We’ve heard many times from nonprofit executive directors: “My board only understands cash.” Even executive directors themselves often admit to being more comfortable with cash basis than with accrual basis financial statements. And we can’t blame you – all you cash basis fans out there are rightly concerned about, well, cash!

Introducing ASU 2016-14

And so you may be interested in the new ASU 2016-14 liquidity disclosure requirement. (ASU stands for Accounting Standards Update.) Nonprofits will now be required to present information about liquidity in their audited financial statements. Specifically, nonprofits must show assets available to meet the cash needs of the organization within one year of the balance sheet date.

Isn’t this the fundamental question that everyone has been asking all along? Are we okay cash-wise? Do we have enough cash to meet our expenses this month? What about next month? And the month after that?

The Financial Accounting Standards Board in ASU 2016-14 has made it clear that information about liquidity is just as important to users of the organization’s financial statements as it is to the organization’s management. (ASU 2016-14 is effective for fiscal years beginning after Dec. 15, 2017. Yes, that soon!) But liquidity is more complicated than simply cash-on-hand. So with apologies to all you cash-basis enthusiasts, we need to drag in a few accrual concepts. But bear with us; it’s not so hard and we think you’ll like what you learn.

Organization Liquidity is More than Cash

The financial assets that you have available to cover operating expenses in the near-term encompass more than just cash at a given point in time. Available financial assets also include those assets that will turn into cash including accounts receivable (such as program service fees receivable), contributions and grants receivable, and short-term investments.

To give you an example let’s look at an organization with assets as follows:

The pledges and grants receivable above are all expected to be collected within one year. The 6-month CD can be converted to cash in six months when it matures. Therefore all of these assets are either cash or will be converted to cash within the coming year. On the balance sheet, these assets would be presented as “Current Assets.” Assuming no donor restrictions or board designations, they would also be disclosed in the notes to the financial statements as assets available to cover operating expenses within one year of the balance sheet date. If the $5,000 pledge was restricted to purchase playground equipment, the total financial assets available for general operations would be $55,000 instead of $60,000.

Include Temporarily Restricted Cash and Receivables?

It’s unclear in ASU 2016-14 if temporarily restricted grants for major ongoing programs would be included or excluded in total available financial assets. Accounting Standards Codification (ASC) 958-210-55 provides examples of how to meet the new liquidity disclosure requirements, but holds open the possibility that “there may be other ways for a NFP to meet the requirements.” Perhaps a nonprofit could present liquidity calculated in the most conservative way possible, then add back grants restricted for major ongoing programs. In fact if some restrictions are sufficiently broad, the related gifts or grants, for all practical purposes, may be considered unrestricted.  For example a food bank may receive a grant restricted to “providing nourishing meals to low income families.” Even though the nonprofit may serve individuals as well as families, this restricted purpose may be sufficiently broad as to make it essentially unrestricted, especially if the grant is relatively small considering the size of the program it supports.

Include Prepaid Expenses?

Notice the assets listed in the above example do not include another common current asset, prepaid expenses. Prepaid expenses arise when you pay for something that benefits you in the future. The most common example is prepaid insurance. If you pay $1,200 for a Directors’ and Officers’ policy that covers you for one year into the future, then you have a prepaid expense that is “used up” $100 per month for the next 12 months. A concept similar to the “available assets” in ASU 2016-14 is Liquid Unrestricted Net Assets (LUNA) which includes prepaid expenses. However, we see the point. Cash spent on prepaid expenses, while it may provide a future benefit, is still cash spent. ASU 2016-14 focuses on cash and assets that will convert into cash, making them available to spend in the coming year.

Liquidity Analysis for Management Purposes

Though not a required disclosure by ASU 2016-14, once you figure out the total financial assets available to fund operations over the coming year, then you can divide that total by average monthly expenses. The result is the number of months your organization can operate using only the financial resources at hand. If possible, use a projection of future average monthly expenses rather than historical monthly expenses as the divisor.

If near term cash flow is a concern, for internal management purposes you could calculate a more restrictive measure of liquidity. For example you could add up cash, receivables, and investments that will convert to cash within, say, three months. Then you could divide that total by average projected monthly expenses. If large cash outlays are projected over the next few months but most of the assets are tied up for nine months, well, those assets may all be “current” but not current enough!

Combine Available Assets with Projected Future Cash Flows

Another aspect of financial strength is anticipated future cash flows. We observed one organization erode their assets available to fund operations over two years after they lost a major funding source to the point where the executive director departed and the organization all but folded. (A happy ending to that story in that the organization is rebuilding, all the wiser for the lessons learned.) So even having financial assets available to cover 24 months of operations may not be enough if you cannot develop and maintain a reliable stream of cash inflow. Significant reliance on a particular funding source has long been a standard financial statement note disclosure, as well as the impact of the loss of a major funding source on an organization’s ability to survive.

Maintain Restricted Cash

We have also seen nonprofits “borrow” against restricted grants by spending cash on operations that should have been held aside as restricted for a particular gift or grant purpose. ASU 2016-14 requires disclosure if a nonprofit fails to maintain an adequate amount of cash to cover gifts with donor restrictions. It’s imperative to manage cash in a way that you do not spend restricted cash for purposes other than what the donor intended.

Policies for Managing Liquidity

In addition to disclosure about the extent of liquid assets available to cover operations, ASU 2016-14 requires disclosure of the organization’s policies for managing liquidity. This means organizations will need to develop policies for managing liquidity if they don’t have such policies already. These policies should address areas such as cash reserves, available lines of credit, and investment of cash in excess of current operating needs. ASC 958-210-55 provides examples of disclosures that include liquidity policies. You can access the Basic View of the Accounting Standards Codification for free.

Cash is King

Carol had a finance professor who was fond of exclaiming, “Cash is king!.” He would be pleased to know that ASU 2016-14 is going to force everyone to get their arms around managing liquidity. As you can see, truly understanding liquidity requires consideration of accrual basis concepts such as accounts, grants and pledges receivable. But isn’t it fun (or at least enlightening) to consider where your future cash is coming from? And isn’t it exciting to know that, in complying with these new accounting standards, you will have the policies and the information you need to manage your organization’s cash needs into the future?