As a grantmaker, you can significantly impact the organizations you support. With so many worthwhile causes, how do you know which is the most viable for your donation? Grantmakers must strengthen their relationships and understand the questions to ask to invest in viable, sustainable organizations.
There are Four Main Questions You Need to Understand:
Let's get started with some details on each of these topics.
An audit is a systematic examination of the books and records performed to verify and report on the facts of the organization's financial operations. The goal of auditing is to verify the accounting data by determining the accuracy and reliability of the accounting statements and reports. The purpose of a financial statement audit is to add credibility to an organization's reported financial position and performance.
Financial Statement Audits
These audits are performed in accordance with generally accepted government auditing standards (GAGAS) when required by law, regulation, contract, agreement, or policy.
Compliance/Single Audits
These audits are required for organizations that expend $750,000 or more of federal awards, either received directly from the federal government or passed through state/local governments or other nonprofit entities. The audit is required in accordance with Subpart F of the OMB Uniform Guidance (2 CFR 200) and is subject to generally accepted auditing standards (GAAS) and GAGAS, often referred to as a single audit. The audit requires an opinion on compliance over significant programs.
The audit findings are presented in the Schedule of Fundings and Questioned Costs and indicate:
Once the audit is complete, an audit report will be compiled which "documents reasonable assurance that the organization's financial statements are free from material misstatements."
There are four types of audit reports: Unmodified Opinion, Qualified Opinion, Adverse Opinion, and Disclaimer of Opinion. While the Unmodified Opinion is the one you will see most of the time, it is essential to understand them all as the three others are the ones you should be most concerned with.
Unmodified Opinion
This is the most common type of auditor report and is also known as a "clean" opinion (previously known as an unqualified opinion). This report indicates that the auditor could perform the required work with the financial statements provided by management, and the auditor had no reservations concerning the financial statements.
Qualified Opinion
This auditor's report is used when the auditor finds material misstatements, omissions, or inadequate disclosures in the footnotes to the financial statements. It indicates that the deviation(s) from generally accepted accounting principles (GAAP) are not pervasive and do not misstate the organization's financial position as a whole. A qualified opinion can be acceptable to most grantors, donors, and lenders.
Adverse Opinion
This is the most unfavorable opinion and indicates that the financial records are not in accordance with GAAP and contain grossly material and pervasive misstatements. An adverse opinion may be an indicator of fraud. Investors, lenders, and other financial institutions do not typically accept financial statements with adverse opinions as part of their debt.
Disclaimer of Opinion
This report is issued when the auditor cannot complete the audit report due to the absence of financial records or insufficient cooperation from management. Also referred to as a scope limitation, it indicates that no opinion over the financial statements was able to be determined.
In 2022, the auditor's report will significantly change. These changes will include how the auditor will present their findings to the organizations. The upcoming changes to the auditor's report include:
Auditors will review these six statements/schedules when they prepare the audit:
Let's discuss what is included in each of these and the warning signs or red flags to watch out for. This overview will help you understand what the auditors are looking for and what will be in their final audit report.
A. Statement of Financial Position
Presents the assets, liabilities, and net assets of the organization. The statement of financial position provides information about the liquidity of the assets and restrictions on the use of certain assets.
| Cash |
| Operating |
| Restricted / Board Designated |
| Cash, investments, or other assets that have donor-imposed restrictions limiting their use for long-term purposes are presented separately from cash or investments that are available for current use. |
| Receivables |
| Current / Long-Term |
| Net Present Value / Collections |
| Restrictions |
| Investments / Assets Held in Community Foundations |
| Current / Long-Term |
| Net Present Value / Collections |
| Restrictions |
| Inventories |
| Valuation |
| Sales |
| Deferred Revenue / Contract Liabilities / Debt |
| Revenue Recognition |
| Ability of the Organization to Pay Its Debts When Due |
| Net Assets |
| Board Designated |
| With Donor Restrictions |
| Without Donor Restrictions (time restriction, use restriction, both) |
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Warning signs related to the statement of financial position:
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B. Statement of Activities
Presents changes in an organization's net assets and includes revenues, expenses, gains, losses, and reclassifications of net assets.
| Revenue |
| Contributions without donor restrictions |
| Contributions with donor restrictions |
| Membership dues, sales, special events - revenue recognition |
| Gains and losses - investments, sales of assets, etc. |
| Expenses |
| Program |
| Management and general |
| Fundraising |
|
Warning signs related to the statement of activities:
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C. Statement of Functional Expenses
Presents the functional and natural classification of expenses.
| Functional Classification |
| Program, management and general, and fundraising |
| Natural Classification |
| Salaries and wages, supplies, interest expense, rent, depreciation, etc. |
|
Warning signs related to the statement of functional expenses:
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D. Statement of Cash Flows
Details the changes in an organization's cash during the year, based on sources and uses.
| Cash Flow |
| Operating, investing, and financing activities |
| Non-cash transactions that affect the financial position of the organization are also disclosed |
|
Warning signs related to the statement of cash flows:
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E. Footnotes
The footnotes to the financial statement are additional information that helps explain how a company arrived at its financial statement figures. They also help explain any irregularities or perceived inconsistencies in year-to-year account methodologies. Below are some examples of footnotes often used:
F. Supplementary Schedules
These are not required for a fair presentation in accordance with GAAP, but an organization may elect to include additional information or grantors may require it.
Financial sustainability is the hallmark of a healthy nonprofit. When the nonprofit is financially sustainable, it can maintain operations, grow resources to weather challenges, and accomplish its mission in the long run. Financial sustainability requires clear objectives, strategies, and action plans.
What are the Most Common Challenges to Financial Sustainability?
Challenges to financial sustainability are varied, so watch out for these concerns with the organization's funding issues.
5 Strategies to Maintain Financial Sustainability:
To offset the challenges to financial sustainability, the organization should have a plan to maintain and grow their financial position. This can be done in many ways, but here are a few to consider:
Select ratios to analyze based on the organization's operations, sources of revenue, and mission. Compare ratios to benchmarks based on the financial information of organizations of similar size and mission. While many ratios can be used, here are a few we recommend starting with and how to calculate them.
| Liquidity Ratios | |
| Current Ratio - Can the organization pay its current liabilities with current assets? | Total current assets / total current liabilities = looking for a factor of 1 or higher |
| Quick Ratio - Based on liquid current assets (excludes inventory) used to pay current liabilities. | (Cash + accounts receivable + other easily liquidated assets) / current liabilities = looking for a factor of 1 or higher |
|
Safety Ratios Safety is defined as whether an organization has increased exposure due to debt. |
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| EBIT / Interest Ratio - Defines whether the organization can meet its interest payments and take on more debt. The higher the ratio, the better it can meet its interest payments and take on more debt. | EBIT / Interest = earnings before interest & taxes / interest expense |
| The higher the Debt-to-Equity Ratio, the greater the risk to a current and future creditor of default. However, if the ratio is too low, your organization is acting too conservatively. | Debt to Equity = total liabilities / total equity |
| The cash flow to the current maturity of the long-term debt ratio indicates whether the organization can pay its principal debt payment over the next 12 months. | Cash flow to current maturity of long-term debt = (net profit + non-cash expenses (i.e., depreciation, amortization)) / current portion of long-term debt |
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Efficiency Ratios Efficiency measures how well an organization effectively employs its assets. The ratios below are standard efficiency measures. |
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| Accounts Receivable Turnover measures how fast the organization is collecting its receivables. Therefore, the higher the turnover, the faster the organization collects its receivables and thereby the more cash the organization has on hand. | Accounts Receivable Turnover = total net sales / accounts receivable |
| Days in Accounts Receivable indicates how many days it takes for the organization to collect all accounts receivable. The goal is to have fewer days, which suggests that the organization quickly collects its accounts. | Days in Accounts Receivable = 365 days / accounts receivable turnover |
| Accounts Payable Turnover measures how fast the organization is paying its creditors. The higher the number could indicate that the organization is managing its creditors and thereby holding on to its money longer. On the contrary, the organization is having difficulty paying its creditors due to cash liquidity issues. Understanding the reason for the higher turnover is critical to determining if a major problem requires alternative resolutions. | Accounts Payable Turnover = cost of goods sold / accounts payable |
| Days in Accounts Payable indicate how many days it takes for the organization to pay all accounts payable. Make sure your organization takes advantage of vendor discounts. | Days in Accounts Payable = 365 days / accounts payable turnover |
| Inventory Turnover indicates how many times an organization sells its inventory in one accounting period. This is an important measure to understand whether improvement is required to correct obsolete and/or under/overstocking inventory issues. A positive trend is showing faster turnover results in improved cash flow and more robust inventory control. | Inventory Turnover = cost of goods sold / inventory |
| Days in Inventory indicates the average length of days it takes to turn over an organization's inventory. | Days in Inventory = 365 days / inventory turnover |
| Sales to Total Assets measures the organization's efficiency in generating sales on each dollar of assets. | Sales to Total Assets = Total sales / total assets |
| The Debt Coverage Ratio indicates an organization's ability to satisfy its debt obligations and its capacity to take on additional debt. | Debt Coverage = (net profit + any non-cash expenses) / principal on debt |
| The Cost to Raise a Dollar Ratio evaluates the efficiency of the fundraising channel or program. Variation of $1.00 to $1.60 is very acceptable for a direct mail acquisition, while $0.20 is considered an average acceptable CRD for an entire fundraising program. Charity watchdog groups use this as a rating variable which is one reason it is essential. | Cost to Raise a Dollar (CRD) = cost of fundraising / amount raised |
As you can see, there is a lot to review when you assess your grantee organizations' financial health. This article is designed to give you insights into what auditors look at and how their reports are generated. By gaining a basic understanding of these findings, you will be equipped with ways to assess before you gift funds to an organization.
If you have any questions or are looking for more information on this topic, reach out to SVA. We are here to help.