Nonprofit Financial Statements: An Introductory Guide

Three days before your quarterly board meeting, the treasurer emails everyone a thick PDF. You scroll through the agenda and land on page three. Numbers fill the next dozen pages. Assets, liabilities, net assets with donor restrictions. Revenue by source, expenses by function. Cash flows from operating activities. Your treasurer will walk everyone through these statements at Thursday’s meeting, but right now they feel more like hieroglyphics than helpful information.

Here’s what most nonprofit leaders know: the IRS requires these statements. Donors want to see them. Auditors scrutinize them. But here’s what matters more: these four documents reveal whether your organization can make payroll next month, whether that new program is financially sustainable and whether you’re burning through cash faster than you’re bringing it in.

Financial statements shouldn’t be compliance paperwork you endure once a year. They’re early warning systems that signal problems before they become crises. They’re decision-making tools that show you what’s actually happening with your money. When you understand how to read them and what they’re telling you, these statements become one of your most valuable management resources.

Why These Documents Matter

The Internal Revenue Service requires most tax-exempt organizations to file annual returns. Organizations that fail to file for three consecutive years automatically lose their tax-exempt status. Beyond compliance, financial statements reveal whether your organization can sustain its mission through economic uncertainty.

The Current Financial Reality

Recent data from the Nonprofit Finance Fund’s 2025 survey paints a sobering picture. Among 2,206 organizations surveyed, 36% ended 2024 with operating deficits, the highest percentage in ten years of survey data. Over half reported having three months or less of cash on hand.

These numbers aren’t abstract statistics. They represent food banks rationing supplies, youth programs cutting staff and community health centers delaying facility repairs.

Who Reads Your Financial Statements

When donors check GuideStar or ProPublica before contributing, your financial statements tell them whether you manage resources responsibly. Grant applications increasingly require detailed financial documentation. Board members need accurate information to make strategic decisions. Vendors want assurance you can pay invoices. Your financial statements speak to all these audiences simultaneously.

The Four Required Statements

Every nonprofit recognized as tax-exempt must prepare four core financial statements annually. Each statement provides a different perspective on your organization’s financial health, and together they create a comprehensive picture of fiscal responsibility.

Statement of Financial Position

Your statement of financial position captures your organization’s financial health at a specific moment. Assets appear first, listed by liquidity. Cash comes before accounts receivable, which precedes property and equipment. Liabilities follow, organized by payment timeline.

The difference between total assets and liabilities reveals your net assets. Current standards require classifying net assets into two categories: those without donor restrictions and those with donor restrictions. This simplified structure replaced the previous three-class system, making it easier for stakeholders to understand which resources remain available for operations.

Statement of Activities

The statement of activities functions like an income statement but focuses on changes in net assets rather than profit. It separates restricted from unrestricted revenue, tracks program income against expenses and demonstrates how effectively you deployed resources to advance your mission.

This statement shows whether contributions grew or declined, whether program revenue covered costs and whether administrative expenses stayed within reasonable bounds.

Statement of Cash Flows

Your statement of cash flows breaks down how cash moves through operating, investing and financing activities. Operating activities show cash from core mission work. Investing activities reflect long-term asset purchases or sales. Financing activities track loans and debt repayment.

With 52% of nonprofits operating on three months or less of cash reserves, this statement has become critical for understanding liquidity. You might show healthy net assets on your balance sheet while struggling to make payroll because most resources remain restricted for future programs.

Statement of Functional Expenses

The statement of functional expenses provides transparency about resource allocation. You must report expenses by both nature, such as salaries and rent, and function, such as program services versus administration. Organizations also must disclose their allocation methodology.

For example, Charity Navigator and GuideStar use this information when rating nonprofits, making accurate reporting essential for public credibility.

How Financial Statements Feed Form 990

Form 990 pulls directly from your four core statements. The statement of financial position provides data for Part X. The statement of activities feeds Parts VIII and IX. Part IX pulls from the Statement of Functional Expenses rather than the Statement of Activities. Your functional expense allocation appears where the IRS and public see how much you spend on programs versus administration and fundraising.

The Importance of Board Review

Discrepancies between audited financials and Form 990 create problems. Board members should review Form 990 before filing. The form asks whether your board completed this review. Answering no raises questions about governance.

Form 990 becomes public once filed. Potential donors often review your most recent filing before making major gifts. They examine numbers but also evaluate how clearly you present your mission and operations. The narrative sections provide opportunities to highlight accomplishments, explain approaches and demonstrate impact.

Common Implementation Challenges

Even well-managed nonprofits encounter recurring obstacles when preparing financial statements. Understanding these challenges and implementing practical solutions strengthens both accuracy and efficiency.

Manage Restricted Funds

Managing restricted versus unrestricted funds presents ongoing challenges for many nonprofits. Donors place restrictions on contributions for specific programs, time periods or purposes. You must track these restrictions carefully while maintaining adequate unrestricted resources for operations.

Effective fund accounting systems that tag restricted revenue at entry and monitor expenditures prevent common problems like spending restricted funds for unintended purposes.

Cash Flow Problems

Cash flow management becomes particularly difficult when you hold significant restricted assets but face shortages for daily operations. This situation demands proactive forecasting that looks beyond total assets to focus on liquid, unrestricted resources. Establishing operating reserves provides a buffer against temporary shortfalls.

Expense Allocation Methodology

Functional expense allocation requires careful methodology and consistent application. Direct costs like program staff salaries are straightforward. Shared costs like rent and utilities need allocation formulas that withstand scrutiny.

Documenting your methodology matters because Form 990 now requires disclosure of how you allocate expenses.

Year-End Close Procedures

Year-end close procedures challenge many organizations. Establishing a detailed checklist that includes reconciliation requirements, cutoff procedures and documentation standards ensures consistency. Regular reconciliation throughout the year rather than scrambling at year-end reduces errors and stress.

Build Financial Confidence With Expert Support

Strong financial statements demonstrate accountability and support strategic decision-making. Board members need context about why transactions appear in specific categories. Executive directors benefit from seeing how daily decisions affect year-end reporting. Finance committees should meet regularly to review interim statements and address concerns before they become problems.

Annual reports should include narrative sections helping donors understand the numbers. Board presentations need visual elements highlighting key trends without overwhelming attendees with detail.

We understand the unique challenges nonprofits face, from managing donor restrictions to preparing Form 990 filings that meet IRS requirements. Whether you need full-service accounting support or targeted assistance with year-end close and audit preparation, we provide the expertise your organization deserves.

Contact us to discuss how our accounting and controllership services can strengthen your nonprofit’s financial foundation.

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