Teaching Finance to Non-Finance People

1. Teaching Finance to Non-Finance People Presented at Nonprofit Leadership Alliance Conference 2013 Tim O’Brien, Ph.D. July 9, 2013

2. Introduction and Agenda • Presenter • Agenda • A story of change • Race Metaphor • Making Sense of the Numbers • Sensemaking Elements • NFP Financial Management • NFP Accounting, a different emphasis • Q&A

3. Transition and realization-a love story • After nearly 2o years in the commercial world, I made a transition to a nonprofit organization • The Multiple Sclerosis Society, Northern California Chapter

4. Transition and realization-a love story • Soon after arriving in my new position as Director of Finance and Administration, I met with staff to get to know them. • Then it hit me • Oh –oh Nobody on the staff had any business training—at all. Finance and accounting carries a lot of terminology and jargon…………….. How do I communicate necessary financial information?

5. Translation • I needed to find a way to communicate and develop staff, to help them understand the necessities of financial management. • That challenge changed my approach, and my life.

6. Metaphor • One way to provide the context that is necessary for understanding finance is to use metaphor: A figure of speech containing an implied comparison --Webster’s New World Dictionary, 3rd College Ed. I needed a metaphor. One staff member told me that he was a runner and ran track in high school so………………………

7. The Metaphor of a Race • A race starts from a fixed position

8. The Metaphor of a Race • The runners then go into motion, the race is on!

9. The Metaphor of a Race • The race ends in another fixed position

10. So, how is this related to finance? • Financial Statements contain data that provide a starting point as of a fixed position in time (on a specified date) • One such statement is called the Statement of Financial Position

11. Statement of Financial Position (AKA Balance Sheet) • Assets: • Cash & Equivalents • Receivables • Inventory • Fixed Assets • Liabilities: • Payables • Payroll tax withholdings • Other liabilities

12. Statement of Financial Position (AKA Balance Sheet Continued) • Net Assets: • Unlike a commercial enterprise, there is no owners equity in a nonprofit. Instead we list net assets (the cumulative surplus that is generated by the nonprofit) • Net Assets are classified by donor restriction i.e. • Unrestricted (can be used for any purpose) • Temporarily Restricted (can only be used for a stated purpose) • Permanently Restricted (gift must be maintained in perpetuity, income from those funds can be used to fund operations). AKA Endowment

13. Statement of Financial Position (AKA Balance Sheet Continued) • This statement shows the reader the resources that an organization has at the beginning of a year (fixed starting point) • Resources=Assets • It also shows liabilities (resources that have been financed through debt or other amounts owed and, • Net Assets= reserves that the organization has

14. The Statement of Activities • Activities – a word that indicated action, movement • The race is on! • The organization brings in and consumes resources in pursuit if its mission • Income and Expenses

15. The Race concludes at the finish line • We are at another fixed position, the finish line. • We measure the same: • Assets, Liabilities and Net Assets • As of the end of the year.

16. One more thing…… • The heart beat of any organization, the fuel for the race= • Cash! • We pay special attention to cash flow, without it the heart stops beating and the work cannot continue!

17. Its not about the numbers, its about what they mean • In addition to our race metaphor, internal (managerial) finance helps us to understand financial reports that are designed to assist in management decision-making • We can use “Sensemaking Theory” to understand this.

18. Sensemaking: How we make sense of the numbers • Sensemaking Theory (Weick): • Sense-making places all sorts of stimuli into some kind of framework • We form unconscious and conscious anticipations and assumptions that in turn form predictions • We then experience events that may be discrepant from predictions • These events then trigger a need for explanation and correspondingly for a process of interpretation.

19. Sensemaking and Finances • How does this apply to finances? • We plan (strategic plan and annual operating budget) • We compare the plan to actual events • We examine the discrepancies and create a narrative about why there is a variance. • Sensemaking then is the locus of management control as well a primary way of exercising fiscal governance. • Let’s see how that happens.

20. Financial Accounting vs. Managerial Accounting • Financial accounting requires that financial statement are prepared in accordance with GAAP. These reports are presented in a standardized format and have an external emphasis. • Managerial Accounting uses the same data but has an internal focus. Reports are designed to aid in governance and management of the organization • We will focus on the managerial function

21. Planning • A key financial element is to take a prospective view, to plan for the future. • Creating an annual budget is essentially how we do this, we create a set of assumptions about the future & implement them, monitoring performance against expectations • Management and Board needs to make sure that there is a planning function (hopefully by policy) that is well organized, clear and concise and supports management’s planning efforts

22. Financial Data/Statements • Interim Financial Statements provide tools to evaluate the position, and activitiesof the organization • Financial Statements are prepared with a retrospective point of view (we look at history) • The statements are a reflection of stewardship and a tool for governance and management

23. Management Control • Annual budgeting is the locus of management control • We create a set of assumptions • We move into action • We compare reality to our expectations • We now have actionable data • Governance monitors all of this and engages as a fiduciary • Governance creates and oversees the operation through policy development, ongoing education, provision of resources

24. Interim Reporting • Once the annual budget is approved by the board, it is implemented and actual activities are reported against the budget (plan). • We then make sense of the variances and ask if there are any actions that need to be taken (i.e. if there is a revenue shortfall, how will that be addressed?) • Timing is important here. Your report shows month actual vs. budget and a variance, but doesn’t show YTD Budget so it is difficult to make sense about where you are YTD.

25. Statements Defined • The interim statements that are presented to leadership consist of the following……..

26. Budget vs. Actuals Statement • Detailed list of sources of income • Support • Contributions (non-reciprocal transfer of assets) • This area of income is unique to the nonprofit sector and drives accounting and reporting • Classified by donor restriction • Unrestricted • Temporarily Restricted • Permanently Restricted • Revenues (fees, sales etc.)—economic exchange of value • Gains/losses from investments (if applicable)

27. Budget vs. Actuals Statement • Expenses: • The statement details all of your operating expenses by ‘natural category” • Change in Net Assets • The “bottom line” result (income minus expenses) is titled Change in Net Assets. In a commercial organization this is called Net Income. In the nonprofit world, this refers to an increase or decrease in our reserves as the result of our activities.

28. Analysis • Financial Statements provide a lot of information, but often require analysis in the form of ratios that help the reader interpret the statements • Examples: • Current Ratio = Current Assets/Current Liabilities. This measures the organization’s ability to meet short tem obligations • Debt to Net Asset ratio = % of Total Liabilities and Net Assets that are Net Assets vs. Debt. This measures the % of how much of the organization is funded by debt and by net assets (reserves) • There are many more ratios that measure a variety of financial measures

29. Analysis • It is recommended that the board and staff develop Key Performance Indicators (KPI’s) • Examples: number of participants versus plan, fundraising event intermediate results, revenue and expense levels and variances etc. • This helps the members of the organization to make sense of the finances

30. How do we interpret the financial element? • Through financial literacy; the ability to make sense of the finances. • Recognize that the institutions that you are governing have results that go beyond the numbers, but the mission is sustained by solid finances. Finances can be thought of as mission support • Keep the mission at the center of financial decisions, how do finances advance the mission?

31. Sensemaking • Providing comparable data: • budget vs. actual • This year vs. last year • For Assets et al. where are we now compared to the beginning of the year? • This leads to questions akin to the description of sensemaking (where are we compared to expectations?) • Questions or inquiry is the key: we create reports that reveal data and ask why: • Are we off budget? • Are we different from last year? • Why is cash up or down? Etc.

32. Conclusion • Provide a metaphor as a means of understanding • Use sensemaking • Build context • Avoid jargon, use common language to avoid creating barriers to understanding • Engage staff and board in determining what is important to understand, then measure it. • Encourage inquiry • Examine assumptions • Continually improve

33. Questions ?

34. Resources • Financial Management of Nonprofit organizations: Policies and practices by Zeitlow, Hankin and Seidner. John Wiley & Sons, 2007. • Not-for-Profit Accounting made easy 2nd Ed. By Warren Ruppel. John Wiley & Sons, 2007. • Financial leadership for nonprofit executives. Bell & Schaffer. Compasspoint-Fieldstone Alliance, 2005. • Making sense of the organization. Weick, K. (2001). Malden, MA: Blackwell Publishers.

35. Presenter InformationTim O’Brien, Ph.D.timmutuality@yahoo.comwww.mutualityassociates.com(312)968-7750