Glossary of Common Financial Terms
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501(c)(3)
the section of the Internal Revenue Service code that establishes the requirements for tax-exempt status for charitable organizations. This term is often used to refer to an organization which has tax-exempt status.

Accrual basis accounting
a method of accounting which records transactions when they occur. Using this method, a pledge of a gift is a transaction recorded when the pledge is made, rather than when the gift is received. A bill is a transaction for payment and is recorded when the bill is received, not paid. Thus, accrual accounting provides a window into some future cash receipts or payments. This future-looking method can require the transaction to be cancelled at a later date such as when a pledge is no longer expected to be received. Pledges over a many-year period are recorded at less than full value under accrual accounting.

Annual audit
a procedure performed annually by a certified public accountant to review the organization’s financial account and assure the board that the financial statements it receives provide a reasonably good picture of the financial condition of the organization. Audits do not review everything but rather look at a representative sample of transactions to see if they are properly recorded under generally accepted accounting standards. The audit provides opinion letters and a management letter detailing issues of concern to the auditor regarding the organization’s operating procedures.

Asset allocation
the distribution of one’s investments across various categories of investments such as equities, bonds, treasury securities, and real estate. The asset allocation is the primary determinant of the likely risks and return on investment from an investment program.

Audited statements
the end-of-year financial statements of an organization that have been reviewed by an annual audit.

Balancing the budget
adjusting the organization’s budget so that total revenues equal total expenditures. If the organization has reserves, the adjustments can include adding to or subtracting from reserves. Revenues are difficult to adjust in the middle of a fiscal year so that most mid-year budget balancing efforts are focused on expenditure changes and reserves. When a proposed budget is being reviewed, balancing can include revenue changes such as fee increases or decreases, new fundraising efforts, and grant proposals.

Board designated reserves
monies that are set aside for special purposes by board resolution. The resolution can include rules or procedures for adding to or subtracting from the reserves. These rules and procedures can be changed by the board so the financial statements of the organization record these reserves as unrestricted. Reserves are distinguished from endowments by the organization’s ability to utilize the entire value of the reserve while it can use only limited portions of an endowment.

Budget
a plan for acquiring revenues and incurring expenses for a fiscal year. A budget can be a simple set of estimates of major categories of revenue and expenditure. A budget is most useful if it is based on a specific set of goals and tasks to be achieved during the fiscal year.

Budget balancing strategies
policies and plans for adjusting revenues or expenditures, utilizing reserves, investing, or borrowing in order to have resources equal expenses in a fiscal year.

Cash balances
investments of an organization that are readily available at their full value. Investments that can be sold at full value within one to three months are viewed as part of cash balances. Bank accounts are considered cash if they can be liquidated without significant penalty in one to three months. A one-year certificate of deposit, for example, would not generally be considered part of cash balances.

Cash basis accounting
a method of accounting which records a transaction only when cash is received or disbursed. Cash accounting uses no estimates or adjustments; however, it provides no forward-looking information, such as pledges that will be received or bills that are waiting to be paid.

Cashflow
the pattern of cash receipts and expenditures during the fiscal year. Cashflow is the underpinning for having sufficient cash available to meet scheduled expenses, of which payroll and tax obligations are most significant. Positive cashflow refers to periods in which more cash is received than disbursed; negative cashflow refers to periods in which more cash goes out than comes in, reducing cash balances.

Clean opinion
also referred to as an unqualified opinion in an audited statement. This boilerplate language by the external auditor is generally as follows : “In our opinion, such financial statements present fairly, in all material respects, the financial position of the Company as of June 30, 2002 and 2001 and the results of its operations, the changes in its net assets, and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States.” Contrast this statement with a qualified opinion, in which the auditor cannot offer such an opinion because the statements do not “present fairly” or they are not “in conformity with accounting principles.” A qualified opinion is a major red flag that something abnormal is going on and the board should delve deeply into the auditor’s concerns.

Community needs
a demand for services that is not completely met by the private or governmental sector. Nonprofit organizations are granted tax-exempt status as an incentive for individuals to contribute funds to the organizations that provide services to address such community needs.

Conservative budget
a term often used to describe a budget that intentionally uses low revenue estimates or high expense estimates. This term is a misnomer because this approach to budgeting compromises fulfillment of the organization’s mission and is therefore counter to the board’s responsibility to conserve the mission.

Continuation and initiatives budget
a budget approach that focuses the board’s attention on the subset of activities that are intended to change or improve the organization’s achievement of its goals, objectives, and mission. Budgeting of ongoing, unchanged, “continuing” activities occurs largely at the staff level only.

Continuation budget
the portion of a continuation and initiatives budget that includes the ongoing, unchanged activities from the prior year.

Endowment
an investment account of an organization that is intended to last in perpetuity and which allows only the total investment return to be utilized by the organization. Often the amount and timing of the use of the total return is specified by the original donor or by board resolution.

Endowment draw (see also target rate of return)
the amount of total investment return of an endowment that is utilized by the organization in a particular year. The draw may be specified by the original donor or by board resolution. The typical draw is three to five percent of the three-year moving average of the endowment’s market value. Also called endowment payout.

Fiduciary
a person entrusted with management of, and responsibility for, assets belonging to others. Generally boards of directors of nonprofit organizations are considered to be acting as fiduciaries. A fiduciary can have personal financial liability for mismanagement of the organization. It is common for a nonprofit to indemnify board members and officers and to acquire directors and officers (D&O) insurance to protect the directors’ and officers’ personal wealth from liability.

Financial reports
(contrast with financial statements) a set of reports that are prepared for the use of board and/or staff to represent the financial activities and condition of the organization. The most effective financial reports consist of a narrative about progress on the organization’s primary goals and objectives for the year with an accompanying table or two of data on that progress.

Financial statements
(contrast with financial reports) financial tables that follow the specific definitions and formats required under generally accepted accounting principles (GAAP). Financial statements can be prepared only by certified public accountants (CPAs).

Forecasting
a plan that assigns specific levels of revenues and expenses to future years. The most important characteristic of a good forecast is that the plan is based on a series of events and activities that are compatible and mutually consistent with each other. It is less important that the level of revenue or expense in any year be an accurate prediction of what revenue or expense actually turns out to be. The board should use a forecast to ascertain if its plans are mutually consistent with each other and whether the plans result in a series of outcomes that are consistent with the mission and priorities of the board.

Initiative
a special project that is proposed in a budget to advance a specific goal or objective. An initiative has a specific timetable, set of desired outcomes, and list of required resources that can be easily tracked and managed over the course of the year.

Investment risk
the risk that the value of an investment may decline. The cash balances of an organization generally have no investment risk, while endowment funds can have considerable investment risk. Investment risk is related to the return on investment an organization desires and to the asset allocation of the investment portfolio.

IRS Form 990
a mandatory annual filing for any tax-exempt organization except churches and those with less than $25,000 of annual revenues. The form reports on achievement of the organization’s mission, allocation of expenditures to each aspect of mission, gifts from major donors, as well as payments to staff, board members, and major vendors and consultants. Widely available on the internet (www.guidestar.org), the Form 990 is increasingly becoming a primary document used by grantors to evaluate the effectiveness and relevance of a nonprofit organization.

Macro level
a term used to refer to high-level, organization-wide issues.

Micro level
a term used to refer to detailed, operational issues.

Milestones
in a timetable for a project or initiative, the dates on which significant stages of the project are expected to be accomplished and to be measurable. Milestones provide the board with an opportunity to inquire objectively about the progress of a project or initiative in an effective and efficient way that does not intrude on the operational role of the staff.

Nonprofit
an organization that is tax-exempt (see 501(c)(3)). Nonprofits are distinguished from for-profits by how they spend their profits, not by whether they earn profits.

Permanently restricted
a class of gifts in which the donor has set unchangeable rules that limit the organization’s ability to utilize the gifts. Restrictions generally specify the purpose for which monies can be spent as well as the amount of money that can be spent in any particular year. Permanently restricted gifts add to the wealth of an organization but they generally are not available for budget balancing purposes.

Profits
the amount by which the revenues received from an activity exceed the expenses incurred for that same activity. It is often useful for a board to know which of its activities earn profits and which do not. Most nonprofits will have a sufficient number of profitable activities to provide sufficient monies to support their unprofitable activities and sustain the organization’s mission over the years. The calculation of profit can be simplistic or complex depending on how extensively the organization wishes to allocate particular revenues and expenses across more than one activity.

Restricted
a term that describes a reserve or endowment that is subject to rules concerning the purpose for which monies can be used or the amount and timing of use of those monies. Restrictions can be unchangeable by the mandate of the donor or they can be changeable at the discretion of the board.

Strategic planning
a multi-year plan which identifies goals and objectives that are necessary to sustain the mission of the organization as well as a set of projects and activities that should lead to achievement of those goals and objectives. A strategic plan should also be accompanied by a financial plan that lays out the specific resources that are needed for those activities and a plan of action to acquire those resources in a timely and reliable manner.

Structural balance
a financial plan that is characterized by a stream of revenues that equals the stream of expenditures over a long period of time such as a business cycle. An organization that has structural balance is able to sustain its mission.

Sustainability
a desirable quality of a service provided by a nonprofit such that the patron or client utilizing that service can know with reasonable confidence that the service will be available on a reliable basis for the foreseeable future.

Target rate of return
in endowment and portfolio investment management, the desired return on investment. The target rate of return is closely related to the asset allocation and investment risk that the organization has chosen. The endowment draw is usually closely related to the target rate of return that is chosen for the endowment.

Temporarily restricted
a term that refers to monies that are expected to be available for spending in the current year. Temporarily restricted monies usually are tied to specific expenses such that when the expense occurs the monies are immediately made available to pay the expense. For example, grant monies can be temporarily restricted when the money is already in hand but the organization has not yet provided the service and incurred the expense the grant is funding.

Unrestricted
an asset that can be utilized for any purpose desired by the organization. At times the board may still choose to limit the staff’s discretion on the use of some unrestricted monies, in which case the unrestricted monies are usually called board designated reserves. Unrestricted assets can be immediately available (unrestricted cash balances) or they can be limited as to the amount and time they are available (unrestricted endowment or board designated reserves).

Unrestricted cash balances
assets which are immediately available for any purpose. These assets are usually invested so that there is no investment risk and therefore a lower target rate of return.

Validate execution
a limited form of board oversight that seeks to ensure that a high priority activity is meeting the milestones and objectives described in the budget. This oversight occurs on a monthly or quarterly basis and is limited to the criteria for success listed in the budget. It is to be contrasted with management oversight by the staff which pays more frequent and more detailed attention to daily execution by specific staff members.