Financial statements look intimidating, with their dense columns of numbers. It can be really tempting to gloss it all over and leave the heavy lifting to the treasurer.

This is a very bad idea.

All board members bear a fiduciary duty towards the organizations they lead. This means that, under the law, all board members can be held accountable if someone cooks the books or makes a mistake in the accounting. Ignorance is not an excuse.

Most treasurers and staff people are honest, of course, but enough mistakes happen that the Canadian charitable sector loses an average of 5-7% of its annual sector revenue every year due to fraud, [1] accounting for median losses over $100,000 [2]. No organization can afford losses like that. And you as a board member could potentially be sued to recover that loss.

Now for the good news: reading and interpreting financial statements is entirely within anyone’s grasp. You just need to know where to look.

Accounting Equation

Financial statements are constructed based on the basic accounting equation in which

• Assets: things the organization owns
• Liabilities: things the organization owes
• Net Assets: also called funds, the portion of assets funded by the organization’s own resources. There are three types of net assets:
  • Unrestricted net assets: use this money to fund daily operations
  • Temporarily Restricted net assets: if you receive money to be used in a specific way, such as to fund a particular program, then this is restricted until the time comes to use it for that specific purpose
  • Permanently restricted net assets: this is where you keep your endowments and funds which are to be kept in perpetuity. This is a pile of money which you normally cannot spend; however, you can spend the interest.

Statement of Financial Position

This is usually the first statement you’ll see in a financial report. It will look generally like the following. I’ve put in some numbers for illustration. The numbers for your own organization could be very different.

Current Ratio

The current ratio will give you an indication of the organization’s ability to pay short- and long-term obligations. You calculate it as follows:

Take a minute to open the calculator app on your phone and calculate the current ratio for the sample financial statement above. I’ll wait.

Generally speaking, it is best for the current ratio to be a little higher than 1. Lower than 1 means that the organization may be at risk of defaulting on payments. Much higher than 1 means that the management may not be managing its assets most effectively – it may be time to think about spending some of those assets to support the mission.

Quick Ratio

Before you start spending money, however, check the quick ratio. For the quick ratio, you subtract some things from the current assets, which cannot be used to pay off debts. For example, suppose the assets above were broken down as follows:

Cash is something you can definitely use to pay off debts. You can use grants and accounts receivable IF the money comes in. Prepaid expenses and inventory cannot be used to pay off debts.

Subtract the prepaid expenses off the top. Also, maybe there is a $100,000 grant promised from an organization which is on shaky financial ground itself. Subtract that out because you can’t be sure of it. After subtracting these out, you’ll have your quick assets.

Open up that calculator app again and give it a try.

Your quick ratio should definitely be greater than 1. If it is less than 1, then you really need to rein in spending, right away.

Now you try it

The current and quick ratio are a couple of quick calculations anyone can do, to quickly assess the current financial health of an organization. Give it a try yourself. Here are some real financial statements. Calculate the current and quick ratios. For the quick ratio in this case, subtract the prepaid expenses and the inventory. Based on these, what can you infer about the organization’s current financial health?

• Current ratio: 3.3
• Quick ratio: 3.1
• Current financial health= good

Want to learn more?

We’ll post more about how to read other financial statements. In the meantime, come to our upcoming workshop, where you will learn from a Certified Professional Accountant, how to make sense of those columns of numbers.

Click here to register Tuesday, December 4, 2018. 9:00 a.m. to 12:00 p.m.

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Related blog posts:

• The Canadian charity sector loses at least $12 MILLION a year to fraud. Are you sure you’re not exposing yourself to risk?
• Legal Obligations of Board Members
• Managing Risk