Local government finance departments are frequently asked to evaluate the financial stability of nonprofit organizations. This could be nonprofits that the government is already working with, or to which it is considering making a grant.
In such cases, the finance department should evaluate the nonprofit organization’s financial condition. It is wise to answer questions, such as ‘is the nonprofit strong enough financially to continuously operate for at least the time specified in the contract?,’ before starting a working relationship or providing funds to the nonprofit.
The same questions should be answered for companies that a government is working with or considering working with, such as software vendors, franchisees or construction contractors.
What are the steps for evaluating a nonprofit organization’s financial stability?
The first thing to do is to obtain the three most recent years of financial statements for the organization. The level of detail and number of years that you should review will vary, depending on the importance of the nonprofit to the local government’s success.
However, the following five questions are commonly the minimum concerns you should address and verify when reviewing the organization’s financial statements:
If any of these five questions above indicate increased risk, it is appropriate to have further conversation with entity management to determine:
a) whether there are good reasons and explanations for the risks noted (e.g., unrestricted net assets of less than 30 days of operating expenses may be acceptable if they have quick access to capital of a parent organization or a “white knight” funder); and /or
b) to agree on how they can mitigate the noted risks (e.g., improving their current ratio before entering into a contract with the local government).
Of course, the five financial strength considerations above represent only a simple review of the most important elements of an entity’s financial stability. If a more thorough assessment is desired, there are many other elements of financial strength you may want to consider, such as:
Please contact Kevin Harper directly if you’d like further help on how to evaluate an organization’s financial stability beyond and/or after the factors explained above.
Kevin Harper, CPA
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