Last week I taught one of my favorite classes, “Understanding Your Nonprofit’s Finances: A Hands-on Workshop for Board Members”. I had asked the students to bring in the most recent financial report that their board had received. One student, a bright, articulate woman who had recently joined a nonprofit board, handed me a seven page budget that listed income and expenses for the current month in great detail, showed a comparison with the budget for that month and a comparison for the year-to-date budget with the previous year.

The new board member told me “No one on the board understands this and yet, when the executive director asks for questions, no one responds so we move on to the next item on the agenda. I hope this workshop can help me figure this out.”

I told her that I understood her frustration because it would take me a long time to figure out the budget…and I still wouldn’t have the information needed to fulfill my financial oversight as a board member. Budgets can be an important planning tool and it can be useful for the board to see where they may be overspending or where there is an income shortfall. However, the detailed budget is a management tool for the executive director and the finance manager.

Budgets generally include only the operating income and expenses for the nonprofit. Board members are responsible for the oversight of the total finances of the nonprofit (operations, land, property and equipment) and need to know the big picture, not that the organization spent an extra fifty dollars on supplies this month. There are two key reports that board members need to review monthly to truly understand the financial position of their nonprofit.

Statement of Financial Position

In the for-profit world, this is called the Balance Statement and many nonprofits also use this term (especially if they are using for-profit software for recording financial transactions). This report is a snapshot of the finances of the nonprofit at a specific date. The key figure to review on this report is “Net Assets”. Commonly known in the business world as “Equity”, this figure tells you what the total worth of the organization is on that particular date, the value of your nonprofit business.

Several years ago, while working with a nonprofit board who had only received budget reports, I asked the question “If you closed your doors tomorrow, how much money would you have in the bank?” No one knew and all were amazed that this organization had a net worth of three million dollars, most of it in property they owned, but a significant amount in cash. Board members had spent the previous meeting debating the question of how to reduce office supply expenses because that line item in the budget was over by $200. No wonder both board and staff members felt meetings were too long and too focused on minutiae.

Statement of Activities

In the for-profit world, this is commonly referred to as the Income Statement. This report focuses on the income and expenses for a particular time period and board members should receive one for the previous month at each meeting. Unlike in a budget, the revenue and expenses are summarized in general categories. The key number to identify here is “Change in Net Assets” which shows either the profit or loss for the particular month. This is the bottom line to pay attention to because it tells you if you made or lost money that particular month.

Given that it is important to keep an eye on the overall financial picture, I suggest that boards receive a year-to-date Income Statement because this shows the bigger picture and lets you know if your nonprofit is bringing in enough revenue to pay the expenses. It is likely that some months may show a loss, depending on when you do your annual fund campaign or when a grant comes in, but the overall number should be a positive number.

If you as a board member receive and understand these two reports each month, you are well on your way to providing good financial oversight for your nonprofit. Does this mean your organization doesn’t need a budget? Absolutely not! The board needs to approve an annual budget for the staff to use as a guideline to manage the business in the coming year. The finance committee should receive a condensed budget-to-actual report at least quarterly and it is useful for the board to get a current year budget summary before they begin preparing the following year’s budget. Just remember that the budget is a planning tool and the financial reports reflect the complete financial condition of the nonprofit.

©2010 Jane B. Ford

Let’s start out this discussion with a simple exercise. Think back, if you can, over the past 30 years. What has happened over this period of time? We have had both good times and bad times in the economy and the stock market. The geopolitical environment has been in rapid flux with the emergence of China and several eastern bloc countries. We have also seen the mighty fall as in the case of Greece, Italy and some would argue the UK. Global warming has become a reality that has clear implications for the lives of each of us. And finally, technology has exploded. The year 2013 looks nothing at all like 1983.

Even though many of these things are playing out on a global stage, they have clear implications for each of us in terms of our lifestyles and our finances. So, why do I bring this up? Because many of us will soon be entering the retirement phase of our lives that could easily go on for 30 years or more. Does anyone truly believe that the next thirty years will be any calmer, more predictable, or less impactful on our lives than the last 30 years? Retirement planning, because of all of this uncertainty, is complex and unpredictable. Anyone who puts this whole process on autopilot is making a big mistake because nothing stays the same and you need to be in a position to adjust.

So how do you deal with a situation that is this unpredictable? I would suggest a couple of things:

1. Don’t put retirement on autopilot. Be vigilant of the things than can affect you. Above all, you need to be flexible. If global warming causes drought conditions that increase food prices, how will you adjust your spending to compensate? Maybe you start a vegetable garden or get more creative in the recipes you use. If the stock market becomes more volatile, how will you shift your investment strategy to protect your retirement saving? If inflation, in the future, becomes a huge issue, how will you adjust your spending to ensure that you will have enough money to fund the duration of your retirement (despite rising costs)?
2. Plan for the uncertainty. Now to some of you, this is going to sound like a contradiction. If something is volatile and unpredictable, how could you possibly plan for it? Well, it is not like day one of your retirement is when the world begins. Many of things that are likely to happen in the next 30 years have probably happened, in some form or another, previously. How did people deal with it then? What has been written that can help you develop a coping strategy. This is where vigilance is important? If you see some issues starting to bubble up on the horizon, plan for it now. Don’t wait until the wave crashes to get out of the way.
3. Account for uncertainty in your assessments, but update frequently. From a retirement financial perspective, incorporate uncertainty into your assessment of whether you have enough money to retire. One way that financial planners do this is to use “Monte Carlo” techniques in their assessments. What, you may ask, is this? Well Monte Carlo is a statistical procedure that has been used for several decades to deal with variation and volatility. When you ask the question about whether you have enough money to retire, a typical financial calculator will come back with some estimate of how many years you savings will last given the assumptions that you enter into the calculator. For example, it may come back and tell you that your money will last for 25 years. However, some of the key inputs, such as investment returns on your savings or inflation can vary considerably year-to-year. If you get these inputs wrong (and you probably will), the answer will be wrong. Monte Carlo techniques take this volatility into account based on historical variation. Rather than giving you a specific number of years that your savings will last, it changes the question to the probability that your savings will last for various time periods. So, what is the probability that your savings will last for 20 years, for 25 years, or for 30 years?

While the past is not always a good indicator of what you can expect in the future, it is the best estimate that you have of what to expect. So, incorporate past volatility and variation into your plans. However (and this is critical), update, update, update. You can’t do your planning once and forget it. You need to change you assumptions and re-estimate as conditions “on the ground change.” This allows you to adjust.

So, realize that there will be uncertainty during your retirement years, but don’t be unduly flustered by it. You have made it this far. I am sure that you will navigate retirement just fine. I will leave you with the sage advice of two historical figures smarter than I to point the way:

He who fails to plan is planning to fail.

Sir Winston Churchill – English Leader

Uncertainty and mystery are energies of life. Don’t let them scare you unduly, for they keep boredom at bay and spark creativity.

R. I. Fitzhenry – Businessman & Publisher