Not-for-Profit Entities – Ready or not, liquidity disclosures are coming…….and they may impact your ability to receive funding from foundations!

Background:

The Financial Accounting Standards Board (FASB) has issued Accounting Standards Update (ASU) 2016-14, Not-for-Profit Entities (Topic 958): Presentation of Financial Statements of Not-for-Profit Entities (NFP’s) which is effective for fiscal years beginning after December 15th, 2017. Yes, that means calendar year 2018 and fiscal years ending in 2019.  This update focuses on, among other things, simplifying the reporting requirements and presentation of an NFP’s financial statements, addressing inconsistencies relating to information reported for period expenses, and enhanced disclosure requirements for information an entity must provide relating to their liquidity. The concept of liquidity is important to understand as the update emphasizes changes to standards that impact an entity’s perceived liquidity position. Liquidity can be briefly described as the resources an entity has available that could be easily converted into cash for use in the near future.

Liquidity Changes Under ASU 2016-14:

  • Net assets classified as, with donor restrictions or without donor restrictions will replace the previous classifications of unrestricted, temporarily restricted and permanently restricted.
  • Enhanced disclosures are to be provided regarding amounts and purposes limiting the use of resources resulting from governing board appropriations/ internal restrictions. Additionally, disclosure is required for the composition of donor restricted assets and the affect those restrictions have on the entity’s use of those resources.
  • Disclosure of quantitative information that conveys an NFP’s availability of financial assets to meet cash needs for general expenditure purposes within one year of the balance sheet date is to be presented either on the face of the balance sheet or in the notes.
  • In relation to the change noted above, additional qualitative information regarding the availability of assets and how an NFP manages its liquid resources available to meet general cash needs within one year of the balance sheet date also requires disclosure.

For an NFP, financial assets such as cash, short-term investments, pledges, receivables, and other current assets that can be utilized in order to support general expenditures within one year of the balance sheet date are all considered liquid assets. However, for most NFPs the availability of these assets for liquidity purposes of the organization might be limited due to either internal or external restrictions. For example, donors may restrict a pledge so that the money can only be used for a specific purpose or the governing board of the organization may designate certain assets for various reserve funds. The presence of a restriction placed on an organization’s asset results in the possibility that an otherwise liquid asset can no longer be considered available to meet organizations obligations.

Implementation:

In order to disclose more relevant and useful information regarding their liquidity, NFP’s should assess the availability of their financial assets by identifying any existing donor-imposed restrictions, governing board designations, or other restrictions that affect the use and timing of an asset and perform an analysis to better determine the implications of imposed limits. Understanding the restrictions placed on net assets and the availability of resources allows an organization the ability to self-assess their current liquidity position and prepare for the new disclosure requirements.

An organization that has a limited amount of resources available for general expenditures carries with it a greater liquidity risk. Under the new qualitative disclosure requirements, such an organization will want to consider disclosing to their financial statement users information relating to how they are managing this risk and how they expect to cover their expenditures. From a qualitative standpoint, disclosure of information such as the expectation of a large donation/ grant or the ability to draw on a line-of-credit conveys to users that the organization is taking steps to actively manage its liquidity position. Furthermore, an organization should review current policies in place that relate to its management of liquidity. If no current policy exists, management should establish and implement a policy for how it manages liquidity and liquidity risk. Actions such as reviewing how the board designates assets and documenting the procedures enable an organization to determine if current policies need adjustment or if new policies are needed.

An organization that presents their statement of financial position in the classified format, which shows current and noncurrent assets and liabilities, may already be in compliance with all or part of the quantitative information required and should assess whether further disclosure is necessary. Alternatively, an NFP that is financially strained or one that has limited available resources may want to consider creating a draft of the new quantitative requirements as doing so may result in a small amount of financial assets available for use and signify to management an increased liquidity risk. An option to consider for an NFP with an already high liquidity risk is to fund an operating reserve to improve the organization’s overall liquidity position.

Donor Benefits:

Liquidity is an important metric used to assess the strength and future viability of an entity. Some foundations funding non-profits have already been taking into account the liquidity of organizations they fund.  Large, well-known foundations have stipulated that having two or more months of negative liquid unrestricted net assets in their most recently completed fiscal year or having between one to two months of negative liquid unrestricted net assets and an operating deficit greater than 5% of operating expenses will not be considered for funding.

Simplification of the financial statement presentation and enhanced disclosures enables an NFP the opportunity to convey more relevant and useful information about the entity’s resources and financial performance during the period. This provides potential donors, grantors, creditors, and other users of the financial statements with a better understanding and ability to assess an entity’s liquidity and financial flexibility.