By Andy Robinson and Nancy Wasserman

Nonprofit board members are asked to make many financial decisions, which means they need to understand certain fundamentals that shape their organization’s financial health, whatever their background may be.

Cash or Accrual

Are your financial statements prepared on a cash or accrual basis?

Cash-based accounting records revenues and expenses when the money comes in or goes out. It’s great for showing your exact cash position: how much money you have at this moment. Cash-based accounting, however, can make you appear healthier than you really are. For example, that big donation immediately puffs up the bank account—which looks and feels great—but your accounting system tells you nothing about the services you’re obligated to provide with that money.

Accrual-based accounting records expenses as they occur, but doesn’t record revenues until the service has been delivered – so you can’t book that big grant as income until you’ve completed (and paid for) the work it’s funding. For example, you receive a $10,000 grant for a series of four programs in your local school. Under an accrual accounting system, you earn $2,500 in revenue—one quarter of the total—each time you present one of the four programs. Before delivering these programs, that money is shown as deferred revenue, which you’ll find on the liability side of the balance sheet.

A nonprofit chorus selling season tickets offers another example. Under an accrual system, season ticket income would be listed as deferred revenue, and would be earned throughout the season as subscribers attend the concerts they’ve paid for in advance.

As you can see, accrual-based accounting provides a more accurate picture of your financial situation, but it’s more complicated to manage.

Liquidity

Is there cash in the bank? Can you pay the immediate bills, including staff salaries?

Healthy organizations have enough money to cover typical expenses for three to six months. For example, if your organization typically spends $20,000 per month, it’s prudent to have working capital [the difference between current assets and current liabilities] of at least $60,000 in the bank.

Your goal, obviously, is to have enough cash to give you some flexibility. If a grant doesn’t come through or you’re faced with a financial surprise, ready cash buys you time to develop and implement Plan B without entering panic mode.

Solvency

Are you worth anything? If you shut down tomorrow, would you have anything left to pass along to another nonprofit (when nonprofits are dissolved, they’re required to give their assets to another tax-exempt organization) or would you still owe your staff or vendors?

Your financial balance sheet will help answer this question by showing total net assets. This is not just cash in the bank, but includes other assets such as equipment, vehicles, or property.

Profitability

Year by year, are you generating more money than you’re spending? For nonprofit organizations, the notion of profit might seem inappropriate, but if you’re consistently paying out more than you’re bringing in, your group won’t last long.

This raises the question of sustainability – can you keep operating in the same fashion over the long term? If not—if you run a long-term deficit, losing money year after year—you obviously need to change the way you do business.

Efficiency

How well do you use your money? How do you know? In your particular field, what are the standard measurements?

Let’s say you serve on the board of your local food bank, which collects food and distributes it to agencies serving the hungry. Food banks use several calculations to measure their efficiency, including the amount of food delivered for each dollar raised. For example, the national network Feeding America provides 10 pounds of food to member food banks for each dollar the organization raises, which is pretty impressive.

Youth mentoring programs track the cost of each adult-child match. Revolving loan funds calculate the expense of managing each dollar they lend to local businesses and nonprofits. Mental health agencies compute the cost per client served.

In these fields, as in many others, there are measurements or benchmarks for tracking how efficiently funds are used. While benchmarks for similar organizations can vary by geography, population served, or depth of services, it’s still helpful to know and track the relevant benchmarks for your type of organization.

Impact

Are you doing what you set out to do? Are you getting the results you hope to achieve? How do you measure those results in ways that are not financial?

Your finances may look great, but if you’re not changing lives, promoting human rights, providing compassionate care to elders, presenting great theater, improving public policies and the like, good financial management is almost irrelevant. So if your nonprofit creates a measurable impact but your finances are a mess, imagine how much more effective you’ll be once you get your financial house in order.

This article is excerpted from The Board Member’s Easier Than You Think Guide to Nonprofit Finances, by Andy Robinson and Nancy Wasserman, published by Emerson & Church. All rights reserved.