If a Not-for-Profit Organization (NFP) has financial statements that follow U.S. GAAP, it discloses a liquidity policy in the footnotes. Does the management team and Board understand this policy, or are they even aware of it? Many are not. NFP executive leadership needs to ensure the liquidity policy is documented and reviewed regularly by the Board or appropriate Committee.

In the new year, it’s time to re-evaluate what liquidity actually means and how well-crafted policies can improve an organization’s operations, finances, and be a tool for educating the public, the Board, and management.

Benefits and Uses of a Not-for-Profit Liquidity Policy

The benefit of a transparent liquidity policy is that financial statement users clearly understand how an organization is using its cash and other available resources, and how those assets are defined. For example, a contribution with a total value of $25,000 isn’t readily available to meet any operating needs in the current year if it’s been pledged over five years, or if it’s restricted for a specific use by a donor. Without the right disclosures, external users will not understand the full picture. This could have implications for funding, financing, and donor relations.

Also consider the inevitability of issues arising throughout the year that may require an organization to access debt, investments, or other reserves. Take COVID-19, for example. All unrestricted assets may have been tapped to keep the lights on, and the only funds left are restricted funds that may not be usable for general operating purposes. A well thought out liquidity policy can give NFPs and their Boards much-needed guidance during turbulent, and calm, economic times.

Balancing current assets, reserves, donor restricted and unrestricted resources are key to an organization’s future. A liquidity policy helps ensure there will be enough money to accomplish the NFP’s mission and ensure that the organization isn’t holding on to too much cash.

At a basic level, implementing a liquidity policy requires NFPs to:

  • Draft a quantitative liquidity policy to clearly show which assets are available for immediate use.
  • List qualitative disclosures in narrative form to provide context to the quantitative amounts, and any additional resources available, such as a line of credit.
  • Understand and document the time horizon for managing liquidity.
  • Document the operating reserve policy.

Really, what NFP leaders and Boards are doing is developing an organization-wide spending and reserve strategy.

Not-for-Profit Liquidity Reflected in the Financial Statement

In 2018, the Financial Accounting Standards Board, or FASB, followed through with the biggest change in not-for-profit financial reporting in 25 years. Now that it’s been a few years and organizations have had a few financial cycles to adapt, many are closer to understanding how their financial information is presented, and what it means.

The basic requirements for a liquidity disclosure are to list financial assets that are available for operational needs within a designated horizon, typically 12 months. These assets include unrestricted cash, accounts receivable, contributions, and short-term investments. Since flexibility is another aspect of accessing cash, NFPs also will need to disclose any donor restrictions, board designations, or bank requirements on use of funds. FASB requires both qualitative and quantitative information – charts and tables plus written explanations.
FASB provides examples at ASC 958-210-55-5 through 55-8. You can also search for your favorite nonprofit’s audited financial statements and see what they disclose. Examples of nationwide NFP liquidity policies are United Way (Note 14), Red Cross (Note 7), and Feeding America (Note 14).

CPAs can work with NFP leadership to develop accurate, transparent and consistent financial reporting measures that satisfy FASB’s requirements for liquidity disclosures.

Next Steps

NFP leaders will want to work with their Board to discuss how the organization should be managing liquidity and reserves. Examine monthly cash flows and determine if there are times of the year when cash inflows are low; a liquidity policy will help to manage those periods.

A best practice is to set a goal to have a certain number of months’ expenses available in current assets. Often, this is around three months of expenses, but it varies from one organization to another.

Determine what additional methods of cash flow can be tapped during a crisis – lines of credit, reserves, reducing expenses (and which ones), and so on. On the flip side, develop a policy that addresses what to do with the excess.

Overall, NFP leaders need to remember that simply disclosing assets isn’t enough for FASB requirements. Additional disclosures are needed to help financial statement users better understand an organization’s cash position and cash management policy. Further, a strategic liquidity policy helps an organization weather financial storms and find opportunities to invest extra cash when it’s available.

For questions about not-for-profit financial best practices or liquidity policies, reach out to Bo Garner, CPA, MBA, Partner and PBMares’ Not-for-Profit Team Leader.