Understanding your organization’s financial statements is essential to controlling the purse strings. These ten tips are intended to help you better assess and interpret your Statement of Operations – a.k.a. Income Statement, Statement of Revenues and Expenses, Profit and Loss Statement (P&L).
Your operating statement captures revenues and expenses, and the difference between them: a breakeven (revenues = expenses), or a surplus (revenues > expenses), or a deficit (revenues < expenses). This statement mirrors your day to day activities. Understanding it is essential to making sound operational decisions for your charity.
- Understand your financial documents. Formal financial statements (including those prepared by professional accountants and those generated by commercial software programs) are designed to be understandable by people who’ve made a reasonable effort to learn how to read them. It’s worth taking the time to become familiar with the layout and terminology. Read your operating results regularly. The more familiar you are with your organization’s reports, the better you’ll become at spotting good news and bad news, and knowing how to address potential problems.
- Read with a critical eye. If you’re the manager, and you’re not “hands-on” with the bookkeeping, it’s important for you to be alert for accounting errors. Even the best bookkeepers finger-slip from time to time. Does a certain number look surprisingly high or low? Ask about it! Your constructive feedback supports and encourages excellent staff work.
- Relate your revenues and expenses. The operating statement is designed to compare revenues to expenses, and tell you whether you’ve made or lost money. Within that, though, much can be learned by comparing specific revenue and expense items. For instance, what is the difference between Fundraising Revenue and Fundraising Expenses? Are you getting a satisfactory return from your investment in fundraising? Similarly, compare program revenues to program expenses. Do your various activities net to a financial gain or a financial investment? (Either can be fine!) Comparing revenues and expenses by area will help you to evaluate whether you’re maximizing opportunities, and deploying your resources effectively.
- Relate this year to your overall financial position. This year’s operating result is Revenues minus Expenses, leading to a surplus, deficit or breakeven. The Balance Sheet shows your organization’s “lifetime” result – the accumulated surplus or deficit – in the Net Assets section. This year’s revenues contribute to the accumulated surplus or deficit, and this year’s expenses reduce it. Reading your operating statement without ever looking at the Balance Sheet can be a dangerous business! Consider: your operating statement might show that you’re in good financial shape this year – but if you have a huge accumulated deficit from the past, you might still be in trouble. You would only know that by reading the Balance Sheet. By the same token, your operating statement might show big financial problems for the current year – but if you’ve got a bigger accumulated surplus from the past, you might still be ok. (NB: see also “Ten Tips for Analysing Your Organization’s Balance Sheet.”)
- Variance analysis – don’t look at this year’s results in isolation. A single column of numbers showing this year’s operating results can actually be quite uninformative! Compare your revenue and expense actuals to the budget, to assess whether you’re meeting your goals – and whether you need to change tactics. Create this variance analysis column in your report using the formula (Actuals – Budget = Variance). Similarly, compare this year to the same period from last year, to learn how your results stack up against past accomplishments. This can help you to evaluate how you’re managing within an ever-changing environment. Create this variance analysis column using the formula (This Year – Last Year).
- Ratio analysis – percentages highlight the “weight” of numbers. Using spreadsheet software, it is quite straightforward to calculate each revenue item as a percentage of total revenue, and each expense item as a percentage of total expense. Use the formulas Revenue Item / Total Revenues x 100, and Expense Item / Total Expenses x 100. These ratios can be easier to scan than the “hard numbers,” because they’re all on a common base of 100. You can use a separate column to create another set of ratios that will convert your variance analysis to percentages. For instance, in the previous bullet-point you read about creating a budget variance column using the formula Actuals minus Budget. You can convert this to a percentage using the formula (Actuals – Budget) / Budget x 100. It is easy to scan the percentages and tell at a glance where the high and low rates of change are – and to focus your attention on the items that need it most.
- Trend analysis – past data has predictive value. Your past accomplishments offer guideposts towards your future. If you know you’ve achieved a certain result before, you can assess whether you’re likely to pull it off again. If you’ve never achieved a certain objective, be careful about counting on it as part of this year’s forecast! You need at least three years of results (ideally more) to identify trends. (A year over year change could be a “blip.”) This can be done easily in a spreadsheet: use Column A to list your revenue and expense categories, and Columns B onward to record past operating results. Each year, add a new column of results to your spreadsheet, to build a picture of your charity’s financial history. Most spreadsheet software will readily convert your table of numbers into helpful graphs, to provide visuals of your financial trends.
- Comparative analysis – keeping an eye on the Joneses. It’s very easy to be immersed in your own organization’s day to day challenges, and lose sight of what’s going on in the sector as a whole. Knowing how your charity stacks up against comparable organizations can help to validate your results – or it can galvanize change. Networking with colleagues can be very informative. Some sectors of the charitable world have associations that gather and disseminate comparative data to help you assess your progress.
- Use publicly available comparative research data. All registered charities in Canada must file a T3010B Charities Return within six months of their financial year-end. These returns (minus certain confidential information) are publicly available on the Canada Revenue Agency website, at www.cra.gc.ca/charities. Do you want to know how another charity is doing financially? On this website, you can access a summary version of their financial statements, plus general information on their activities, fundraising practices, staff and board.
- Go beyond the numbers. Financial figures only capture so much. You need to understand the organization’s context in order to interpret them accurately. It’s important to supplement financial documents with information on your operating environment. Internal factors might include human resources issues and future obligations (e.g. the operating report shows this year’s rent expense, but doesn’t indicate how long the lease is, or what annual escalations you are expecting). External factors might include economic, taxation and regulatory circumstances.
This tip sheet was created by Heather Young of Young Associates. Founded in 1993, Young Associates provides bookkeeping and financial management services in the charitable sector, focused on arts and culture. Young Associates also provides consulting services in the areas of data management, business planning and strategic planning. Heather Young published Finance for the Arts in Canada (2005), a textbook and self-study guide on accounting and financial management for not-for-profit arts organizations.