Understanding Not-For-Profit Financial Governance

This information is helpful for non-financial management and board of directors of Not-for-profit organizations (NFPO) so they can understand the financial part of being a board member or an executive director of a NFPO. A lot of board members have different experiences and have worked in different industries but not all board of directors are comfortable with the financial aspect of their fiduciary duties as board members for a NFPO. They are however required to have the basic knowledge of the finances and financial governance for the organization.

What is financial governance?

Financial governance refers to the processes and structures used to direct and manage an organization’s financial transactions and activities. These are the resources, people or material resources, that you put together as management of a NFPO or as a board of director to ensure that the assets of the NFPO is used effectively and efficiently, that the assets are protected and used for the purpose for which they were intended.

Why you need good financial governance?

• There’s currently increased competition for funding amongst NFPOs. All NFPOs are competing for the donations of donors or government grants. No matter how good an organization is or the good cause it is pursuing  there are several NFPOs competing for the limited donation or funds available. 
• There is also heightened expectations from members and other stakeholders. The government is always increasing their requirements when it comes to financial reporting, donors are also increasing their expectations. It is very important that a NFPO have good financial governance to establish trust and accountability.
• The ability to attract quality board members also depends on the financial governance of a NFPO. No board member wants to be a part of an organization that doesn’t have a good structure in place. So, if a NFPO wants to attract quality board members, then they need to ensure that they have good financial governance in place.
• Having a good reputation is very important for NFPO, good financial governance can help establish good reputation. The longevity of a NFPO is determined by the reputation they have established in their community.

What are the results of a good financial governance?

You need to focus on activities that contribute most to your overall objectives. If you have good financial governance in place, you will be able to focus on activities that contribute most to your overall objectives. If you use your resources effectively, that is if you have good board of directors, treasurers and accountants in your organization, you prepare your reports timely and accurately, it will give you an idea of what your status is financially and then you will be able to effectively use your resources and make quick strategic decisions. It also ensures that your NFPO is managed in the best interest of its members and community. These are the people that contribute and donate to your organization.

Now let’s look at the Stakeholders of a NFPO 

We have the members, the board of directors, the executive directors/CEO, the employees and the volunteers.

Members: are members of a society. If the NFPO is an association or a society, the members are the people that are benefiting or contributing to the NFPO. Those members are the ones that elect the board of directors.

Board of directors: are there to oversee the NFPO, the management and the financial reporting of the organization. The board of directors appoint an executive director or CEO to manage the daily activities of the organization. So, the CEO reports to the board of directors and the board of directors’ reports to the members.

Executive director/CEO: is responsible for hiring the right employees with good competences. When it comes to financial reporting or financial governances, the executive director is responsible for ensuring that they have a good financial expert on board either as a volunteer, an employee or contractor to manage the finances and ensure that the financial reports are recorded timely and effectively.

Volunteers: There are NFPO that have volunteers who volunteer their time to help the organization achieve its missions.

What is the Process of Financial Reporting?

We have internal and external financial reporting. In the internal financial reporting, they are the staff members who could be the creators as well as the users of the financial statements. They are responsible for recording daily transactions and ensuring they are entered in the system on a timely basis and accurately. It is recommended that the finance staff have experience in NFPOs. From there we have the finance director. The finance director supervises the finance staff and ensures that the financial reports are prepared timely and accurately. They also oversee the finance department and report to the executive director or the CEO of the organisation. The other internal member are the board members. One of their roles would be to prepare the budget. Normally they would assign a treasurer to assist with the preparation of it. Board members are also responsible to review the draft audited financial statements and the in-year financial reports which are the monthly financial reports. These reports can be reviewed on a monthly basis, bi-monthly basis and some even quarterly depending on the size and complexity of the organization.

For the external financial report stakeholders, one would be the members. They are interested in knowing the financial performance of the organization and how their funds have been deployed. Most members pay monthly or yearly annual fees to the organization and they want to make sure their fees are being used effectively for the purpose for which they were intended. Another external user would be the donors, contributors, the people that make the donations to the organization. They are interested in assurance that donations were used according to their wishes. We also have the funders which could be the government or foundations that support the NFPO. They want to be assured that funds have been used in accordance with funding agreements. Finally, we have the government or CRA. They are also interested in the financial reports for the NFPO. You need to file the annual financial reports to the government.

The roles of the Management (Executive Director/CEO)

• Ensures financial information is prepared timely and accurately, through the appointment of a financial expert.
• Responsible for developing internal financial controls. They want to make sure controls are in place to prevent fraud and to protect the assets of the organization.
• Ensures budgets are well prepared by getting the inputs of other managers responsible, financial experts and the treasurer that represents the board of directors.
• Presents financial reports to the Board on a consistent basis. (Monthly is recommended)
• Monitors risk and financial stability and brings urgent matters to the Boards attention.
• Ensures donors and funders matters are well managed. They make sure donors are treated well and the lines of communication are good.
• Explores funding opportunities on behalf of the entity.
• Oversee all financial programs and report all financial matters to the Board in a timely manner.

The roles of the Board of Directors in Financial Governance

• They provide overall financial oversight mainly through the appointment of an Executive Director/CEO to manage day to day operations. They are responsible for overseeing the financial transactions of the organization.
• They provide oversight over the identification and management of risk. The timely collection, analysis and reporting of risk-related information is very important. They identify the risk and ensure there is adequate process and procedures in place to mitigate or to prevent this risk. e.g. liabilities, property insurance. They ensure appropriate internal controls are in place to prevent errors and to safeguard the assets of the entity.
• Review and approve financial policies and procedures which could be new or amendments
• Development and review of the budget. They appoint a treasurer or finance committee to oversee the process, but all the members of the board are still responsible for the financial oversight.
• Financial performance review and approval of annual reports: KPI (Key Performance Indicator, budget vs actual variance, cash flow, event net profit (Income vs Expenses)
• They ensure the entity is in compliance with applicable regulations and agreements. Licenses of NFPO can be revoked by the government if they are not in compliance. e.g. tax filings, payroll remittances 
• They ensure the entity is financially stable. They develop strategies, together with the management, to ensure that funds are adequate to support the programs of the organization.
• They ensure there is effective communication with members and other stakeholders when it comes to the financial aspect of the organisation.

The roles of the Auditors

• They are appointed by the Board to make independent assessments of the entity’s financial statements, and to provide professional opinions on the fairness of the entity’s financial position and results of operations. 
• They are like the outside, external or independent eyes that comes to inspect the books and records of the entity and provide users of the audited financial statement with a higher level of assurance. Because they are independent, there is more trust when they issue an opinion on the financial statements.
• They should report directly to the board audit committee or board of directors if the don’t have a committee without management present.

Financial documentation to keep

• Organizational documents e.g. bi-laws, policies and procedures, incorporation documents. (These need to be kept for as long as the organisation is in existence.)
• Contracts and Agreements e.g. vendors, external parties
• Expense invoices
• Sales/Donors Receipts
• Bank statements and Reconciliations (Should be prepared on a monthly basis)
• Retention policy (Minimum 7 years)

Financial Reports 

Main Financial Statements: Income Statement, Balance Sheet (These statements are reviewed by the board of directors on a monthly basis)

Other Financial Statements: Statement of Changes in Net Assets, Cash flow Statement (These statements along with the main statements are required in your annual auditors’ statement)

Supporting Documents: Financial Dashboard (To see trends and give a pictorial view), Notes & Disclosures

Income Statement

This statement reports the revenue and expense transactions that have occurred during the specific period. For example, in January, your Income Statement would show the total revenue and the total expenditures for January. When it comes to revenue, what do we mean? It’s an increase in economic resources related to operating activities. e.g. grants, donations, service fees, auction revenue, membership fees, contributions. Then for expenditures, it’s the amount spent in operating activities. e.g. salaries, supplies, utilities, rent, depreciation. The total revenues minus the total expenditures gives you the net revenue. This net revenue could result to be a surplus or deficit. Surplus meaning you have more revenue then expenses or deficit meaning you have more expenses then revenue.

What are contributions?

They are unique revenues to NFPO as it is a non-reciprocal transfer from donor to the organization. When people donate to an organization, they are not expecting to get something in return, and this only happens in a NFPO. There are three types of contributions:

• Restricted contribution: subject to externally imposed stipulations specifies by the donor. (program or purchase of capital assets/property)
• Endowment contribution: restricted contribution with stipulations that contribution be maintained permanently. The donor specifies that you must keep this donation permanently and invest it. The organization can only spend the interest they get from that investment.
• Unrestricted contribution: free to be used in any manner, no restriction imposed by donor.

Donation receipts must be issued to donors at the end of the calendar year. Not the organization’s fiscal year but at the end of the calendar year. These receipts must be issued no later than February 28th of the following year. There are some requirements on what information must be included in your donation receipts so make sure you speak to your financial expert to ensure you meet all the CRA requirements.

Accounting for Contributions

 NFPOs are required to distinguish between contributions and other revenues. They should be tracked and recorded separately. There are two methods of accounting:

• Deferral Method: Restricted contribution for future expenditure are called deferred contribution and deferred revenue. For example, if you receive a donation and the donor says you should use it for a specific expenditures and you have not spent the money yet, this amount of contribution must be deferred and you only recognize it as revenue when the money has been used for the purpose it was intended for. At that point, your accountant will move it from your deferred revenue account (liability account because it haven’t been used) to your revenue account to be recognized or amortized if restricted for capital expenditures. 
• Restricted Fund Method: Organization will report a general fund and at least one restricted fund and an endowment fund if any. Endowment and externally restricted revenue are recognized as revenue in the corresponding restricted fund.  Unrestricted contribution is reported as revenue in the general fund. So, in this case, funds are not deferred. They are recognized as revenue immediately, but they are classified as restricted revenue or recognized as general fund. Unrestricted contributions are reported as revenue in the general fund. So, if they are received under the restricted fund method and they have no restrictions, they are reported as revenue in the general fund in the year in which it is received. However, externally restricted contributions for which there is no corresponded restricted fund, is reported in the general fund using the deferred method of accounting

The method to be used would be decided at the beginning when the organization is set up. If you change the method after, it would have to be disclosed in your audited financial statement and there needs to be a good reason for the change.

Balance Sheet 

This is where your assets, liabilities and net assets are reported. It also reports the financial position of the organization overtime. What are assets? They’re what the organization owns. e.g. land, buildings, equipment, computers, furniture. What are liabilities? They’re what the organization owes. e.g. creditors, mortgage. The difference between what is owned and what is owed is your net assets. i.e. Assets – Liabilities = Net Assets. And what does net assets mean? It’s the amount available to be used in the future by the organization to achieve its mission.

The Income Statement and the Balance Sheet are the two must important financial statements in a NFPO. Again, we also have the Cash Flow Statement and the Statement of Changes in Net Assets that must be included in your audited financial statement. But when it comes to the board oversight or reviewing the finances of the organization on a monthly or quarterly basis, it’s important that you review your Income Statement (which could also be called Profit and Loss Statement) and your Balance Sheet (which could also be called Statement of Financial Position).

I hope this gives you some basic financial governance knowledge for NFPOs.

In collaboration with CPA Canada we provide a free 60 minutes presentation on this topic  to Board of Directors of  NFPOs. If you will like to host a presentation please contact Victoria at [email protected].