Like any other organization, a nonprofit is evaluated by a wide assortment of entities like donors, investors, bankers, creditors, public watchdogs and government to get a picture of its financial position before donating, lending or accrediting the organization. IRS also seeks a lot of periodical information from organizations which enjoy tax exempt status. Form 990, which is submitted by organizations to IRS at the end of each year, becomes a child’s play if the proper financial statements are in place.
Towards these ends, all nonprofit organizations in U.S.A must prepare 5 essential documents at the end of each financial year. They are:
I) Statement of activities (aka income statement): Record of income earned and all expenses incurred by the NPO during the year that passed.
Shows whether the nonprofit organization earned income or incurred suffered a loss resulting in decreases in equity or net assets.
II) Statement of financial position (aka balance sheet): Record of assets owned and liabilities owed by the NPO as on end of the year.
Shows whether the organization owns fixed assets and whether it is solvent enough to pay its short term liabilities. At end it shows the ‘net worth’ of your organization, which is the difference between what the organization owns (assets) and what it owes (liabilities).
III) Cash flow statement: Record of all cash transactions of the NPO (inflows & outflows)
Appraises all cash inflows and outflows in three transaction categories:
1) Cash flow in operating activities
2) Cash flow in financing activities
3) Cash flow in investing activities.
IV) Statement of functional expenses: A breakdown of the organization’s expenses into 4 categories: a) Program expenses, b) Management expenses and C) General expenses d) fundraising expenses.
V) Notes to the financial statements: The notes section tells the story behind the numbers. This statement includes a literal explanation of major income, expenses, accounting procedures and other material disclosures that cannot be noted in numbers and dollars.
All accounting and book-keeping activities of nonprofit organizations are directed towards and culminate into preparation of these 5 documents at the year end.
In addition, large nonprofit organizations are required to undergo an external audit. They are required to furnish an Independent auditor’s report towards that end.
See: When audit is required?