For obvious reasons, executives and board members of non-profit organizations prefer to see that revenues exceed expenses. This difference would normally be described as net income, but for non-profits, it’s referred to as the change in net assets. Since non-profit organizations have a special type of revenue recognition, this bottom line on the financials can be misleading.
Non-profit organizations recognize revenue when received or based on the date of the promise, grant or contribution document. Revenue is not recognized when it is actually earned as is the case with for-profit entities. There may be some deferred revenue grants or contracts, but most grants are restricted money that will be used for a program that could run for a couple of years. For example, a $750,000 three-year restricted grant received one month before year-end will be recorded as $750,000 revenue in the current year, but most, if not all, of the matching expenses will be incurred in the following 2 years and 11 months. This looks great for the income statement, but does not give a true picture of the operations of the organization as gross and net income will be inflated.
The statement of activities is the non-profit version of the income statement. It should show the current month’s activities along with the year-to-date activities for all types of net assets: unrestricted, restricted and permanently restricted. To truly see how an organization has performed throughout the year, one should review the unrestricted net assets column.
Under the unrestricted column, an account called “Revenues Released” shows additional income equal to the revenues earned or released under the restricted grants. Releases are typically triggered by expenses incurred. There is an offsetting negative amount in the restricted column netting this account to zero overall. This “additional” revenue in the unrestricted column helps to show what is the true “operational” income or loss as it matches the revenue earned to the corresponding expenses incurred. Most organizations try to achieve operational income unless the budget was created with a planned loss.
Operational losses are sometimes inevitable and not necessarily bad. Depending on the timing, length of period, and size of a grant, expenses can easily exceed revenues in a period and beyond. In the example above, $750,000 will show up on the current financials inflating revenue since the expenses attributed to the grant won’t be disclosed until future years. When the expenses are incurred, the organization may very well show a loss for the next three years.
To obtain an accurate picture of a non-profit’s performance, it is best to review the unrestricted revenue and expenses in the statement of activity rather than the overall net income or change in net assets. Just remember that having higher expenses than revenue might not be bad. The ending unrestricted net assets amount is the “surplus” they have to cover administrative and other operational needs when there is a shortfall.
A CPA since 1998, Doug Whitescarver is the Client CFO at Lumix CPAs and Advisors with over 20 years of experience in accounting and management. He is responsible for all aspects of Lumix’s Client Accounting Services. Doug has extensive tax experience and previously served as an audit manager. He is a soccer coach, fisherman, and avid outdoorsman.