Navigating Government and Nonprofit Financials

Many investors have some understanding of typical financial statements like the balance sheet, income statement and cash flow statement but governmental and nonprofit financial statements may be significantly less familiar.

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? It’s important to understand the different financial statements for these nonbusiness organizations (NBOs) so you can be sure where your money is going.

Key Takeaways

• Government and nonprofit organizations use an accounting system called fund accounting.
• Governments aren’t trying to make a profit so they treat their money distinctively.
• There are three major classifications of funds in a government: proprietary, governmental, and fiduciary.
• Every governmental organization in the U.S. and Canada must release a Comprehensive Annual Financial Report (CAFR) each year.

What Is Fund Accounting?

Government and nonprofit organizations aren’t interested in making money so they use an accounting system called fund accounting. They’ll often use specialized accounting software that’s designed to meet their financial reporting obligations.

Fund accounting groups financial data together into funds or accounts that share a similar purpose. This gives the organization a better idea of what resources it has available to complete a specific task. Fund accounting typically isn’t a topic that’s enjoyed by people who are used to the concepts of for-profit accounting.

Understanding what fund accounting is and how it works is nonetheless 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 a distinctive way because they’re not trying to make a profit. A government ideally wants expenditures to be very close to revenue in any given year.

Differences between revenues and expenditures are referred to as surpluses (a positive difference) or deficits (a negative difference). A surplus isn’t a profit, however, nor is a deficit a loss. Governments aren’t in the business of hoarding money nor are they “in business” at all. A government will usually take steps to lower the tax burden for its residents if it finds itself operating at a large surplus or profit,

Government/NBO Funds

Knowing what the various funds represent can be useful in the analysis of governmental financial statements. There are three major classifications of funds in a government:

1. Governmental funds: These are used to provide services for which expenditures aren’t met by the fees that are charged for them.
2. Proprietary funds: These funds are used to account for business-type activities such as trash collection where the services are completely paid for by charges to the customer.
3. Fiduciary Funds: This money is used to account for funds that are held in the interest of a third party such as a pension fund. They aren’t reported in governmentwide financial statements because they’re not government-owned assets.

Governmental Reporting

Every governmental organization in the U.S. and Canada releases a Comprehensive Annual Financial Report (CAFR) annually. The formats and contents can vary but 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.

Important

CAFRs are prepared according to GAAP and Governmental Accounting Standards Board (GASB) regulations.

CAFRs often present financial information for individual funds or at least significant funds as well as governmentwide financial statements that show the position of the government as a whole. Governments use modified accrual accounting for their statements. They include reconciliations explaining how they made the switch from cash-basis accounting that is typically used throughout the year to the modified accrual basis in which they report.

Governments present their consolidated financial statements in the CAFR. Some have other names but these statements essentially mirror the for-profit statements.

The MD&A is a very useful portion of the CAFR that gives quite a bit of insight into the decisions made by a government’s decision-makers. The MD&A typically has quite a bit more content than the managerial discussions found in the annual reports of business organizations.

Nonprofit Reporting

Like governmental organizations, nonprofits aren’t in it for the money. They also use fund accounting and offer financial statements to the public each year.

Nonprofits straddle the fence between the private sector and the government. They’re not out to make a profit, either, so fund accounting provides the best system for most nonprofit organizations. The same fundamental ideas apply to nonprofit accounting as governmental accounting. The goal is for annual expenditures to end up very close to annual revenues.

Nonprofits don’t publish CAFRs. Their reports will instead be referred to as a Report of Consolidated Financial Statements. The statements for both governmental and nonprofit organizations are very similar, however. Three nonprofit financial statements are common.

Analyzing the financial statements of a nonbusiness organization shouldn’t be too much of a stretch if you’re at all familiar with the analysis of for-profit financial statements and if you understand what each statement is supposed to be.

Nonprofit organizations report using accrual basis accounting and Financial Accounting Standards Board and GAAP standards.

Government and nonprofit financial statements can typically be found on the organization’s website or you can call them and request a copy.

Make Your Voice Heard

It’s essential to determine from your review of an NBO’s financial statements whether you feel that the organization is treating your money prudently. Don’t give it your money if you find a nonprofit organization with exorbitant operating expenses. Hold your politicians and governmental employees accountable 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.

What Is GAAP?

GAAP is the abbreviation for Generally Accepted Accounting Principles. It’s the brainchild of the Financial Accounting Standards Board (FASB) and the Governmental Accounting Standards Board (GASB). All publicly traded companies and any entity that releases its financial statements to the public is required by U.S. law to adhere to GAAP financial and accounting standards.

Do I Get a Tax Break for Investing in a Nonprofit?

An investment in a nonprofit is treated the same as any other type of investment, subject to capital gains on growth and profit. You can claim a tax deduction for contributions you make to qualified organizations, however. The word “contribution” is key here. You’re giving them money rather than investing with the hope of getting your money back plus a gain at a future date.

The IRS allows you to claim a tax deduction of up to 100% of your adjusted gross income (AGI) or the amount of your cash contribution, whichever is greater, if you give to a qualified organization. You must itemize your deductions on your return to do so, however.

What Is Accrual Accounting?

Accrual accounting is the process of recording revenues at the time they’re earned rather than when they’re received. Expenses are recorded when they’re incurred even if they’re not yet paid. The process accommodates the general operations of a business in which the totals of expenses and revenues aren’t always exchanged for payment at the same time.

The Bottom Line

It’s madness to not look at a governmental financial statement just as you would for any other substantial investment given the amount of money you pay in taxes. Donating money blindly without making sure that it’s getting to those who need it is the same. You must approach it as an investment decision on some level.

You can make sure that you’re getting the most for your money with a little knowledge about how governmental and nonprofit financial statements work even if you’re not expecting anything more than a warm, fuzzy feeling as a return on your investment.