Glossary of Terms to Help Understand Nonprofit Financial Operations and Better Interpret Financial Statements

by Omar Visram

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Glossary of Terms to Help Understand Nonprofit Financial Operations and Better Interpret Financial Statements

Financial statements are the heart of any nonprofit organization’s story. They provide a narrative, written in numbers, that reveals the organization’s past, present, and future. But like any tale, this one can be complex, with its own language and intricacies. To truly understand and interpret a nonprofit’s financial statements, one must become fluent in the language of nonprofit finance. That’s where this blog post comes in.

In the world of nonprofits, financial transparency is not only an ethical imperative but also a key element of trust. Donors, board members, grant makers, and stakeholders all rely on financial reports to assess an organization’s health, efficiency, and impact.

So, whether you’re a nonprofit professional striving to manage your organization’s finances or a dedicated supporter eager to decode the financial narrative, this blog post is your roadmap.

We’ll dive into the essential nonprofit financial terms, demystifying balance sheets, income statements, and cash flow statements. From “temporarily restricted funds” to “donor restrictions,” we’ll explore the language of nonprofit finance and empower you to decipher the stories these statements tell. With this knowledge, you can make more informed decisions, support your nonprofit’s mission, and ensure that every dollar has a purpose.

Let’s embark on this financial journey, unlocking the secrets of nonprofit financial statements and gaining a deeper understanding of the fiscal tales that shape the world of nonprofits.

Accounting Standards: Rules and guidelines that govern nonprofit financial reporting, such as Canadian Accounting Standards for Not-for-Profit Organizations (ASNPO).

Accrual Accounting: A method of accounting that recognizes revenues and expenses when they are earned or incurred, not necessarily when cash is received or paid.

Accruals: Recognized revenues or expenses that have been earned or incurred but not yet received or paid.

Amortization: The allocation of the cost of tangible and intangible assets over their estimated useful lives.

Annual Report: A document that provides an overview of the nonprofit’s activities, financial performance, and impact during a specific year.

Assets: Resources owned or controlled by the nonprofit, such as cash, investments, buildings, and equipment.

Audit: An independent examination of the nonprofit’s financial statements to ensure accuracy and compliance with accounting standards.

Auditor: A qualified professional who conducts independent examinations of an organization’s financial statements to ensure accuracy and compliance with accounting standards.

Balance Sheet: A snapshot of the nonprofit’s financial position at a specific date, showing assets, liabilities, and net assets/liabilities (also known as the Statement of Financial Position).

Board of Directors: The governing body of the nonprofit responsible for overseeing its financial and strategic decisions.

Budget Variance: The difference between the budgeted amount and the actual amount spent or received.

Budgeted Expenses: Projected or planned expenses outlined in the organization’s annual budget.

Cash Equivalents: Highly liquid investments that are easily convertible to cash, typically with maturities of three months or less.

Cash Flow Statement: A financial statement that shows how changes in the balance sheet and income statement affect cash and cash equivalents.

Charitable Purpose: The primary mission and objectives of the nonprofit organization, typically defined in its governing documents

Charitable Registration: The process of registering as a charitable organization with government authorities to receive tax-exempt status and provide tax receipts to donors.

Charitable Registration Number: A unique identifier issued by regulatory authorities for charitable organizations.

Contributions: Donations and gifts received by the nonprofit, which can be restricted or unrestricted.

Current Ratio: A measure of short-term liquidity, calculated by dividing current assets by current liabilities.

Debt to Equity Ratio: The ratio of total liabilities to total net assets, showing the organization’s reliance on debt for financing.

Depreciation (also see amortization): The allocation of the cost of tangible and intangible assets over their estimated useful lives, representing the decrease in value due to wear and tear.

Donor Restrictions: Conditions or requirements imposed by donors on the use of their contributions.

Donor Retention Rate: The percentage of donors from one year who continue to donate in subsequent years, indicating donor loyalty.

Endowment Fund: A fund established by a donor to be maintained permanently to generate investment income to support the nonprofit’s ongoing operations or specific purposes.

Expenses: Costs incurred in the operation of the nonprofit, including program costs, administrative expenses, and fundraising expenses.

Financial Ratios: Tools for assessing financial health, efficiency, and effectiveness, including current ratio, program efficiency ratio, and debt to equity ratio.

Financial Statements: Reports that summarize the nonprofit’s financial results, financial position, and cash flows, including the income statement (statement of operations), balance sheet (statement of financial position), and statement of cash flows.

Financial Transparency: Openness and clarity in financial reporting, ensuring that stakeholders can access and understand financial information.

Fiscal Year: The 12-month accounting period used by the nonprofit, which may not align with the calendar year.

Fixed Assets: Tangible assets with a long useful life, such as buildings, equipment, and land (also referred to as capital assets, or property and equipment)

Fund Accounting: A method of accounting that segregates resources into separate funds to track specific activities, restrictions, or purposes.

Fundraising Efficiency Ratio: The ratio of fundraising expenses to the total contributions received, measuring the cost-effectiveness of fundraising efforts.

GAAP (Generally Accepted Accounting Principles): Standard accounting principles and practices used in the preparation of financial statements.

Grant: Financial assistance provided by a grantor to support specific projects, programs, or activities.

Grant Proposal: A formal request submitted to a grant maker or donor, outlining a project, its goals, budget, and expected outcomes.

Grants Payable: Amounts owed to grant recipients, typically recorded as a liability on the balance sheet.

Income Statement: A financial statement that summarizes revenues, expenses, and net income or loss for a specific period (also known as the Statement of Operations).

In-Kind Contributions: Non-cash donations, such as goods, services, or expertise, that may be recorded as revenue when received and used.

Intangible Assets: An identifiable non-monetary asset without physical substance (for example, software and licenses)

Internally Restricted Reserves: Funds set aside by the board for specific purposes, such as emergencies or future initiatives.

Investment Income: Returns earned from investments, such as stocks, bonds, or endowment funds.

Liabilities: Financial obligations or debts, including accounts payable, loans, and accrued expenses.

Liquidity: The ability to access cash or convert assets into cash quickly without a significant loss in value.

Net Assets: The residual interest in the assets after deducting liabilities; often divided into four categories: unrestricted, internally restricted, externally restricted and endowment funds.

Operating Reserve: A financial cushion that helps the organization cover unexpected expenses or temporary revenue shortfalls

Pledges: Promised future donations to the nonprofit, which may be recognized as revenue when the promise is made (conditionally or unconditionally).

Program Efficiency Ratio: The ratio of program expenses to total expenses, indicating the percentage of expenses directly related to program activities.

Program Income: Revenue generated directly from program-related activities, such as funding, donations, fees or ticket sales.

Residual Value: The estimated value of an asset at the end of its useful life, used in calculating depreciation or amortization.

Restricted Reserves: Funds set aside for specific purposes or activities, subject to donor-imposed restrictions.
Revenues: Funds received or earned by the nonprofit from various sources, including donations, grants, program fees, and investments.

Tax-Exempt Status: A legal status granted by government authorities to nonprofit organizations, allowing them to operate without paying certain taxes and providing donors with tax benefits.

Unrestricted Funds: Funds that can be used at the organization’s discretion, without donor-imposed restrictions.

Understanding these nonprofit financial terms is essential for effective financial management, reporting, and decision-making. By becoming familiar with this financial vocabulary, nonprofit professionals, donors, and stakeholders can better interpret and assess the financial health and impact of nonprofit organizations.

About Omar Visram

Omar is the co-founder and CEO of Enkel, one of Canada’s leading financial operations firms established in 2016. For over 15 years, Omar has been active in the Canadian taxation, strategic planning, audit advisory and finance operations disciplines within senior roles at KPMG and BCAA. Omar holds a BBA from Simon Fraser University and is a qualified CPA, CA.