Student Publications

Author: Hasmig Kochanian
Title: Financial Accounting & Management

Country: United States
Avialable for Download: Yes

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-           Financial Management
-           Financial Statements & The Analysis
-           Planning & Forecasting Financial Statements
-           Balance Sheets & Cash Flows
-            Trial Balance & Income Statement
-           Assets & Depreciation
-           Conclusion
-           References

Accounting & Financial Management

Financial management is a process which brings together planning, budgeting, accounting, financial reporting, internal control, auditing, procurement, disbursement and the physical performance of the project with the aim of managing project resources properly and achieving the project's development objectives. Financial management is a critical ingredient for a project success. Timely and relevant financial information provides a basis for better decisions, thus speeding the physical progress of the project and the availability of funds, and reducing delays and bottlenecks. This is why Bank policy and procedures require good financial management in Bank-funded projects.

Financial management provides:

*essential information needed by those who manage, implement and supervise projects, including government oversight agencies and financing institutions;

*the comfort needed by the borrower country, lenders and donor community that funds have been used efficiently and for the purposes intended; and

* a deterrent to fraud and corruption, since it provides internal controls and the ability to quickly identify unusual occurrences and deviations.

The Financial Management Team has the overall responsibility for financial management in operations in the respective regions. The financial specialists provide professional leadership in ensuring high quality performance with respect to compliance with Bank policies and procedures and efforts to build financial management capacity in client countries. Financial Management specialists provide direct support to Task Teams throughout the project cycle.

New business leaders and managers have to develop at least basic skills in financial management. Expecting others in the organization to manage finances is clearly asking for trouble. Basic skills in financial management start in the critical areas of cash management and bookkeeping, which should be done according to certain financial controls to ensure integrity in the bookkeeping process. New leaders and managers should soon go on to learn how to generate financial statements (from bookkeeping journals) and analyze those statements to really understand the financial condition of the business. Financial analysis shows the "reality" of the situation of a business -- seen as such, financial management is one of the most important practices in management. This topic will help you understand basic practices in financial management, and build the basic systems and practices needed in a health business.

If your small business is a corporation, you would do well to find someone experienced in financial management and encourage them to be your board treasurer (your board chair has this responsibility to find someone suitable, as well). Therefore, it's important to understand the role of the board treasurer.

If you are inexperienced in financial management, then you should get an accountant initially to help you set up your bookkeeping system, generate financial statements and do some basic financial analysis. But don't count on an accountant to completely take over your responsibility for financial management! The accountant can help you set up a bookkeeping system, generate financial statements and analyze them, but you have to understand financial data to the extent that you can understand the effects of your management decisions, the current condition of your business and how decisions will effect the financial condition of your business in the future.

Financial controls exist to help ensure that financial transactions are recorded and maintained accurately, and that personnel don't unintentionally (or intentionally) corrupt the financial management system. Controls range from very basic (eg, using a checkbook and cash register tapes to more complez, eg, yearly financial audits).

A budget depicts what you expect to spend (expenses) and earn (revenue) over a time period. Amounts are categorized according to the type of business activities, or accounts (for example, telephone costs, sales of catalogs, etc.). Budgets are useful for planning your finances and then tracking if you're operating according to plan. They are also useful for projecting how much money you'll need for a major initiative, for example, buying a facility, hiring a new employee, etc. There are yearly (operating) budgets, project budgets, cash budgets, etc.  The  overall format of a budget is a record of planned income and planned expenses for a fixed period of time.

As a new business, your biggest challenge is likely to be managing your cash flow  probably the most important financial statement for a new business is the cash flow statement. The overall purpose of managing your cash flow is to make sure that you have enough cash to pay current bills. Businesses can manage cash flow by examining a cash flow statement and cash flow projection. Basically, the cash flow statement includes total cash received minus total cash spent. Cash management looks primarily at actual cash transactions.

To really understand the current and future conditions of your business, you have to look at certain financial statements. These statements are generated by organizing and analyzing numbers from your accounting activities. You should understand the two primary financial statements, the Profit and Loss Statement (or Income Statement) and the Balance Sheet. (Some sources believe that there are other primary statements, too, such as the cash flow statement or change in capital, etc. However, the Income Statement and Balance Sheet are the two standard statements for any business.)

These "P and L" statements depict the status of your overall profits. These statements include much money you've earned (your revenue) and subtract how much you've spent (your expenses), resulting in how much you've made money (your profits) or lost money (your deficits). Basically, the statement includes total sales minus total expenses. It presents the nature of your overall profit and loss over a period of time. Therefore, the Income Statement gives you a sense for how well the business is operating.

 Financial analysis can tell you a lot about how your business is doing. Without this analysis, you may end up staring at a bunch of numbers on budgets, cash flow projections and profit and loss statements. You should set aside at least a a few hours every month to do financial analysis. Analysis includes cash flow analysis and budget deviation analysis mentioned above. Analysis also includes balance sheet analysis and income statement analysis. There are some techniques and tools to help in financial analysis, for example, profit analysis, break-even analysis and ratios analysis that can substantially help to simplify and streamline financial analysis. How you carry out the analysis depends on the nature and needs of you and your business. The break-even analysis uses information from the income statement and cash flow statements to compute how much sales much be accomplished in order to pay for all of your fixed and variable expenses. Fixed expenses are expenses that you'd have regardless of the level of sales of products or services (eg, sales, rent, insurance, maintenance, etc.). Variable expenses are incurred according to the level of sales of products or services (eg, sales commissions, sales tax, freight to ship products, etc.). Break-even analysis can help you when projecting when you'll make a profit, deciding how much to charge for a product, setting a sales goal, etc.  

There are a variety of ratios that can be used to help determine the current and future condition of a business. The following links provide explanation and procedures for using those ratios. The ratios are produced from numbers on the financial statements. Note that the usefulness of ratios often are from comparing ratios from different time periods in the same business or from industry standards for a type of business, eg, manufacturing, wholsales, service, etc.

Financial accounting is the branch of accountancy concerned with the preparation of financial statements for external decision makers, such as stockholders, suppliers, banks and government agencies. The fundamental need for financial accounting is to reduce principal-agent problem by measuring and monitoring agents' performance.

The accounting equation (Assets = Liabilities + Owner’s Equity) and financial statements are the main topics of financial accounting.

A financial accountant must equal assets with liabilities and owner’s equity. The Balance Sheet (or the statement of financial position) is the financial statement that summarizes the assets, liabilities, and owners’ equity of the company.


An accounting system is comprised of accounting records (checkbooks, journals, ledgers, etc.) and a series of processes and procedures assigned to staff, volunteers, and/or outside professionals. The goals of the accounting system are to ensure that financial data and economic transactions are properly entered into the accounting records and that financial reports necessary for management are prepared accurately and in a timely fashion.
Traditionally, the accounting system includes the following components:

Chart of Accounts

The chart of accounts is a list of each item which the accounting system tracks. Accounts are divided into five catagories:
Assets, Liabilities, Net Assets or Fund Balances, Revenues, and Expenses. Each account is assigned an identifying number for use within the accounting system.

General Ledger

The general ledger organizes information by account. The chart of accounts acts as the table of contents to the general ledger. In a manual system, summary totals from all of the journals are entered into the general ledger each month, which maintains a year-to –date balance for each amount.
In a computerized system, data is typically entered into the system only once. Once the entry has been approved by the user, the software includes the information in all reports in which the relevant account number appears. Many software packages allow the user to produce a general ledger which shows each transaction included in the balance of each account.

Journals and Subsidiary Journals

Journals, also called books of original entry, are used to systematically record all accounting transactions before they are entered into the general ledger. Journals organize information chronologically and by transaction type (receipts, disbursements, other). There are three primary journals:

  1. The Cash Disbursement Journal is a chronological record of checks that are written, categorized using the chart of accounts.
  2. The Cash Receipts Journal is a chronological record of all deposits that are made, categorized using the chart of accounts.
  3. The General Journal is a record of all transactions which do not pass through the checkbook, including non-cash transactions (such as accrual entries and depreciation) and corrections to previous journal entries.

As organizations mature, and handle greater numbers of financial transactions, they may develop subsidiary journals to break out certain kinds of activity from the primary journals noted above. The most common examples of subsidiary journals include:

    1. The Payroll Journal, which records all payroll-related transactions. This may be useful as the number of payroll transaction s grows and becomes too large to handle reasonably within the cash disbursements journal.
    2. The Accounts Payable Journal and Accounts Receivable Journal track income and expense accruals. These are useful for grouping income and/or expense accruals which are too numerous to track effectively through the general journal. Some accounting packages require you to set up all bills as accounts payable and all revenue as accounts receivable, eliminating the cash disbursements and receipts journals altogether.

The process of transferring information from the journals to the general ledger is called posting. Computerized accounting systems often require users to post all income and expense transactions through the accounts receivable and payable journals.

The accounting procedures manual is a record of the policies and procedures for handling financial transactions. The manual can be a simple description of how financial functions are handled (e.g., paying bills, depositing cash and transferring money between funds) and who is responsible for what. The accounting procedures manual is also useful when there is a changeover in financial management staff.

The accounting cycle may be requested schematically as follows:

financial transactions -> analyze transaction -> record transaction in journals -> post journal information to general ledger -> analyze general ledger account and make corrections -> prepare financial statements from general ledger information

The key tasks for maintaining the integrity of an accounting system include the following:

Trial Balance

In a manual system all balances from the general ledger are tallied on a monthly basis to make sure that debit balances equal credit balances. Once debits equal credits, financial statements can be prepared using trial balance amounts. Computerized accounting systems almost always produce a trial balance as a built-in report. Many software packages will not allow you to post an entry to the general ledger until the debit and credit balances are equal.

Bank Reconciliation

Each month you will need to reconcile the balance in your checkbook with the balance in your account according to your bank. This process has three basic steps:

  1. Compare deposits and checks as they are recorded in the checkbook with those reflected in the bank statement. Adjust any discrepancies.
  2. Adjust for bank charges or interest earned into the checkbook balance.
  3. Subtract uncashed checks from the bank s balance and add in checks you have deposited which are not yet reflected in the bank's balance

Your accounting system will change as your organization's needs and resources change. A new, small organization may only need to keep an accurate record of activity in its checkbook. As the number of transactions grows, that organization will add manual cash disbursements and receipts journals, but may still prepare monthly reports using a summary sheet of income and expense items. Finally, as the organization acquires assets other than cash, accruals are added, and transactions become more complex, a full general ledger system will need to be incorporated. As their volume and complexity grow, the financial management activities will also require increasingly sophisticated staffing, whether by paid or volunteer staff or a combination of staff and outside service providers. An accounting system is only as good as the staff's ability to put it into practice, and should be designed with its users in mind.
Many small nonprofits use cash-basis rather than accrual-basis accounting to record expenses and revenues. This means that they only record revenue when the cash is received and only record expenses when they are paid. Some nonprofits use a modified-cash basis of accounting. They will record payroll taxes withheld from employees or large revenue or expense items on an accrual basis. This means recording revenues when they are earned and expenses when obligations are incurred. Most businesses track all expenses and revenue s using accrual accounting.
In a multi-program organization, all costs can be divided into two different types: direct and indirect. Direct costs are those which are clearly and easily attributable to a specific program. For example, the cost of new basketballs is clearly related to the after-school athletics program. Similarly, it is easy to justify charging counselors salaries to the counseling program.

Indirect costs are those which are not easily identifiable with a specific program, but which are, nonetheless, necessary to the operation of the program. These costs are shared among programs and, in some cases, among functions (program, management and general, and fundraising). The executive director's salary is a common example of an expense which benefits all programs and functions. Other indirect, or shared, costs may include rent, telephone, postage, printing and other expenses which benefit all programs and functions of an organization.
One method of allocating indirect costs is to determine a rate of actual usage for each program. For example, you may decide to keep track of long distance telephone calls and charge them to the appropriate program when you pay the phone bill each month. Similarly , some organizations use a counter or log to track copying expenses for each program and/or function. Time sheets may form the basis for allocation of salaries for the executive director, accountant, and staff whose work benefits more than one program or activity. A different method can be adopted for each line item or case.The advantage of this method is that it seems to "make sense." A major disadvantage, however, is that it often requires a great deal of time consuming record keeping

There are several measures used to determine the proportion of indirect costs to allocate (apply) to each program. The following simple example illustrates an indirect cost rate based on the relationship between total indirect costs and total direct costs:
Example 1- The Tadpole League
The Tadpole League has a total budget of $3,300. The budget is distributed as follows:

  1. Program A has direct costs of $1,000
  2. Program B has direct cost of $2,000
  3. Inderect costs to run the programs is budgeted at $300
  4. Total costs are $3,300

Since Program A's direct costs are one-third of the total direct costs of the agency ($1,000 out of $3,000), it should bear one-third of the indirect costs. Similarly, since Program B incurs two-thirds of the total direct costs of the agency, it should bear two- thirds of the indirect costs, as well.

The Tadpole League can create an indirect cost rate which will allow it to easily accomplish this allocation. An indirect cost rate (using direct costs as a base) is established by dividing the total indirect costs by the total direct costs. For the Tadpole League the indirect cost rate is:

Total Indirect Costs divided by Total Direct Costs = $300/$3,000 = 10 percent of total costs

Each program s share of indirect costs can be calculated as a proportion of its direct costs:

  1. Program A indirect expenses: $1,000 x 10% = $100
  2. Program A indirect expenses: $2,000 x 10% = $200

Total indirect expenses = $300

After the indirect costs have been allocated to the programs, the budget now reads as follows:

  1. Program A has direct cost of $1,000, indirect cost of $100 = $1,100
  2. Program B has direct cost of $2,000, indirect cost of $200 = $2,200

Total costs are $3,300

This illustrates that after Program A has picked up its fair share of indirect costs, the true cost of running Program A is $1,100. As you can see from this example, using direct costs as a basis for your indirect cost rate will result in larger programs being charged with more of the indirect costs than smaller programs.

Cash-basis and accrual-basis accounting use different criteria for determining when to recognize and record revenue and expenses in your financial records. On a cash-basis revenues are recognized when cash is received and deposited. Expenses are recorded in the accounting period when bills are paid. In accrual-basis accounting, income is realized in the accounting period in which it is earned (e.g., once contracted services are provided, grant provisions are met, etc.), regardless of when the cash from these fees and donations is received. Expenses are recorded as they are owed (e.g. when supplies are ordered, the printer finishes your brochure, employees actually perform the work, etc.), instead of when they are paid.

To illustrate, let's take a simple example. At the end of a summer camp's fiscal year, it has recorded the following deposits and expenditures. A balance sheet has also been prepared to show the camp's assets, liabilities and fund balance.

Example of Cash-Basis Balance Sheet

September 1 - August 31, 19xx

















$ 3,000



$ 127




Property, Plant and Equipment


Fees from Campers








Accumulated Depreciation


Total Income



Net Fixed Assets

















Food and Supplies



Loan from President

















Printing and Postage





Total Expenses





Since the information was taken from activity in the checkbook, we know these statements were produced on a cash basis. However, some pertinent information has not been recorded. For example,

    • A foundation has given the camp a grant of $10,000 to provide scholarships for low-income children. The children did attend the camp, but the foundation has not yet sent in the check.
    • Because cash is tight, the camp has not paid the final installment to their printer for this year's brochure. They owe her $1,500.
    • The insurance premium was paid in December, and covers the period December through November. So, it is good for another three months.

To take these three factors into consideration on the financial statements, revenues and expenses need to be recorded on an accrual basis. Several line items need to be added to the balance sheet in order to update the financial statements. These are:

Accounts Receivable

Reports revenues which have been earned, but not yet received. For example, a payment from a government grant which has been vouchered, but not yet received is an account receivable. In this case, the camp has a grant receivable of $10,000, since the children have already attended the camp and the camp has therefore "earned" the scholarship money from the foundation.

Increase grant income by $10,000 to $13,000
Increase grants receivable to $10,000

Accounts Payable

Reports expenses which are owed to others. The money owed to the printer for completing the brochure is a $1,500 account payable.
Increase printing expenses by $1500 to $5000
Increase accounts payable to $1500

Prepaid Expenses

Reports expenses which have already been paid, but are for a future period. In this example, three months of insurance is considered a prepaid, rather than a current, expense.
Decrease insurance expense by $1,050 ([$4,200/12 months] x 3 months) to $3,150
Increase prepaid expense to $1,050

Reported on an accrual basis, using the categories described above, the camp's financial statements now look as follows:

Example of Accrual-Basis Balance Sheet

September 1 - August 31, 19xx

















$ 13,000



$ 127




Accounts Receivable


Fees from Campers



Prepaid Expenses





Net Fixed Assets


Total Income




















Food and Supplies



Accounts Payable





Loan from President












Printing and Postage





Total Expenses





This example illustrates how preparing financial statements on an accrual basis, using these categories, will give a much more accurate and complete picture of an organization's financial condition. However, cash-basis accounting is easier to use on a day-to-day basis since there are fewer transactions to track. For this reason, many nonprofits, especially those with smaller budgets, choose to keep their books on a modified cash-basis. This means they do one or more of the following:

    • Keep the books on a cash basis and prepare reports on an accrual basis. One way to accomplish this is by making accrual adjustments for receivables, payables, etc. on a worksheet and incorporating this information into the financial statements, without formally entering it into the books.
    • Record small transactions (e.g., under $100) on a cash basis, but larger transactions and withheld payroll taxes are recorded on an accrual basis.
    • Record income on a cash basis and expenses on an accrual basis. This is the most conservative method for recording income and expenses, since you only report cash which has actually been received, but you include expenses whether or not they have been paid.

Your chart of accounts, which is a list of each account that the accounting system tracks, should be designed to capture the financial information you need to keep track of your financial information and make good financial decisions. Only information recorded with an account code from the chart of accounts will be recorded into the financial records, and from there into financial reports. The chart is divided into five categories: assets, liabilities, net assets or fund balances, revenues, and expenses. Each account is assigned an identifying number for use within the accounting system.

Account categories are presented in a standard order, beginning with the accounts presented in the Statement of Position (Balance Sheet.) These are:

    • Assets
      Assets are the tangible items an organization has as resources, including cash, accounts receivable, equipment and property. Assets are usually listed in descending order of liquidity. This means that cash and other assets which are easily converted to cash are listed first, and fixed assets such as property and equipment are listed last. Asset accounts usually start with the number "1."
    • Liabilities
      Liabilities are obligations due to creditors, such as loans and accounts payable. Current liabilities, those obligations which fall due within the next year, are usually listed first, followed by long-term liabilities. Accounts payable and payroll taxes payable are usually listed before other payables. Deferred revenue and other liabilities are often further down on the list. Liabilities often begin with the number "2."
    • Net Asstes (or Fund Balances): Nett assets, formerly referred to as the fund balance(s), reflect the financial worth of the organization. They represent the balance remaining after obligations are subtracted from an organization's assets. Accounting software designed with for-profits in mind may report net assets under the heading "equity." Organizations which only receive unrestricted gifts will have only one net asset account. Those with temporarily or permanently restricted net assets, such as endowments will have more than one net asset account. Net asset accounts begin with the number "3."

   Sample Chart of Accounts













7110     Salaries & Wages of Officers, Directors, etc.           



Checking Account






Petty Cash





Savings and Temporary Cash Investment


7210       Other Salaries & Wages


Accounts Receivable


7310       Payroll Taxes, etc.


Allowance for Doubtful Accounts



FICA Payments (Employers 'share)


Pledges Receivable



Unemployment Insurance & Taxes


Allowance for Doubtful Accounts



Workers, Compensation Insurance


Grants Receivable



Disability Insurance







Prepaid Expenses


7520       Accounting Fees






Audit & Accounting Fees





Bookkeeping Services "Outside





Payroll Services "Outside






Bank Service Charges






7710    Supplies


Accounts Payable





Loans from Trustees & Employees


7810    Telephone


Mortgage Payable


7910    Postage & Shipping







Net Assets









8010   Occupancy


Current unrestricted net assets


8011   Office Rent






8012    Janitorial &

Service Fees










8110   Equipment Rental & Maintenance


Contributions (Direct Mail)





Special Events (Gift Portion)


8210    Printing & Duplicating








Donated Services and Use of Facilities


8220   Publications








Corporate Grants





Foundation Grants


8310   Travel


Government Contributions








8710   Insurance


Sales to Public of Program-Related Inventory





Other Program Service Fees





Membership Dues "Individuals




Nonprofits are required to record the purchase of long-lasting, substantial property and equipment (such as computers, vans, buildings, etc.) as assets in the financial records, and to charge a portion of the cost of those items to each year in which they have a useful life. This process is called capitalizing and depreciating fixed assets. For example, suppose that on January 1st an organization acquires a computer with an estimated useful life of four years. The computer costs $2,500. When the purchase is recorded, the following journal entry is made:

Fixed Assets (increase by)




Cash (decreases by)



Explanation: To record the purchase of a computer for $2,500

At the end of each of the next four fiscal years, including the current year, the following journal entry will be made:

Depreciation Expense (increases by)
($2,500/4 years = $625 per year)




Accumulated Depreciation (increases by)



It is very important to remember that the cash for the computer was spent in the first year. However, one-fourth of the expense for the computer will appear on the Statement of Activity (Income Statement) for each of the four years it is deemed to have a useful life. Therefore, in the three years after the purchase a depreciation expense of $625 will appear on the financial statements even though no cash was expended during those years. Accumulated depreciation, as the name implies, reports on the amount of depreciation which has accumulated over time. By the end of the first year, one-fourth of the computer will be depreciated. At the end of the second year, two-fourths (i.e., one-half) will be depreciated. By the end of the fourth year the computer will be fully depreciated. In other words, the full cost of the computer will have been recorded as an expense. The fixed asset portion of the Statement of Position (Balance Sheet) will represent this accumulated depreciation for the computer as follows:

 Year 1


 Computer (cost)


 Less: Accumulated Depreciation


 Net Fixed Assets


 Year 2


 Computer (cost)


 Less: Accumulated Depreciation


 Net Fixed Assets


Over the remaining two years, accumulated depreciation will increase by $625 per year and net fixed assets will decrease by $625 per year, until accumulated depreciation is $2,500 and net fixed assets is zero. In this example, the organization determined that the useful life of the computer was four years, and that at the end of that time the computer would have no remaining value. Most nonprofits charge an equal amount of depreciation expense to each year of the asset useful life. This is called straight-line depreciation. To calculate depreciation charges for each fixed asset, you must know how much the asset cost (including all costs necessary to make the asset operational), how long the asset can reasonably be expected to last before it needs to be replaced, and whether the item will have any salvage value at the end of its useful life. Since there are certain conventions for items such as computers, vehicles, furniture, buildings, and other fixed assets, you should consult with your accountant when estimating the useful life of a new capital purchase. Since depreciation expense is a non-cash expense (that is, cash is usually paid out in the year the asset is acquired, but the expense is distributed over several years), it is important to plan for the replacement of fixed assets as they wear out or become obsolete.

An audit is a process for testing the accuracy and completeness of information presented in an organization’s financials statements accepted accounting principles.”

The board of directors of a nonprofit organization has a responsibility to safeguard the organization's assets, and to ensure that funds are used to further the organization's goals. In addition, the board must ensure that donor designations are honored, and that cash and other investments are managed wisely.
 Specifically, the board should review three areas related to investments:

Cash management refers to ordinary transfers, usually of small amounts, between the checking account and other liquid accounts such as savings accounts. For example, if an organization anticipates having excess cash for a few months, the organization may open an account that earns more interest and temporarily hold cash there.
While these tasks are typically managed by staff, the board has a responsibility to oversee cash management and periodically review staff work. In most boards, the finance committee meets periodically with finance staff to review cash management guidelines and practices.

Endowment funds, also called permanently restricted net assets, are created when donors designate contributions to a fund where the principal amount of the gift (the amount of the contribution) will not be spent, but will be maintained in perpetuity, for the purpose of producing income for the organization. In a term endowment fund the donor has specified that, after a stipulated passage of time or after the occurrence of some event, the principal amount may be spent as well. Most endowment funds specify that the principal will be held in perpetuity, but that earnings on the principal may be used for the organization's operating expenses.

Whether assets belong in an organization's general fund, its endowment fund, or other fund, these assets should be invested wisely. Organizations with substantial assets often hire a portfolio manager. Organizations with fewer dollars to invest usually rely on the expertise of a board member or the finance committee.

The portfolio manager, typically employed at a bank, brokerage, or an investment advisory firm, is responsible for making in vestment decisions for the organization. The portfolio manager will meet with the finance or investment committee to learn about the organization's financial objectives and other concerns, and then make investment decisions throughout the year to meet those objectives. The portfolio manager should give the organization a monthly or quarterly written report which shows all the trades made in the period, the investments at the end of the period, and the value of each investment.

"Cash flow" management refers to the need to have cash come in -- flow in -- at the right times, so that it is available to flow out as needed. Everyone knows that if an organization has more expenses than income, sooner or later it will find itself in trouble. However, even if income matches or exceeds expenses in a given year, the cash fro m the income may not arrive in time to pay the bills as they come due. A cash shortage can be very disruptive to your ability to carry out your mission. To avoid disruptions of business or to take advantage of temporary cash surpluses, cash flow can and should be projected, monitored, and controlled. Projections of receipts and expenditures, which comprise cash flow, are typically developed as part of the budget process, so that you can anticipate and develop strategies for funding the shortages or investing the surpluses. (Many of these strategies are described later in this response sheet.) Cash flow projections follow a format similar to your budget. For each month, anticipate how much money you will receive and how much you will spend in each category.

As the year progresses, cash flow projections can be updated. By comparing budgeted cash flows to actual deposits and expenditures, and understanding the nature of any variances, you can strengthen your ability to accurately anticipate cash flow in the future.

Note: A cash flow budget or projection should not be confused with a financial statement called "Statement of Cash Flows." The statement describes changes in cash from year-to-year due to operating surpluses or deficits, makes adjustments for non-cash items such as depreciation, and shows increases or decreases in accounts payable an d accounts receivable. This statement is usually prepared by your auditor along with other financial statements during the audit. In a simple example, imagine an organization with no cash in the bank and a balanced budget, with $10,000 in revenue and $10,000 in expenses. If the income is received first, the organization will be able to spend it down as expenses are incurred. If, however, the expenses come in before the income, the organization cannot pay its bills until the cash is received. In this case, the organization has a problem with the timing of cash flow rather than a shortage of revenue or an excess in expenses.

At least two or three months before the beginning of your fiscal year you will want to start thinking about the budget for the upcoming year. The budget ordinarily corresponds to your fiscal year, which should be selected to reflect your organization's operating cycle.

The end products of the accounting process are the financial statements, summarizing all of the financial transactions of the organization for the period. Three primary financial statements:

  • Statement of Financial Position (Balance Sheets)
  • Statement of Activities (Income Statement)
  • Statement of Cash Flows

In addition, nonprofits must provide information about expenses as reported in their functional classifications (program services and supporting services.) Voluntary health and welfare organizations are also required to present a statement that reports expenses by their natural classification (e.g., salaries, rent, telephone, printing, etc.) Other nonprofits are encouraged to report in both formats as well.

The following briefly describes the information included in each statement.

The Statement of Financial Position Reports amounts of the organization's assets, liabilities and net assets (fund balances) at a specified date. This statement was previously known as the Balance Sheet.
Assets are properties and resources the agency owns and can use to achieve its goals.

Current assets include cash accounts, certificates of deposits and other investments, and items such as receivables which will be converted to cash within one year. Fixed assets include land, buildings and equipment.
Liabilities are debts of the organization, what is owed. Current liabilities typically include accounts payable to vendors, short-term loans due, withheld payroll taxes due, etc. Long term liabilities include long term debt, mortgages, etc.

Net Assets (previously called fund balances) represents the net of assets over liabilities. Three classes of net assets must be reported on unrestricted, temporarily restricted, and permanently restricted. Restrictions are determined by the conditions which donors place on their contributions.

Statement of Activities Reports revenues, expenses, and the resulting change in net assets for the year. Charges are reported for each of the three classes of net assets (unrestricted, temporarily restricted, and permanently restricted.) This statement was previously known as the Income Statement or Statement of Revenue, Expenses and Changes in Fund Balances.

Statement of Cash Flows Reports how the organization's cash position changed during the year. Cash flow information is divided among receipts and disbursements from investing, financing, and operating activities. Many nonprofits ask their auditors to prepare this statement.

Readers of financial statements can learn a great deal about the health of a nonprofit organization by examining the numerical information presented. In particular, financial information helps readers:

  • Measure the organization's efficiency, using factors such as:
  • Units of service produced compared to costs
  • Fundraising income compared to amounts spent on fundraising
  • Net income in a fee-producing program compared to the fees received
  • Evaluate the adequacy of financial resources, often through:
  • Liquidity ratios, such as the current ratio
  • Comparison of total liabilities or total assets with net assets (formerly called fund balance)
  • Cash flow projections
  • Seek significant financial trends by:
    • Vertical analysis (looking at a simple line item as a percentage of total   revenue or expense)
    • Horizontal analysis (comparing prior periods with the current period)

For different organizations, different numbers will have different meanings. For example, imagine an organization that shows an operating deficit for the year of $20,000. Is that a red flag? In a small organization with few reserves, such a deficit may indeed indicate serious over-spending of failure to generate revenue. In a large organization, $20,000 may represent less than one percent of revenue and may not be significant. Yet another organization may be purposefully spending down cash reserves on an important program and this "deficit" may represent that decision. For still another organization, a loss of $20,000 may not be a concern by itself, but because it represents the third consecutive year of deficits, does cause concern. Ratios, too, have different meanings in different situations. For example, a new organization may find it spent 90 percent of its dollars on fundraising. In an established organization, such a ratio would certainly be a red flag. But on closer look, this new organization's services are delivered by volunteers, and the only paid staff they have is a fundraiser.

In several cases, ratio analysis is used to evaluate the organization's financial health. Ratios are a tool for comparing numbers representing different aspects of an organization's financial status. The value of the tool is in identifying which numbers to compare, and determining what the comparison might indicate.

If income is greater than expenses within a given period, say a year, the organization has generated a surplus. If expenses are greater than revenue, the organization experiences a deficit for the period. There is no rule that says organizations should have surpluses, deficits, or break even. Typically nonprofits budget to break even. However, organization may deliberately decide to spend down their cash reserves (expandable net assets) for a specific purpose such as starting a new program. Doing so results in an operating deficit, but one which is planned. Similarly, if a nonprofit has determined that it needs a cash reserve for specific future purposes (cash flow, investing in a new program guarding against future declines in funding, etc.), the Statement of Activity should reflect an operating surplus. An "unplanned" surplus, deficit, or even a break even position should be analyzed to determine its causes and to plan for the implications.

As a conclusion, good financial management is important for the economic health of the business. Financial managers also must decide how to finance the firm, what mix of debt and equity should be used and what specific types of debt and equity securities should be issued. So the primary goal is to maximize the value of the firm. In addition, to achieve this goal he must understand how businesses are organized and how financial markets operates. Finally, accounting is the language of the business. This is because accounting is the means by which business information is communicated to stockholders stakeholders use accounting reports as primary source of information on which they base their decisions.


  • Baum, Warren C. The Project Cycle. Washington, DC: The World Bank Group. 1982.
  • Salida, Anne C.M. Historical Dictionary of the World Bank. Maryland: Scarecrow Press, Inc. 1997.
  • Warren Reeve Fess , Financial Accounting, Eight Edition
  • Brigham Ehrhardt, Finanacial Management: Theory  and Practice,Thomson
  • Lebanon Opportunities, January 2006
  • Economics, Sept 2005




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