Donors and grant-makers alike want to know how nonprofits manage short-term risks to their cash flows. Board members want to see how their organization will fare in the event of a financial crunch. How a nonprofit manages its liquidity can say a lot about it manages operations and about future sustainability, and that’s why the new liquidity reporting requirements are so valuable.
Annual financial statements issued for years ended December 31, 2018 and thereafter were the first since the new nonprofit financial reporting standard, Accounting Standards Update No. 2016-14, Not-for-Profit Entities (Topic 958): Presentation of Financial Statements of Not-for-Profit Entities, became effective. The key objective of this part of the standard is to improve the quality of information users have to assess liquidity and how nonprofit organizations manage their exposure to liquidity risk including limitations on the use of financial assets which would make them unavailable to satisfy general obligations of the organization within one year from the reporting date. These disclosures can offer new insight and help stakeholders see a nonprofit’s liquidity more clearly.
How Liquid Are Your Assets?
Evaluating liquidity risk requires a thorough understanding of the financial statement’s components, specifically the identification of financial assets. For most nonprofit organizations, financial assets will consist of items where there is a market to transact for those instruments such as cash and cash equivalents, investments, pledges and accounts receivable. Financial assets would not include items such as prepaid expenses, property, plant and equipment or certain other types of assets. Instruments such as lines of credit are considered a source of liquid funds available should they be needed to draw down upon.
Conversely, some assets are less liquid than financial statement readers might realize. The nature of the asset may limit its usefulness in a cash crisis. A receivable due in 15 months will not provide short-term assistance, and a pledged contribution paid out regularly over the next five years will have limited utility. Assets may also have internal or external limits placed on them. The nonprofit may have a contractual obligation to maintain a certain balance in reserves, or a donor may restrict the use of a donation. Even board members may designate certain financial assets for long-term investment or for future operational and strategic goals.
Quantitative and Qualitative Disclosures
Nonprofit organizations must now draft disclosures that cover liquidity from multiple angles. Because the financial statement itself does not immediately show which assets are liquid, the new standard requires a separate quantitative disclosure to provide this information. A common way to prove liquidity is to first show all financial assets — cash, receivables, investments, etc. — and then remove amounts that are unavailable for general expenditure within one year. The result shows how much of those financial assets are truly liquid and available.
On the other side of the coin, qualitative disclosures provide context to the numbers and allow the organization to highlight what they are doing well. For example, in the form of a narrative, an organization may want to point out the following, as applicable:
Together, the quantitative and qualitative disclosures give donors, grant-makers and board members useful information about the nonprofit’s ability to general obligations as they become due.
Telling Your Liquidity Story
Look at this accounting change not as an obligation, but as an opportunity to tell your nonprofit’s liquidity story more transparently and effectively. Engage with internal and external stakeholders impacted by this new standard — executive management, the board of directors, lenders and funders — to make sure you are on the same page. As you analyze liquidity risks, talk through any concerns you have about your organization’s ability to meet its short-term cash needs.
You should also ensure that you are prepared to draft these disclosures. New accounting schedules may be necessary, or a new task for your accounting staff may be needed. You also might need to make some structural adjustments to your chart of accounts to track financial assets separately if not already doing so, enabling a more accurate presentation of your liquidity.
The new nonprofit financial reporting standards are in effect for fiscal years beginning after December 15, 2017, and for interim periods within fiscal years beginning after December 15, 2018. Contact our nonprofit team if you have any questions about how to tell your organization’s story of liquidity in a way that provides your donors and other stakeholders the data and insight they need.
March 21, 2019
