Financial governance for NFP’s.

Hello I’m Lisa Gissing from Westpac’s Davidson Institute. Welcome to our video on ‘Financial governance for not-for-profits. Before we begin today, I would like to acknowledge the traditional owners of the land from which I am recording this video from, the Wiradjuri people, and pay my respects to elders past and present.

In Australia there are over 750,000 incorporated not-for-profits and that number rises into the millions when you include all the unincorporated organisations too. These organisations exist for a social purpose. These purposes are incredibly diverse but have one thing in common. To achieve their purpose, the organisations need money, and that money needs to be efficiently managed to ensure the organisation is able to achieve its purpose.

The effective management of money by an organisation is known as financial governance.

Before I get started I need to let you know that this presentations is general in nature and has been prepared without taking your objectives, needs and overall financial situation into account. For this reason, you should consider the appropriateness of the information to your own circumstances and, if necessary, seek appropriate professional advice.

We are going to cover a number of elements to day starting with • “Why do we need good financial governance?” and why it’s important to the organisation. • Secondly good financial governance starts with keeping good records. So, what records should you keep for your organisations?

• And thirdly, good financial governance is not just about keeping good records you also have to produce regular financial statements so that you and the board and anyone else that needs to know, knows what's going on financially. These financial statements measure how efficiently an organisation is managing its money & communicates that with board members, funding bodies etc … in fact anyone who needs to know what is going on financially.

Firstly, why it’s important to get the governance right. Let me pose you the question – why did you get involved with your organisation? It’s my experience that people get involved with an organisation because they are passionate about the outcomes that organisation provides to the community. Organisations operating in the social sector are established with the aim of enhancing life in some way for some one.

Whether it is a charitable organisation that provides food and shelter for the homeless, an organisation that provides services in the disability sector, or a sporting club or arts organisation, the aim is to improve the lives of people in our communities. It therefore stands to reason that we want to be able to do this efficiently and over a long period of time … that is, we want to be sustainable.

Therefore, understanding the regulatory framework that the organisation works within and the financial position of the organisation is critical for anyone involved in decision making in either a board or management capacity. Financial governance is one of the most important areas of any organisation as without good financial management and reports it is like running your organisation in the dark.

Good record keeping helps to build accurate financial reports to manage the organisation and supports auditing to show that the organisation is compliant. The records that need to be kept and checks and balances you put in place will depend on the constitution of the organisation, and it’s legal and financial structure.

While being compliant is important I believe good financial management is about achieving the purpose of the organisation. By providing, accurate, timely and more understandable financial information for the directors and staff they will be better able to allocate resources efficiently and be able to identify more quickly when things are going off track in your organisation.

The not-for-profit sector has a number of different government regulators depending on the size of the organisation, the legal structure of the organisation, and in some cases its purpose. Understanding the role each of these regulators plays, and knowing which applies to your organisation is the beginning of financial governance.

A key regulatory body for anything financial of course is the Australian Taxation Office. Even though your organisation may not pay income tax there are other regulations that you’ll need to comply with. If you’re a company, you need to comply with ASIC and if you’re a charity you will need to comply with the ACNC and provide them with financial information each year.

It’s not just about the government departments it’s also about how your organisation is structured. There are 3 common structures for NFPs in Australia • Un-incorporated Association • Incorporated Association and • Companies limited by guarantee.

There are other structures, but these are the main ones and it’s important to understand which structure your organisation uses because this will influence which of those regulatory bodies you need to comply with. This could be at national level like the Australian Tax Office and also state government departments or a combination of both. So, which governing body is relevant for your organisation?

If you’re an unincorporated association, you should have a constitution which is typically set up when the organisation was set up and contains all the rules by which the organisation is run and usually has information about the records you need to keep and whether your accounts need to be audited or not.

Companies limited by guarantee will typically have a constitution, sometimes known as a memorandum and articles of association, and you will be obliged to comply with ASIC regulations.

Regardless of the organisation structure you will probably at some stage have dealings with the Australian Tax Office. Whilst many not for profits don’t have to pay tax you may still be required to interact with the ATO. If you turnover more than $150,000 you need to collect GST on behalf of the government & return it to the tax office. But even if your turnover is less than $150,000 it might be worth registering for GST because you can then claim back the GST you are paying to your suppliers.

If you employ people and pay them, you are going to collect tax on behalf of the tax department. You’ll have to make superannuation payments so you will have dealings with the tax office. If your supplier is not registered for GST and doesn’t provide a tax invoice, then you will be required to withhold PAYG tax and submit that to the tax office.

So, unless you’re a very very small organisation you are probably going to deal with the ATO. The ATO requires you to have an ABN or Australian Business Number and you must keep your financial records for 5 years. The records to be kept are your financial statements and any supporting documents.

So that is the regulatory framework and a brief overview of the various bodies that organisations need to comply with and keep financial records for. But exactly what records do you need to keep? Firstly, you need to keep a record of any money the organisation receives. There are lots of ways for an organisation to get income: donations, corporate sponsorships, government grants, selling goods or services, maybe selling tickets to a fundraising event.

For any money received, records should be kept of … • Who did you get the money from? • How much did you receive? • What was the money received for? and • When did you receive the money? These records are generally initiated by the organisation issuing an invoice – for services rendered, sale of an item, memberships etc.

Then when the money is received a receipt may be issued. Invoices & receipts are the basis of the financial records and copies need to be kept to support those records. Remember when issuing invoices to include your ABN as this makes it a valid tax invoice. If you don’t, businesses can withhold 45% of the amount of the invoice which they then pay to the tax office and you'd then need to claim it back. It’s much easier for everyone if you include your ABN on your invoices in the first place.

What about the money going out? Organisations also need to keep good records of the money paid out. Again, this includes details of: • Who are you paying it to? • How much was paid? • What the payment was for, and • When it was paid.

Sometimes some expenses need more information. For example, when you’re paying staff make sure you record the number of hours worked and rate of pay and other information required for PAYG tax and Superannuation. Copies of invoices, receipts, time sheets etc need to be kept to support these records.

But it’s not just money in and out. Sometimes labour will be provided by volunteers, or you may receive donations in kind, that is goods or services instead of cash. For donations in kind, records of the goods or services received or provided should include information like • What was it? • Who provided or received it? • What for? • When? and • How much? Or what's the value of it?

For example, if your organisation is donated a car how much would you have had to spend if it wasn’t donated? And how much might you need to spend to replace it in the future. As for volunteers … How many hours do they work, what do they do for the organisation? A good exercise is to work out if we did have to pay them, how much money would we be spending? This can help if in time the volunteers are not available and the organisation needs to employ someone to do that task/job.

Another set of records is what's called an Asset register – a list of all those things that the organisation owns– things such as cars, chairs, computers, desks, sporting equipment and so on. Some of the details that should be kept include: • What is it? • When was it purchased? Or where did it come from? • Its value • Where is it (Which office, where’s it held), and • When is it likely to need to be replaced?

It’s a good idea to do an audit regularly to check if the assets are all still there and working properly. An asset register helps to plan for future replacement or repairs as the asset wears out over time. From all of those records … Money in, money out, donations in kind, volunteers, and asset registers … the accountant will prepare the necessary financial statements for taxation purposes, possibly for audit purposes, and for reporting to the board or other stakeholders.

But more importantly than for regulatory purposes, the financial statements tell the story about the organisation’s financial performance and position. Vital information for those managing the organisation as it indicates whether the organisation is financially sustainable. The 2 most common and most used financial statements are the balance sheet and income statement (sometimes known as the Profit and Loss statement or P&L).

Let’s have a look at what each of these statements are and the information they provide about an organisation.

Let’s start with the Balance Sheet. The Balance Sheet tells us about the financial position of the organisation. It records the assets the organisation owns, and the liabilities and equity that were used to pay for those assets. It’s called a balance sheet because the two sides must balance. That is the Assets must equal the Liabilities & Equity. The balance sheet shows a snap shot of all those things at a specific point in time … commonly at the end of the financial year.

Let’s delve a little deeper. “Assets” is the accounting term for things that are owned by an individual, a business, or an organisation. In the case of a not-for-profit organisation the purpose of assets is twofold. They are used to deliver the organisations service and to provide operational capacity.

The difference here is that an organisation may have an office to operate from with computer and communication equipment that provides the capacity to be operational, however their actual service may be delivered via a vehicle eg meals on wheels. As well as service delivery, an organisation also wants those assets to be helping generate more income for the organisation so that they can fund more of the service delivery.

In the balance sheet the assets are broken down into 3 categories Current Assets turn into cash within 12 months. Things like cash, stock, debtors Fixed assets are those that last longer than 12 months – things like motor vehicles, computers, desks, chairs and so on. Intangible assets are those things that you can’t touch or feel but add value to an organisation– things like goodwill, licenses, patents, or intellectual property.

Liabilities and equity are the sources of money to pay for the assets. Equity is the organisations own funds, while liabilities are the money owed to other businesses, organisations, or financial institutions. Current liabilities are those that need to be repaid within the next 12 months – things such as creditors, or short terms loans like credit cards or overdrafts.

Long term liabilities are those that will be repaid over a longer term than 12 months – things like equipment finance, and building loans. Equity is, as I said, the organisations own money – perhaps initial seed capital or an initiating bequest, and is added to annually by any profits or surpluses made by the organisation.

Let’s have a look at an example. We can see here that this particular organisation has a significant amount of cash and some stock as their current assets. Some office equipment and vehicles as their fixed assets – all totalling $355,000. As you can see there is an equal amount of liabilities & equity – which is broken down into current liabilities … being their credit card and creditors, a long term loan for the car, and their equity.

This is the summation of their financial position at this point in time.

Now let’s have a look at the Income statement also known as Profit & Loss or Statement of Financial Performance The income statement collates all the income that the organisation has collected, expenses incurred, and calculates the surplus or deficit over a period of time, commonly a financial year. It’s useful to further break down the expenses into those incurred through actually providing the service, and those necessary purely to be operational.

As an example, if our organisation was one that provides a helicopter transport service for people needing medical care … the types of expenses that we might incur to be operational are things such as our communications system, insurances, & equipment maintenance … however the costs we incur in actually transporting a patient might be things such as fuel, pilots wages and air traffic control charges.

Our aim of course is to use more on service delivery than operations however this is not always the case.

And here’s how an Income Statement might be set out This organisation received an income of $240,000 over the financial year being a mixture of grant funding and fund-raising. They spent $230,000 on a variety of expenses, leaving a surplus, or profit, of $10,000.

So, the balance sheet tells us about the financial position of an organisation at a specific point in time, and the income statement tells us about the financial performance over a specified period of time – useful information in both cases. But it’s when we look at the two statements together, not in isolation, that we get a more complete picture of the financial operations of the organisation.

The first step here is to understand how the financial operations of an organisation works. To demonstrate this we are going to have a look at the financial operating cycle. When the organisation was originally established funds would have been made available in one form or another and this is the original Equity of the organisation. If this wasn't enough to get started the organisation may have had to obtain some stock on credit or borrow from a financial institution to top up the equity.

This of course is known as Liabilities.

Then with our money (Equity) and the others money (Liabilities) the organisation used these funds to purchase the assets they need to operate. This may be assets like stock, vehicles, equipment etc. These assets are then used to provide our services and generate more income or revenue. As soon as we begin operations we are going to incur some expenses like some wages, electricity etc. and at the end of the period if we have managed this process well we will have a surplus.

This surplus is retained in the organisation as equity and used in two ways … 1. Reinvest in assets – saved as cash, purchase more stock or another piece of equipment etc OR 2. Reduce debt.

The key to long term sustainability is to keep this cycle turning over smoothly and efficiently. We want to efficiently be using our assets/resources in providing our service and generating more income for ourselves. We want to efficiently be managing our expenses to provide as much of our service as we can with the funds available.

Then efficiently be using any surplus to reinvest in the organisation to either reduce the risk and costs by reducing debt, or to increase our outputs or grow the organisation by reinvesting in assets.

This model also demonstrates the relationship between our financial statements. Asset = Liabilities + Equity is our Balance Sheet. It provides a snapshot of the organisations assets and how they were paid for as at a point in time. Revenue – Expenses= Surplus is our income statement and shows how the organisation has performed financially over a period of time.

But what we can clearly see now is that there is a relationship between the two and to have a complete picture of the organisation’s financial position we need to be able to read and understand both.

Before we move on from this model I just want to make one final point. The model shows that any surpluses are reinvested in the organisation and used it 2 ways. What if the organisation makes a deficit instead of a surplus? … this would indicate that the organisation would either need to borrow more (often not an option) or reduce the assets. A reduction in assets often means a reduction in our ability or capacity to be able to deliver on our purpose in the community.

Not a position any organisation wants to be in.

The key to long term sustainability is to keep this cycle turning over smoothly and efficiently. But how do we measure that efficiency? We use financial ratios. The ratios simply compare one number with another which tells us something about the organisation. As I mentioned earlier its useful to understand what percentage of expenses is spent on operations and what is spent on service delivery.

It’s also useful to look at how the surplus is being used to either reduce liabilities and reduce the risk to the organisation, or in reinvesting in assets to grow the organisation and increase the social impact.

So in this video, we have looked at the regulatory framework for not-for-profits and why it’s important to keep good financial records. We looked at the types of records that need to be kept, then at the financial statements that are collated from these records and what information we can glean from them.

Thanks for watching ‘Financial governance for not-for-profits. I hope you found this information helpful and I encourage you to check out the other financial education resources on the Davidson Institute website to help build your financial confidence.