Understanding Community Group Finances

As a manager of a not-for-profit organisation, you wear different hats and juggle several 'management' balls at once. But the one hat you can never shed is that of financial manager and planner.

Even when you have an accounting system that produces timely and accurate financial statements, as a manager you have the responsibility of understanding and interpreting exactly what you have.

The process of analysing your statements is not a glamorous task, and the best way to start is to roll up your sleeves and dig in. Three steps are required:

Making a statement

All financial analysis begins and ends with financial statements. The two basic statements are the balance sheet and the income statement (also known as a Profit & Loss statement).

The balance sheet functions as a historical record of activity since day one in your business. Functionally it's like taking a snapshot of the business at a point in time-usually the end of an accounting period. It reveals three things: assets, liabilities and net worth. This fundamental relationship is summarised in the following formula:

Assets = Liabilities + Net Worth

There are several issues worth noting in relation to your balance sheet. First, the assets should be broken down into three basic sections, based on the time it would take to convert them to cash: current assets, fixed assets and intangibles. Since assets are things the business owns, they have to be bought. Liabilities reflect funds in the form of loans, and net worth reflects funds in the form of capital investment and retained earnings.

Three classes of assets

Let's discuss briefly the three classes of assets.

Current assets are those that normally will be converted to cash within one year-such as cash, accounts receivable, and inventory. In retail businesses these three types of asset interact to create the working capital cycle - you take your cash to buy goods for inventory that you sell in return for accounts receivable which are then turned back into cash. Even if you're working on a not-for-profit model, you'll still have to account for these three areas - money in hand, what people owe you, and the things you own. In current assets, you also typically find a category called 'prepaid expenses'. These are things like rent and insurance that you pay for in a lump sum and 'use up' over the course of a year.

Fixed assets include tangibles such as land, buildings, and plant and equipment. With the exception of land, fixed assets are depreciated-or written off-over the 'useful life' of the items.

Intangibles are the third asset category, and are items such as goodwill, brand value, and franchise rights. These don't feature largely in the accounts of most not-for-profits because they're difficult or impossible to sell to anybody else.

Most of your assets are placed on your books at cost or fair market value-whichever is less.

Liabilities and net worth

Liabilities are also classified into short-term and long-term, depending again on whether they are paid within one year. Current liabilities (short-term), such as accounts payable, overdrafts and accruals, are paid within one year (accruals are simply a way of saying, "I know I owe it, but I haven't written the cheque yet"). Long-term liabilities, such as mortgages or equipment loans, are those that will be repaid over a period exceeding one year.

The last section of the balance sheet is labelled 'net worth'. It's what the organisation has built up over the years and what it's got available for its goals.

Balance and income

To sum up the balance sheet: it's a record from day one and measures what the organisation owns and owes at a point in time. The key financial issues relating to the balance sheet are liquidity or solvency, financial risk, and asset management.

And why does a balance sheet balance? Remember that equation: Assets = Liabilities + Net Worth. A system of double-entry bookkeeping means that each entry on the assets side is checked by a balancing entry on the other side, and vice versa. If you borrow $10, your Assets go up by $10 and your Liabilities go up by $10. If you're given $10, your Assets go up by $10 and your $10 goes up by $10. If you spend $10 on a pot plant for the office, your Net Worth goes down and your Assets go up.

The income statement is simply the result of operations over a given period, usually one year. The primary benchmark is whether you're in surplus or deficit. At the end of each year, your bookkeeper closes all of the income and expense accounts to produce 'net profits after tax' (your income statement). This amount goes directly into retained earnings (your balance sheet) and then you start all over again on income / expense. Thus, the income statement represents only one year at a time while a balance sheet represents the full financial history of your organisation.

You should prepare income statements for all your individual sections or projects, so you can see whether you're making or losing money in each area, and then combine them into an income statement for the whole organisation.

Now let's wrap it all up. This information can be used to see where you've been and where you're going. The goal? Planning and control. The tool? Analysis of the relationships and trends in the form of ratios.