How to Prepare a Nonprofit Statement of Cash Flows

Introduction

Brief Overview of What a Statement of Cash Flows Is

In this article, we’ll cover how to prepare a nonprofit statement of cash flows. The Statement of Cash Flows, a crucial component of an organization’s financial reports, provides a detailed breakdown of cash inflows and outflows over a specific period. Unlike the income statement, which shows financial performance based on accrual accounting, the cash flow statement reveals how cash is actually generated and used in operations, investments, and financing. This transparency in cash activities helps stakeholders understand the liquidity and overall financial health of an organization.

Importance of a Cash Flow Statement for Nonprofit Organizations

For nonprofit organizations, the statement of cash flows holds particular significance. It not only showcases the cash positions resulting from critical fundraising activities and donations but also highlights how efficiently these funds are being utilized towards achieving the nonprofit’s mission. Since nonprofits often rely on grants and donations that can have restricted uses, the cash flow statement provides a clear picture of the liquidity and financial viability of the organization in meeting its obligations and funding its operations.

Moreover, a well-documented cash flow statement helps nonprofit managers make informed decisions about budgeting and financial planning. It also reassures donors and grant-makers of the organization’s fiscal responsibility and capacity to sustain its activities, which is crucial for securing ongoing support. In an environment where financial transparency plays a key role in donor trust and compliance with regulatory requirements, the cash flow statement is an indispensable tool for nonprofit stewardship and governance.

Understanding Cash Flow Statements

Definition and Purpose of the Statement of Cash Flows in a Nonprofit Context

In the nonprofit sector, the Statement of Cash Flows is a financial document that provides a summary of the cash inflows and outflows from the organization’s activities over a particular period. This statement is essential for showing how activities related to operating, investing, and financing generate or consume cash. For nonprofits, the primary purpose of the cash flow statement is to provide clarity on the liquidity and cash position, which is crucial for managing the organization’s day-to-day and long-term financial stability. It helps ensure that there is enough cash available to fund programs, services, and investments aligned with the nonprofit’s mission.

Differences Between Cash Flow Statements in For-Profit and Nonprofit Sectors

While the structure of the cash flow statement is similar across for-profit and nonprofit sectors, there are notable differences in content and emphasis:

1. Sources of Cash:
   • For-Profit: Cash inflows primarily come from sales of goods or services, returns on investments, and financing activities like loans and stock issuance.
   • Nonprofit: Cash inflows are largely derived from donations, grants, membership fees, and fundraising events. Some nonprofits also receive cash from services provided or products sold, but these are typically mission-related.
2. Use of Cash:
   • For-Profit: Cash is typically reinvested into the business, used for paying dividends, expanding operations, or buying back shares.
   • Nonprofit: Cash outflows are mainly for program expenses, administrative costs, fundraising activities, and other mission-supportive services. Unlike for-profits, nonprofits do not distribute profits but reinvest any surplus funds back into the organization’s mission-driven activities.
3. Presentation and Reporting:
   • For-Profit: Emphasis is placed on profitability, efficiency in asset utilization, and return on investment.
   • Nonprofit: Focus is on sustainability, adequacy of cash reserves to support mission activities, and alignment of spending with donor restrictions and organizational goals.
4. Regulatory and Reporting Requirements:
   • For-Profit: Cash flow statements are part of mandatory financial reporting aimed at providing information to shareholders and investors.
   • Nonprofit: The statement is crucial for demonstrating accountability and transparency to donors, grantors, and regulatory bodies, ensuring that the organization is using its funds appropriately in accordance with its nonprofit status.

These differences underscore the unique challenges and priorities of nonprofit financial management, emphasizing the need for tailored approaches in preparing and interpreting cash flow statements in the nonprofit sector.

Key Components of the Cash Flow Statement

Operating Activities

Operating activities are the primary revenue-producing activities of the organization that are not investing or financing activities. For nonprofits, this includes cash received from donors, grants for operational purposes, revenues from services provided, membership dues, and cash spent on program services, administrative expenses, and fundraising costs. The cash flows from operating activities provide insights into the cash-generating abilities of the organization’s core operations.

In a nonprofit context, the statement of cash flows differentiates cash received and spent in operations from net income or loss, which is reported on the income statement. The income statement includes non-cash items like depreciation and amortization, whereas the cash flow statement adjusts for these items to show actual cash flow. This section of the cash flow statement is crucial as it reflects the liquidity available from regular nonprofit activities, which is essential for daily functioning and planning.

Investing Activities

Investing activities in a nonprofit include the acquisition and disposal of long-term assets and investments not included in cash equivalents. These might consist of purchasing or selling fixed assets like property, buildings, or equipment, which are used in delivering nonprofit services. It also includes investments in marketable securities beyond cash management purposes.

For nonprofits, investing activities often reflect how the organization is planning for future growth and sustainability. These activities might not occur as frequently as operating activities but are crucial for long-term strategic planning. Monitoring cash flows from investing activities helps ensure that a nonprofit is not over-investing its liquid assets in ways that could jeopardize its operational liquidity.

Financing Activities

Financing activities for a nonprofit involve the flows of cash that affect the size and composition of the net assets or equity of the organization. This includes obtaining resources from donors that are restricted to long-term purposes, receiving long-term grants, or any borrowings meant for beyond a year. Financing activities also cover cash received from issuing bonds, mortgages, notes, and other short-term borrowings if they are part of the nonprofit’s fundraising strategies.

Unlike for-profits, which often consider financing activities as ways to balance between equity and debt, nonprofits view these activities as essential for funding their mission sustainably. Donations and grants are common examples where cash does not need to be repaid but may be restricted in use by the donors. Understanding these restrictions and managing them within the cash flow statement is crucial for compliance and effective fund management.

These key components—operating, investing, and financing activities—provide a comprehensive view of a nonprofit’s cash flow and are critical for assessing the organization’s financial health and operational efficiency.

Preparation Steps

Data Collection

The first step in preparing a statement of cash flows involves gathering all necessary financial documents and data. This ensures accuracy and completeness in reporting. For a nonprofit, the required documents typically include:

• Balance Sheet: Needed to identify changes in assets, liabilities, and net assets.
• Income Statement: Provides a starting point for the cash flow from operating activities and adjustments for non-cash transactions.
• Bank Statements: Essential for verifying cash transactions throughout the period.
• Receipts and Invoices: Useful for cross-verifying the cash transactions related to operating, investing, and financing activities.
• Grant Letters and Donor Restrictions: Important for distinguishing between different types of receipts and their classification under operating, investing, or financing activities.
• Previous Year’s Cash Flow Statement: Helps in understanding the year-over-year changes in cash flows.

Compiling these documents before starting the cash flow statement can help streamline the process and ensure that all cash movements are accounted for accurately.

Calculating Cash Flows from Operating Activities

Direct Method vs. Indirect Method

• Direct Method: This method lists all major operating cash receipts and payments during the period to show net cash provided by or used in operating activities. This method is straightforward as it reflects actual cash transactions such as cash received from donors, cash paid to suppliers, and cash paid for salaries. However, it might require more detailed tracking and reconciliation of cash transactions against revenue and expense accounts.
• Indirect Method: The indirect method starts with the net income from the income statement and adjusts it for all non-cash transactions like depreciation and changes in balance sheet items such as receivables, payables, and unearned revenue. This method is more commonly used because it ties the cash flow statement more closely to the other financial statements, making it easier to prepare using readily available information from the accrual-based financial statements.

Adjustments for Non-Cash Transactions

When using the indirect method, adjustments are made to convert the income statement from accrual basis to cash basis. This includes:

• Adding Back Non-Cash Expenses: Items such as depreciation and amortization, which do not impact cash but are expenses on the income statement, are added back to net income.
• Changes in Working Capital: Adjustments for changes in operational working capital accounts (like accounts receivable, inventory, prepaid expenses, accounts payable, and accrued expenses) are made. An increase in an asset account or a decrease in a liability account is deducted from net income, and a decrease in an asset account or an increase in a liability account is added to net income.

These adjustments are critical as they reflect the actual cash impact of operating activities, which is essential for understanding the liquidity provided by core operations. Through careful preparation and understanding of these processes, nonprofits can accurately represent their financial health in the statement of cash flows.

Identifying and Calculating Investing and Financing Activities

After addressing the cash flows from operating activities, nonprofits must identify and calculate cash flows associated with investing and financing activities. Each of these categories captures distinct types of transactions:

• Investing Activities: For nonprofits, investing activities typically involve:
  • Purchases or sales of fixed assets: Such as buying equipment or property necessary for the organization’s operations or selling off old assets.
  • Investments in securities: Including the purchase or sale of stocks, bonds, or other investment instruments that are not considered cash equivalents.
  • Loans made to others: If the nonprofit provides loans, the cash outflow when the loan is given and the inflow when it is repaid are recorded here.
• Financing Activities: Financing activities in a nonprofit include:
  • Receipts of donor-restricted funds designated for long-term use: These could include endowments or other restricted donations that are not meant to be used within the current operating period.
  • Proceeds from issuing debt: Such as bonds or mortgages taken out by the organization to finance larger projects or to maintain liquidity.
  • Repayments of debt: Including the principal amounts of any loans or bonds.
  • Contributions by and distributions to owners: While rare and typically not applicable to nonprofits, any funds received for the issuance of the organization’s equity or paid out as distributions would also be recorded here.

Each transaction in these categories affects the nonprofit’s cash position and must be tracked diligently to provide an accurate picture of how funds are utilized outside of regular operations.

Reconciliation of Net Cash Flow to Cash Balances: Ensuring the Statement Ties Back to the Balance Sheet

The final step in preparing the statement of cash flows is to ensure that the calculated net cash flow from operating, investing, and financing activities reconciles with the opening and closing cash balances shown on the balance sheet. This process involves:

• Starting with the opening cash balance: This is the cash balance at the beginning of the period, as reported on the balance sheet from the end of the previous period.
• Adding the total net cash flows: Sum the net cash flows from operating, investing, and financing activities to the opening cash balance.
• Comparing the result with the closing cash balance: The sum should equal the cash balance at the end of the period as shown on the balance sheet. If there are discrepancies, they must be investigated and resolved, which may involve rechecking the cash flows and adjustments made for each category.

This reconciliation confirms the integrity of the cash flow statement and ensures consistency with the balance sheet, providing transparency and trust in the financial reporting. It is a critical step that verifies all cash transactions are accounted for accurately, reflecting the true financial position of the nonprofit at the end of the fiscal period.

Using the Statement of Cash Flows

How to Interpret the Statement of Cash Flows

Interpreting the statement of cash flows involves understanding the inflows and outflows of cash within the organization across three main activities: operating, investing, and financing. Here’s how each section can be analyzed:

• Operating Activities: This section indicates whether the core activities of the nonprofit are generating sufficient cash to sustain operations. A positive net cash flow from operating activities suggests that the organization is financially healthy and can cover its day-to-day expenses without relying on external funding. Conversely, a negative cash flow might signal potential challenges in managing operational costs or funding essential programs.
• Investing Activities: Negative cash flow in this section is common since it often represents investment in capital assets like equipment or property that are essential for long-term sustainability. However, significant outflows should be matched with strategic plans for growth or efficiency improvements. Positive cash flow, typically from selling assets, might provide temporary liquidity but could also indicate scaling down or divestiture from certain operations.
• Financing Activities: For nonprofits, this section often shows inflows from donations or grants that are restricted for long-term use, or from new debt undertakings. It can help assess how dependent the organization is on new funding or financing to sustain its activities and growth.

Examples of Strategic Decisions That Can Be Informed by the Cash Flow Statement

1. Budget Adjustments: A consistent negative cash flow from operating activities might prompt the need for budget tightening or a strategic review of fundraising activities and spending to ensure operational sustainability.
2. Long-term Planning: Information from the investing activities section can guide decisions on whether to continue, expand, or reduce the scale of certain programs or assets. For instance, frequent cash outflows for equipment repairs might lead to a decision to invest in new equipment.
3. Fundraising Strategies: Insights from financing activities, particularly the inflows from restricted and unrestricted funds, can influence fundraising strategies. An understanding of cash flow trends can help in deciding whether to focus efforts on increasing unrestricted fund donations to bolster flexibility in fund usage.
4. Debt Management: Analysis of financing activities also assists in managing debts efficiently. Decisions on whether to take on new debt or focus on repaying existing liabilities can be informed by reviewing the cash flows associated with existing debt service.
5. Resource Allocation: By understanding which activities are generating cash and which are consuming it, nonprofit leaders can make informed decisions about where to allocate resources most effectively to advance their mission.

Interpreting the cash flow statement allows nonprofit managers to not only ensure financial health but also to strategically steer the organization towards fulfilling its mission in the most effective manner. This insight is invaluable for both operational management and strategic planning, making the cash flow statement a critical tool for informed decision-making.

Common Challenges and Tips

Common Pitfalls in Preparing the Statement of Cash Flows for Nonprofits

1. Misclassification of Activities: One of the most common errors in preparing the statement of cash flows is the incorrect classification of cash flows among operating, investing, and financing activities. This misclassification can distort the understanding of where the cash is coming from and how it is being used, leading to poor financial decisions.
2. Overlooking Non-Cash Items: Nonprofits might forget to adjust for non-cash transactions such as in-kind donations, depreciation, and amortization when using the indirect method for operating activities. This oversight can result in a misleading portrayal of cash flow.
3. Inadequate Documentation and Tracking: Poor record-keeping and a lack of detailed tracking of cash transactions can make the preparation of an accurate cash flow statement challenging. This is particularly problematic when trying to reconcile the cash flow statement with the balance sheet.
4. Failure to Reconcile: Not reconciling the ending cash balance shown in the cash flow statement with the cash balance reported on the balance sheet is a significant error that can call into question the accuracy of all financial reports.

Tips for Accurate and Effective Preparation

1. Thorough Documentation: Maintain meticulous records of all cash transactions throughout the year. This includes keeping detailed documentation of receipts, disbursements, bank statements, and any other transactions that affect cash.
2. Regular Reconciliation: Reconcile bank statements monthly to catch and correct errors early. This practice helps ensure that all cash flows are accounted for correctly and makes the year-end preparation of the cash flow statement much smoother.
3. Understand the Definitions: Be clear about what constitutes operating, investing, and financing activities. Understanding these categories will help in correctly classifying cash flows, thereby avoiding misinterpretations.
4. Use of Financial Software: Implement accounting or financial software that can help automate some aspects of financial reporting. Many systems offer modules specifically designed to generate cash flow statements based on inputs from other financial documents.
5. Professional Training: Ensure that staff responsible for finance and accounting are well-trained and understand the nuances of nonprofit financial management. Continuous professional development in nonprofit accounting standards can prevent many common mistakes.
6. Consult with Experts: When in doubt, consulting with a financial advisor or an accountant who specializes in nonprofit finance can provide valuable guidance and assurance. They can offer insights into best practices and help audit the financial statements for accuracy.

By addressing these challenges and following these tips, nonprofits can ensure that their cash flow statements are both accurate and effective in depicting the true financial status of the organization, thus supporting better strategic decision-making.

Conclusion

Recap of the Importance and Utility of the Cash Flow Statement for Nonprofit Organizations

The statement of cash flows is an indispensable financial document for nonprofit organizations. It provides a transparent, comprehensive view of cash inflows and outflows across operating, investing, and financing activities. This clarity is essential not only for managing day-to-day operations but also for planning long-term sustainability. The statement of cash flows reveals the liquidity and financial viability of an organization, helping stakeholders understand how effectively funds are being used and how well the nonprofit is positioned to continue fulfilling its mission.

Encouragement to Use the Statement as a Tool for Financial Health and Strategic Planning

Nonprofits are encouraged to leverage the statement of cash flows as a critical tool for ongoing financial health monitoring and strategic planning. By regularly reviewing this statement, nonprofit managers can make informed decisions that enhance operational efficiency and financial stability. It allows for proactive management of cash resources, ensuring there is sufficient cash on hand to meet obligations and support mission-critical activities. Moreover, a well-maintained cash flow statement can foster greater confidence among donors, grantmakers, and board members, demonstrating the organization’s commitment to transparency and sound financial management.

In conclusion, the statement of cash flows is more than just a financial statement—it is a strategic asset that, when used effectively, can significantly contribute to a nonprofit’s success and longevity. Organizations are thus encouraged to invest in the skills and tools necessary to prepare accurate and insightful cash flow statements that will guide them in making prudent financial decisions aligned with their long-term goals.

Appendix and Resources

Additional Resources for Further Reading or Learning

To deepen understanding and enhance the ability to prepare and analyze cash flow statements, the following resources are highly recommended:

1. Nonprofit Accounting Basics – Offers a range of articles and tutorials on nonprofit financial statements, including the cash flow statement. Visit Nonprofit Accounting Basics
2. National Council of Nonprofits – Provides tools and resources tailored to financial management in the nonprofit sector. Explore the National Council of Nonprofits
3. The Financial Accounting Standards Board (FASB) – Offers detailed guidelines and standards for financial reporting for nonprofits. Check out FASB Resources

Templates or Software Recommendations for Creating a Statement of Cash Flows

Utilizing the right tools can significantly streamline the preparation of the cash flow statement. Here are some templates and software solutions designed for nonprofit financial management:

1. Microsoft Excel Templates – Excel offers customizable cash flow statement templates which can be tailored to meet specific nonprofit needs. These templates can serve as a good starting point for smaller organizations. Download Excel Templates
2. QuickBooks for Nonprofits – QuickBooks provides a nonprofit version of its software that includes features specifically designed to handle the unique aspects of nonprofit accounting, including the preparation of cash flow statements. Learn more about QuickBooks for Nonprofits
3. Blackbaud Financial Edge NXT – This is a comprehensive nonprofit financial management software that offers robust reporting capabilities, including detailed cash flow analysis. Explore Blackbaud Financial Edge NXT
4. Sage Intacct – Recommended for larger nonprofits looking for extensive financial management capabilities, Sage Intacct includes advanced features for automating and analyzing cash flows. Discover Sage Intacct

These resources and tools are aimed at empowering nonprofit organizations to maintain accurate and effective financial reporting, ensuring they have the insights needed to make informed decisions and sustain their mission over the long term.