A Guide to Financial Statements of Not-For-Profit

Q U E S T I O N S F O R D I R E C T O R S T O A S K1 Introduction The Importance of the Sector and the Role of Directors in Oversight of Financial Affairs It is estimated that 12.5 million Canadians volunteer with not-for profit organizations (NPOs). Many of these volunteers serve as members of their organization’s board of directors.1 NPO boards are responsible for overseeing the affairs of organizations that constitute about 7 percent of Canada’s GDP, generate annual revenues of approximately $80 billion and provide 2 million full-time jobs for Canadians.2 Being a director in the NPO sector is a vitally important role. Board members in the NPO sector have a wide variety of skills and interests. Some may feel uncomfortable reviewing financial information and may be poorly equipped to provide the required oversight of the financial affairs of the organizations which they have been elected to govern. This gap presents a threat to the sustainability of the organization. It may also expose individual board members themselves to legal liability. The bottom line is that overseeing the financial affairs of NPOs is a key responsibility of the board, and of every member of the board. Directors have a “fiduciary duty” to their not-for-profit organization to act honestly and in good faith in the best interests of the organization. This responsibility is sometimes referred to as the “duty of loyalty”, but it is much broader than just loyalty. It speaks to concepts such as the duty of confidentiality and not participating in decisions in which the director may have a personal interest. Directors also have a “duty of care” that requires them to act with the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances. This obligation means that directors must diligently apply their skill, expertise, education and intel- ligence to the job of being a director to make reasonable business decisions. Directors have fiduciary responsibilities to take steps to ensure that funds are spent in accord- ance with donors’ or funders’ criteria, that statutory obligations are fulfilled, such as payroll deductions being remitted to the Canada Revenue Agency, and that internal controls are in place to avoid the occurrence of fraudulent transactions within the organization. A proper understanding of the financial statements and information provided to the directors assists the directors in fulfilling these responsibilities. A board can delegate the work to prepare financial information, but the board as a whole is ultimately responsible for financial reporting. Indeed, one of the fundamental roles of the board of directors is stewardship of the organization’s resources. This duty includes the responsibility to protect the organization’s assets and to oversee its financial affairs. Financial statements are the primary means of communicating information about the organization’s financial position (at a point in time) and financial results of its operations (over a period of time). Though financial information is not the only information required to develop an understand- ing of the organization, it is a key component. Financial information is typically measurable, objective, comparable over time, sometimes comparable across organizations, and can provide an indicator of organizational health. Board members require the ability to understand various financial statements in order to discharge their stewardship responsibility to the organization. Each board member does not need to have financial expertise, or to be a financial expert, but all directors should develop a basic level of financial literacy. This Guide for NPO Directors aims to provide a practical tool to help board members understand financial concepts and com- 1 Statistics Canada, Survey of Giving, Volunteering and Participating, 2007 2 Statistics Canada, Satellite Account of Nonprofit Institutions and Volunteering, 2007 A G U I D E TO F I N A N C I A L S TAT E M E N T S O F N OT- F O R - P R O F I T O R G A N I Z AT I O N S2 prehend financial statements. Most importantly, this Guide will help directors focus on certain elements in the financial statements and understand how they can use that information to critically assess and oversee their organization’s financial affairs. Some Common Barriers Impeding Full Board Participation in Financial Oversight We have an experienced accountant on our board—why should I have to deal with this? Financial experts such as accountants bring a valuable skill set to the board table, along with their field experience and their professional mindset. They are in a strong position to help their board peers deepen their understanding of financial matters. Organizations with a financial professional on the board are fortunate and should use that person as a resource. Further, that director should expect to play a key role in the oversight of financial affairs, perhaps by becom- ing a member of the audit or finance committee of the board. (In some NPO organizations, the functions of these two committees are combined into one board committee.) However, as noted above in the “duty of loyalty”, board members cannot abdicate their responsibility or transfer it to another board member. Each and every board member must fulfill his/her obliga- tions for the oversight of financial matters to the best of his/her ability. Shouldn’t the board be focusing on our organization’s mission? The ultimate goal of every not-for-profit organization, and hence every organization’s board, is the achievement of its mission. Consequently, a significant portion of the board’s time and energy needs to be focused on the organization’s mission and progress in achieving it. However, the organization must protect its assets, pay its bills, compensate its employees, receive and manage donations, and undertake a host of other financial activities. Doing so in an efficient and effective manner is critical to achieving its mission. An organization that is not financially secure cannot focus on achieving its mission, as efforts of the board and management are directed to financial survival. Accounting is just too complex for me! Accounting is indeed a complex subject. There are various financial concepts and accounting principles. However, all board members do not need to be accounting experts. Directors should strive to acquire a basic understanding of financial matters, and a basic ability to read, assess and question financial statements and other financial information. Turning to experts for assist- ance and advice is entirely appropriate, but making final decisions within the context of the organization’s total financial picture is the responsibility of every member of the board. Isn’t this the job of the auditor3 or of management? The auditor and management both have important and distinct roles to play in ensuring fair and complete financial reporting for the organization. So does the board of directors. Management is responsible for selecting the organization’s accounting policies and preparing, presenting and acting on financial information. The board is responsible for overseeing management and the processes for preparing financial information, and for satisfying itself that the resulting informa