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The questions an NFP Board should be able to answer
The Board of a not for profit (NFP) is ultimately responsible for all aspects of the organisation. The finances are a critical component and as such it is imperative that they are well-informed and in a strong position to make decisions about the future of the organisation.
Following are three key questions we believe all Board directors should be able to answer. We know it’s not always easy and the information may not be available at a glance, but each Director has a clear duty to inform themselves through understanding the financial reports, requesting further information if required and asking good, strategic questions.
Are we solvent?
This is the number one question the Board needs to answer – all of the time.
You sign a solvency statement in the annual financial statements… the one that says ‘the organisation can meet its debts as and when they fall due’… but you need to be able to hand-on-heart know this to be true all of the time.
Trading while insolvent is illegal. It is a breach of both the Corporations Act, which is applicable regarding insolvency, no matter how you are incorporated, and the ACNC governance standards. Civil penalties of up to $200,000 may apply, as can criminal charges if there has been dishonesty.
The balance sheet is the first clue to the solvency question. Are current assets greater than current liabilities, and to what extent? A working capital or current ratio calculation will help to make this information readily apparent. The ratio measures assets that will be available as cash within a year and liabilities that will have to be paid within a year. The resulting ratio gives you a clear view of the assets available to fund your liabilities.
For example, if you have $900,000 in current assets and $300,000 in current liabilities, then the ratio is 3:1 – for every $1 of liability you have $3 available to fund it, which is a generous buffer. However, if your current liabilities are $1,000,000, this is a ratio of only 0.9:1 – for every $1 of liability you have 90 cents available to fund it. In this situation there will need to be close attention to the timing of payments as well as the incurring of further debts.
If you are in this situation… is it time to call in the insolvency professionals?
Not necessarily, but it is certainly time to be asking questions. You may be able to source some of the answers from the balance sheet, but some will require input from the management and finance team. You might ask questions like… what are our liabilities comprised of?
When are they due to be paid? Do we have cash available to pay our creditors? Is this a timing issue that will be resolved by the next regular income instalment? Or is there a bigger problem with outgoings exceeding income?
It is worth noting that grant funded organisations can experience volatility in this ratio when substantial funds are received on a quarterly basis… skewing the ratio for that month but not posing any real problem. It all comes back to understanding the make-up of your balance sheet and being able to ask questions and get good answers that allow you to make a judgement about the organisation’s financial position.
A measure of cash cover is useful too… you could measure it in days, weeks or months. To work this out, divide your cash balance by your average daily/weekly/monthly expenses.
For example – an operating budget for the year of $1,200,000 gives an average monthly expenditure of $100,000. If your cash balance is $800,000, then it will cover eight months or 34 weeks of ordinary operations if there is no further income received. However, if monthly expenditure is $400,000, the cash will only fund two months or 8.6 weeks of operations.
Are things going according to plan?
To know whether your finances are going according to plan, you’ll first need to have a plan. It almost goes without saying (but we’ll say it anyway, just to be clear) that the Board should approve a budget for the financial year.
Unless you are running a simple business with few variables, it will be very difficult for you to know whether the finances are performing to expectation without a guide to measure against… in this case, the budget.
Depending on your operating environment, it might be appropriate to plan and budget for a longer term, perhaps two to five years.
This can be useful if your income or expenses vary dramatically from year to year or if you are funded on a multi-year cycle, or in the case that you are running out of funding and you need to plan ahead so that you don’t have to bring the organisation to a sudden halt.
If your cash situation is tight, you would also prepare a cash forecast. This takes your accrual budget and resets it according to when the cash flows in and out of your bank account. For a cash flow positive organisation this can be a useful tool to inform your investment decisions, but for an organisation with tight cash flow and a lean operating budget, it will be a critical tool to guide purchasing, financing and staffing decisions.
Are we getting the information we need to make decisions?
At a minimum, a Board should see a profit & loss against budget for the year to date and a balance sheet with comparative figures from end of last financial year. Directors have an individual responsibility to understand the financial position of the organisation. The treasurer may bring an additional level of finance knowledge, but all directors must be able to read and understand financial reports and to use that information to inform their decision making.
Set some KPIs… this will help the Board to focus on the important measures and encourage you to spend your finance discussion time at the governance level rather than in the weeds of individual line items.
The metrics that are important to your organisation will depend on many factors, including the reliability of your revenue, the predictability of demand for your work, the peaks and troughs of your outgoings. What is a ‘healthy’ ratio for one organisation can be unachievable for another, so it is important that you consider your particular situation and set benchmarks that are relevant to your organisation’s operating environment and your risk appetite.
Contact our team for more information or read more not for profit governance articles.
