While many investors have at least some understanding of typical financial statements like the balance sheet, income statement and cash flow statement, governmental and nonprofit financial statements may be significantly less familiar. But they shouldn't be.
Governments and nonprofits take our tax and contribution money to provide valuable services - shouldn't we be making sure that they're making good use of our money? In this article we'll examine the different financial statements for these non-businesses organizations (NBOs) and teach you how to read them so you'll always be sure where your money is going. (To get started, see Fundamental Analysis Tutorial and Advanced Financial Statement Tutorial.)
What's Fund Accounting?
Government and nonprofit organizations aren't interested in making money, so they use an accounting system called fund accounting. Fund accounting essentially groups financial data together into funds or accounts that share a similar purpose. This way, the organization has a better idea of what resources it has available to complete a specific task. Fund accounting is typically not a topic enjoyed by people who are used to the concepts of for-profit accounting.
Nevertheless, understanding what fund accounting is, and how it works, is the only way to confidently look at the financial publications that governmental and nonprofit organizations publish each year.
Government and Profit
Governments treat our money in an interesting way - they don't want to make a profit! Ideally, a government wants expenditures to be very close to revenue on any given year. Differences between revenues and expenditures are called surpluses (a positive difference) or deficits (a negative difference).
Don't forget, though, that a surplus is not a profit, nor is a deficit a loss - governments aren't in the business of hoarding money (nor are they "in business" at all, as it were).
Unlike a for-profit company, if a government finds itself operating at a large surplus (profit), it will usually take steps to lower the tax burden for its residents.
Knowing what the various funds represent can be useful in the analysis of governmental financial statements. In the broadest terms, there are three major classifications of funds in a government. These are:
1) Governmental Funds - Used by the government to provide services whose expenditures aren't met by the fees that are charged for those services.
2) Proprietary Funds - Used to account for "business-type" activities, where the services are completely paid for by charges to the customer (i.e. trash collection).
3) Fiduciary Funds - Used to account for funds held in the interest of a third-party. These aren't reported in government-wide financial statements, since they're not government owned assets (i.e. pension funds).
Each year, every governmental organization in the United States and Canada puts out a Comprehensive Annual Financial Report (CAFR). While the formats and contents can vary, these reports present the financial statements of the governmental entity, as well as important analysis tools like the management's discussion and analysis (MD&A) and the notes to the financial statements. CAFRs are done according to GAAP and Governmental Accounting Standards Board (GASB) regulations. (To learn more, read What You Need To Know About Financial Statements and Footnotes: Start Reading The Fine Print.)
CAFRs often present financial information for individual funds (or at least significant funds) as well as government-wide financial statements that show the position of the government as a whole. Governments use modified accrual accounting for their statements, and include reconciliations explaining how they made the switch from cash-basis accounting (typically used throughout the year) to the modified accrual basis they report in.
Governments present their consolidated financial statements in the CAFR. While some have different names, these statements essentially mirror the for-profit statements:
|Business Financial Statement||Equivalent Government Statement|
|Income Statement||Statement of Activities|
|Balance Sheet||Statement of Net Assets|
|Cash Flow Statement||Statement of Cash Flows|
The MD&A is a very useful portion of the CAFR that gives quite a bit of insight into the decisions made by your government's decision-makers. Typically, the MD&A has quite a bit more content than the managerial discussions found in the annual reports of business organizations. (To learn how to analyze each of these statements, see Understanding The Income Statement, Breaking Down The Balance Sheet and Analyze Cash Flow The Easy Way.)
Just like governmental organizations, nonprofits aren't in it for the money. They too use fund accounting and offer up financial statements for public consumption each year.
Nonprofits straddle the fence somewhere between the private sector and government. Because they are not out to make a profit, fund accounting provides the best accounting system for most nonprofit organizations. The same fundamental ideas apply for nonprofit accounting as governmental accounting - the goal is to have annual expenditures end up very close to annual revenues.
Nonprofits don't publish CAFRs - instead, their reports will typically just be called a "Report of Consolidated Financial Statements". Either way, the statements for both governmental and nonprofit organizations are very similar. Nonprofit financial statements often consist of:
|Business Financial Statement||Equivalent Nonprofit Statement|
|Income Statement||Statement of Activities|
|Balance Sheet||Statement of Financial Position|
|Cash Flow Statement||Statement of Cash Flows|
If you are at all familiar with the analysis of for-profit financial statements, analyzing the financial statements of a non-business organization shouldn't be too much of a stretch, once you understand what each statement is supposed to be. Nonprofit organizations report using accrual basis accounting and Financial Accounting Standards Board (FASB) and GAAP standards.
Financial statements, governmental or nonprofit, can typically be found on the organization's website, or by calling and requesting a copy.
Making your Voice Heard
After you review of a NBO's financial statements, it is essential to determine whether you feel that the organization is treating your money prudently. If you find a nonprofit organization with exorbitant operating expenses, don't give it your money. In the case of government, hold your politicians and governmental employees responsible for their actions.
Spreading awareness is the only way to make an impact in any large measure, so share what you know about these financial statements with others.
With the amount of money we pay in taxes each year, it is madness to not look at a governmental financial statement just as you would for any other substantial investment. Donating money blindly without making sure that it's getting to those who need it is the same thing. On some level you must approach it as an investment decision.
With a little knowledge about how governmental and nonprofit financial statements work, you can make sure that your getting the most for your money - even if you're not expecting anything more than a warm, fuzzy feeling as a return on your investment.
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