector (cont’d) Volunteering at NFPs In 2009, 26.8% of adults volunteered to assist a NFP. This percentage has been between 26.2% and 26.8% since 2006, however, the percentage averaged 28.8% from 2003 to 2005. In 2008 the Bureau of Labor Statistics estimated that volunteers worked more than 14,000,000 hours Is your NFP tracking volunteer hours? Critical Financial Issues:Strengthening Your Not for Profit

6. Overview of the Not for Profit (NFP) Sector (cont’d) NFPs need a strategy to recruit volunteers Contact your local community college, private college and even high school since many schools require a minimal amount of community service hours to graduate For colleges that have the Federal Work Study program, 7% of federal work studies must be for community service jobs Critical Financial Issues:Strengthening Your Not for Profit

7. What to expect in the next ten years? Fewer new NFPs due to limited resources Additional mergers between existing NFPs to better control costs and gain economies of scale Additional government oversight Redesigned Federal Form 990 American Recovery and Reinvestment Act Increased responsibility of NFPs subject to OMB A-133 (Single Audit) Critical Financial Issues:Strengthening Your Not for Profit

8. Objectives of Not for Profit Financial Reporting Meet the needs of those parties that provide the resources to the NFP Donors (Individuals, Foundations, Corporations) Members (Fraternal organizations, Country Clubs) Government agencies (Federal, State, Local) Contrast with For Profits who primarily report earnings performance Creating, Understanding and Analyzing Financial Statements

9. NFP Financial Statements must provide the following information Amount of assets, liabilities, and net assets Inflows and outflows of resources Organization’s liquidity Service efforts of the organization Creating, Understanding and Analyzing Financial Statements

10. Preparing Statement of Financial Position Classifying assets and liabilities as current and noncurrent. Reader of financials will better understand liquidity (nearness of converting to cash) Promises to give Debt Current is defined as being satisfied within one year Net asset categories: Unrestricted, Temporarily Restricted, and Permanently Restricted Single Column Comparative Statements Allows reader to compare current year and prior year Creating, Understanding and Analyzing Financial Statements

11. Preparing Statement of Activities The statement of activities provides information about changes in an organization’s net assets. Statement shows changes by each net asset category (Unrestricted, Temporarily Restricted, and Permanently Restricted) Only outside grantor or donor can restrict a gift, boards can only designate funds Creating, Understanding and Analyzing Financial Statements

12. Preparing Statement of Functional Expenses Statement only required for voluntary health & welfare organizations Expenses are shown by natural expense classification and must be in either Program, Management, or Fundraising Other organizations must report in total expenses in the three categories (Program, Management, and Fundraising) Creating, Understanding and Analyzing Financial Statements

13. Preparing Statement of Cash Flows The statement of cash flows is required to report: The change in net assets Net cash provided (used) by operating activities Net cash provided (used) by investing activities Net cash provided (used) by financing activities Net increase (decrease) in cash and cash equivalents Creating, Understanding and Analyzing Financial Statements

14. Reporting to the board Monthly reporting should include Statement of financial position (balance sheet) Statement of activities with budget and actual for the month and year-to-date budget vs. actual Results can often lead to budget revisions Narrative report or executive summary Grants or major donations acquired or lost Unexpected events which will affect future operations Program reports (clients served vs. budgeted) Fundraising event results Creating, Understanding and Analyzing Financial Statements

15. Improving Cash Flow During Difficult Times Request acceleration of multi-year grants (3 year to a 2 year) Invoice promptly (twice a month if possible) Consider using ACH transactions to receive cash quicker Request board members help with solicitation of donors Ask donor to change program restrictions (allow expenditures for current operations) Nonprofit Budgeting and Financial Management

16. Improving Cash Flow During Difficult Times Inquire of Foundations whether emergency grant funds are available Increase the charges for program fees Obtain a line of credit or expand current line Borrow against future revenue streams UPMIFA (Uniform Prudent Management of Institutional Funds) permits releasing restrictions on older (more than 20 years old) and smaller ($50,000 or less) endowments with only written notice to the Illinois Attorney General Nonprofit Budgeting and Financial Management

17. Negotiate the Best Possible Lease Terms Request that lessor be responsible for any new government compliance changes relating to the building or property that occur after the lease signing date (ADA and EPA) NFP should negotiate an expansion option in the original lease agreement that will help protect the NFP in the case of future expansion by giving the lessee the right to obtain additional space Tenants generally pay for building leases based on a specified rate per square foot, which can be calculated based on either useable or rentable square footage. Negotiate rent based on useable space. Nonprofit Budgeting and Financial Management

18. Capturing Your Indirect Costs Developing an Indirect Cost Rate First step is to take entire list of expenses and separate into two groups – Direct Costs and Indirect Costs (costs shared by multiple programs) Program Director salary would be a direct cost while the Executive Director’s salary would be an indirect cost Accumulate all indirect costs into an indirect cost pool Prepare cost policy statement that outlines the costs considered as direct as well as the rationale in determining these as direct or indirect Indirect costs rates Grants sometimes establish maximum rates Rates are usually for a short length of time (1 -3 years) Nonprofit Budgeting and Financial Management

19. Capturing Your Indirect Costs (continued) Choose distribution base Usually either total direct costs or direct salaries and wages Simplified Allocation Method Example: Program A = $50,000 of direct costs Program B = $100,000 of direct costs Indirect cost pool = $40,000 Indirect cost rate would be - $40,000 / $150,000 = .267 or 26.7% Program A would receive $50,000 x 26.7% or $13,350 of indirect costs Program B would receive $100,000 x 26.7% or $26,700 of indirect costs Complex organizations would want to use multiple bases to allocate indirect costs (square footage is the best base to allocate occupancy charges) Nonprofit Budgeting and Financial Management

20. Utilization of Ratios to Analyze Financial Results Current ratio = current assets / current liabilities normally a ratio over 1.0 is good, however, collection of receivable problems could be present Debt ratio = total debt / total assets ratio should be less than 1.0 Debt service ratio = net income + depreciation / principal + interest payments + lease payments For NFP entities, banks expect at least a ratio of 1.0 Nonprofit Budgeting and Financial Management

21. Utilization of Ratios to Analyze Financial Results Quick Ratio Cash + Unrestricted Investments + Receivables divided by Current Accounts Payable + Current Accruals Unrestricted Net Assets Ratio Expendable Unrestricted Net Assets divided by Annual Expenses Functional expense ratios Program expenses divided by total expenses Fundraising expenses divided by total expenses Final thought on ratios Ratios tell an organization how efficient they are and NOT how effective the services they provide. Successful outcomes are what measure the effectiveness of an organization. Nonprofit Budgeting and Financial Management

22. Improve Relationship with Lenders and Grantors Stay on budget Banks want to see how you react to revenue shortfalls by your control of discretionary spending Communicate the bad news If grantor notifies your NFP of a reduction to your contract you need to discuss the situation with your bank Submit all necessary reports on a timely basis Grants require timely submission of performance and financial reports Banks may have reporting requirements relating to covenants on debt Discuss loans and lines of credit BEFORE you need it Nonprofit Budgeting and Financial Management

23. Importance of Budgeting Tool for guiding and monitoring operations Budget vs. actual performance is an essential management exercise Guide the acquisition and use of resources Capital budgeting should be used to determine proper time to acquire major assets and how they will be financed Required for grant management Planning for the future Nonprofit Budgeting and Financial Management

24. Major Types of Budgets Organization-wide budgets Program budgets Capital budgets Cash flow budgets Who should participate in developing budgets? Board of directors Executive Director Controller / CFO Program Managers Others Nonprofit Budgeting and Financial Management

25. Preparing for the budget process Developing budget calendars Establish policies and procedures for budget development Budget strategies “Top Down” setting of annual income and expense targets “Bottom Up” setting of program goals by program managers Zero-based budgeting takes a fresh look every year and does not consider prior year’s budget or results Steps to create program budgets Identify the anticipated sources and amounts of income Set specific goals for the program Prepare a work plan to show how goals will be reached Identify all the resources needed to accomplish the goals Nonprofit Budgeting and Financial Management

26. Cash flow budgets Must be prepared for each month since revenue and expenses are not always received or expended evenly throughout the year Example of cash flow budget Beginning cash balance Add: Cash receipt sources (itemize revenue sources) Less: Cash paid out (by expense line) Ending cash balance Cash flow budgets can indicate which months might require short-term borrowings or selling of investments Nonprofit Budgeting and Financial Management

27. Guiding Principles of Redesigned Federal Form 990 Enhanced transparency Promote compliance Minimize burden on filing organizations “…transparency, accountability, and disclosures are virtues in the tax exempt area…” – IRS Commissioner Shulman Corporate Governance and the Redesigned Form 990

28. Governance Best Practices Board and management should review internal documents such as bylaws and mission statement and external documents such as tax exempt determination letter and articles of incorporation at least once every three years to assure: NFP’s tax exempt purpose is still applicable Composition of board or committees is in compliance with bylaws NFP must assure that accurate board minutes are kept and signed by responsible official Corporate Governance and the Redesigned Form 990

29. Governance Best Practices (cont’d) Executive Compensation Charities may not pay more than reasonable compensation for services rendered Form 990 asks if the process used to determine compensation included review and approval by independent persons by using comparability data Rebuttable presumption – compensation is deemed reasonable if arrangement is approved in advance by an independent authorized body and this authorized body used comparable data by looking at similar organizations and the basis for making its determination is documented Corporate Governance and the Redesigned Form 990

30. Governance Best Practices (cont’d) Review of Form 990 by board or committee Part VI, Section B. Question 11A asks “Describe in Schedule O the process, if any, used by the organization to review this Form 990” Review may involve entire board or a committee acting on behalf of the board May make copy available to all board members for any input Corporate Governance and the Redesigned Form 990

31. Establishing Best Practice Policies Written Code of Ethics Risk Management Policy Whistle-Blower Policy Conflict of Interest Policy Record Retention and Destruction Policy Investment Policy Board Structure and Policies Audit committees Expense reimbursement Policy Gift acceptance Policy Fundraising Policy Corporate Governance and the Redesigned Form 990

32. Establishing Best Practice Policies (cont’d) Written Code of Ethics Adherence to the law is the minimum standard for a NFPs behavior Each NFP should outline a code of professional ethics that each employee, board member, or volunteer must adhere to Code should be built on value the NFP embraces Board AND staff should engage in developing the code Code of Ethics should be part of new employee orientation as well as new board member orientation Corporate Governance and the Redesigned Form 990

33. Establishing Best Practice Policies (cont’d) Risk Management Policy Review potential risks of loss of property, programs, and activities Include a strategy to mitigate some of the potential risks Determine adequacy of insurance coverage Board members may be exposed to personal liability for legal violations Corporate Governance and the Redesigned Form 990

34. Establishing Best Practice Policies (cont’d) Whistle blower policy Method for any employee to report a suspicious activity in a confidential manner without any fear of retaliation Compliance officer, who may be a board member, should serve as the one who investigates and resolves the complaints Corporate Governance and the Redesigned Form 990

35. Establishing Best Practice Policies (cont’d) Conflict of Interest Policy Annual disclosure for all employees and board members noting any conflicts of interest Any conflicts must be reported to the board of directors for resolution Any member of management or the board of directors must refrain from participation in any decision on matters that involves a direct conflict of interest Corporate Governance and the Redesigned Form 990

36. Establishing Best Practice Policies (cont’d) Record Retention Policy NFP’s must retain records as required by law and destroy them when appropriate. Other records not required by law, should be retained permanently, such as audited financial statements, personnel records, minutes, legal correspondence, and tax records Items such as invoices, purchase orders, time sheets and expense reports should be kept at least 7 years Items such as bank statements, insurance policies, and employment applications should be kept at least 3 years Corporate Governance and the Redesigned Form 990

37. Establishing Best Practice Policies (cont’d) Investment Policy Objective of investments – Is the goal to maintain value of portfolio? Investment manager – Who will act as manager of portfolio? Timeframe – Will investments be needed for a future time? Asset mix – What does the policy say about a mix of equities, bonds, mutual funds, and cash? Investment restrictions – Is the use of derivatives prohibited by the policy? What are the rules on diversification? Benchmarking – What benchmark will the performance of the portfolio be matched against? Reporting – Who internally will report on the performance of the investments and how often will the reporting be done? Corporate Governance and the Redesigned Form 990

38. Establishing Best Practice Policies (cont’d) Board Structure and Policies Board should include members with diverse background Should be large enough for full deliberation (recommend at least five members) At least one member should have “financial literacy” At least 2/3 of members should be independent Should have clear policy on length of term and number of consecutive terms members can serve At least once every three years the board should do a self-assessment and policy should state the method used to remove ineffective board members Corporate Governance and the Redesigned Form 990

39. Establishing Best Practice Policies (cont’d) Audit committee Members of audit committee should possess financial literacy Members of audit committee should be independent of management and do not have to also be board members The Board should develop an Audit Committee Charter that details the responsibility of the audit committee and this charter should be reviewed annually Corporate Governance and the Redesigned Form 990

40. Establishing Best Practice Policies (cont’d) Audit committee (cont’d) In the areas of financial reporting and internal control, the Committee shall: Oversee the external audit process, including nomination of the external audit firm, auditor engagement letters and fees, timing and coordination of audit fieldwork visits, monitoring of audit results, review of auditor’s performance, and review of nonaudit services provided by the external audit firm for compliance with professional independence standards; Review NFP’s accounting policies; Review the NFP’s financial statements and other reports requiring approval by the board before submission to government agencies Corporate Governance and the Redesigned Form 990

41. Corporate Governance and the Redesigned Form 990 Establishing Best Practice Policies (cont’d) Audit committee (cont’d) In the areas of financial reporting and internal control, the Committee shall (cont’d): Review annual income tax and information returns filed with the Internal Revenue Service and State government agencies (new question on Federal Form 990; Receive and review any other communications from the external auditors that the external auditors are required to submit to the Board or Committee under currently applicable professional auditing standards; Review and discus with management the findings and recommendations communicated by the external auditor;

42. Establishing Best Practice Policies (cont’d) Audit committee (cont’d) In the areas of financial reporting and internal control, the Committee shall (cont’d): Inquire about the existence and nature of significant audit adjustments proposed by the external auditors and significant estimates made by management; Meet privately with the external auditors to discuss the quality of management, financial, accounting, information technology and internal audit personnel, and to determine whether any restrictions have been placed by management on the scope of their external audit or if there are any other matters that should be discussed with the Committee; Review the letter of management representations provided to the external auditors as part of the annual audit and inquire as to whether any difficulties were encountered in obtaining the representation letter; Corporate Governance and the Redesigned Form 990

43. Corporate Governance and the Redesigned Form 990 Establishing Best Practice Policies (cont’d) Audit committee (cont’d) In the areas of financial reporting and internal control, the Committee shall (cont’d): Prepare a report, signed by the chair of the Committee, for presentation to the full Board of Directors, describing the activities and responsibilities of the Committee; Direct special investigations into significant matters brought to its attention within the scope of its duties; Review this Charter on an annual basis and propose any recommended changes to the Board.

44. Establishing Best Practice Policies (cont’d) Audit committee (cont’d) In the area of organizational governance, the Committee shall: Review NFP policies regarding compliance with laws and regulations, ethics, employee conduct, conflicts of interest, and the investigation of misconduct or fraud; Review current and pending litigation or regulatory proceedings impacting organizational governance in which the NFP is a party; Establish and monitor NFP procedures for receiving and handling complaints about accounting and auditing matters; Review significant cases of employee or director conflict of interest, misconduct or fraud; Corporate Governance and the Redesigned Form 990

45. Establishing Best Practice Policies (cont’d) Audit committee (cont’d) In the area of organizational governance, the Committee shall (cont’d): Review plans and budgets associated with the internal audit function to determine that audit objectives, plans, financial budgets, and schedules provide for adequate support of the Audit Committee’s goals and objectives; Require the director of internal auditing to prepare a written report on an annual basis describing the scope and results of internal audit procedures; Discuss with the director of internal audit and the external audit firm the reliability of the NFP’s information technology system and any specific security measure in protecting the NFP against fraud and abuse; Meet regularly with the NFP’s general counsel to discuss legal matters that may have a significant impact on the NFP. Corporate Governance and the Redesigned Form 990

46. Establishing Best Practice Policies (cont’d) Expense Reimbursement Policy Requests for reimbursement of business expenses and requests for payment of credit card bills, must be submitted on a prescribed form or spreadsheet and submitted with documentation to appropriate supervisor While original receipts are recommended for all expenses submitted for reimbursement, they are required for all expenses greater than $25.00. Requests for exceptions to this policy should document extenuating circumstances and be approved by an authorized individual Corporate Governance and the Redesigned Form 990

47. Corporate Governance and the Redesigned Form 990 Establishing Best Practice Policies (cont’d) Expense Reimbursement Policy (cont’d) Substantiation of all expenses to be reimbursed must include: amount of the expenditure time and place of the expenditure business purpose of the expenditure names and the business relationships of individuals other than yourself for whom the expenditures were made Examples of allowable and unallowable expenses should be provided Unallowable would include First Class Travel Policy should have some flexibility (Ex. sometimes the least expensive airfare includes long unreasonable layovers)

48. Establishing Best Practice Policies (cont’d) Gift Acceptance Policy Defines the types of assets that are acceptable Establishes the form of receiving gifts that are acceptable (Ex. Planned Giving) Defines the NFP’s role in gift administration Clearly defines the mission of the NFP and must be approved by the board of directors Explains the types of restrictions that may be placed on gifts NFPs should reserve the right to use legal counsel when appropriate to review potential gifts which are complex and contain various restrictions Corporate Governance and the Redesigned Form 990

49. Establishing Best Practice Policies (cont’d) Fundraising Policy Solicitation materials sent to the potential donors must be accurate and truthful Contributions must be used based on donor’s intent NFP must provide donor with appropriate IRS substantiation for all gifts to NFP NFP should not compensate fundraisers based on a percentage of amount raised Policy should address privacy of donors and not make their names available to the public Corporate Governance and the Redesigned Form 990

50. Alliance for Nonprofit Management Case Management and Governance Checklist for Institutionally Related Foundations Fieldstone Alliance National Center for Charitable Statistics Panel on the Nonprofit Sector Presentation Resources