Board members and new staff from a for-profit background don’t always grasp the differences between the for-profit and not-for-profit ("NFP") worlds. One area of significant variation is their financial reporting approach, including both goals and practices.
Chasing different goals
As the term suggests, for-profit companies are driven by the quest to maximize profits for their owners. NFP's, on the other hand, are generally motivated by a charitable purpose. From a financial perspective, they just want their revenue to cover the costs of fulfilling their mission now and in the future.
Their respective financial statements reflect this difference. For-profits report mainly on profitability and increasing assets, which correlate with future dividends and return on investment to owners and shareholders. NFP's report on their financial position, stability and how their funds are used to funders, board members and the community.
Reporting assets and liabilities
For-profits and NFP's use different financial statements for their reporting of assets and liabilities. For-profit companies prepare a balance sheet that lists the owner’s or shareholders’ equity, which is based on the company’s assets, liabilities, and prior profits. The equity determines the value of a company’s common and preferred stock.
NFP's, which have no owners, prepare a statement of financial position, which also looks at assets, liabilities, and prior earnings. The resulting net assets are classified as: 1) unrestricted, 2) temporarily restricted and 3) permanently restricted, based on the presence of donor restrictions.
The classes will soon be reduced to two: 1) net assets without donor restrictions and 2) net assets with donor restrictions. This change will take place when adherence to the new Accounting Standards Update (ASU) No. 2016-14, Not-for-Profit Entities (Topic 958): Presentation of Financial Statements of Not-for-Profit Entities, is required for fiscal years beginning after December 15, 2017.
Another key difference: NFP's are generally more focused on transparency than are for-profit companies. Thus, their financial statements and footnotes include disclosures about the nature and amount of donor-imposed restrictions on net assets. The new standard will require more disclosures on the amount, purpose and type of board designations of net assets. Additional disclosures will be required to outline the availability and liquidity of assets to cover operations in the coming year.
Reporting revenues and expenses
For-profits and NFP's also take different reporting approaches to revenues and expenses. For-profits produce an income statement (also known as a profit and loss statement), listing their revenues, gains, expenses and losses to evaluate financial performance.
NFP's often rely on grants and donations in addition to fees for service income. So they prepare a statement of activities, which lists all revenue less expenses, and classifies the impact on each net asset class.
Many NFP's currently produce a statement of functional expenses. But when the new accounting standard kicks in, organizations will be required to classify expenses by both nature (meaning categories such as salaries and wages, rent, employee benefits, and utilities) and function (mainly program services and supporting activities). This information will need to be expressed in a grid format that shows the amount of each natural category spent on each function.
Similarities remainDespite their different approaches, for-profit and NFP organizations share some financial reporting similarities, too. Both must carefully track all of their transactions, maintain supporting documentation, and produce accurate, timely financial statements. And both can benefit from the services of LGT's qualified financial professionals with knowledge in areas specific to your organization.
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