0.13 Chapter ten: the complexities of nonprofit financing  (Page 3/10)

To recognize donor-imposed restrictions in the financial statements of non­profit entities, a special form of accounting called fund accounting, which links resources and their intended use, was developed. Although straightforward in con­cept, fund accounting can be extremely confusing in practice. An attempt to clar­ify the mysteries of fund accounting would take us too far afield; however, there are two issues of broad importance that are illuminated by the Society's accounts. First, the distinction between restricted and unrestricted revenues is a funda­mental fund accounting concept that, if misunderstood, can lead to serious con­fusion concerning the financial health of an organization. Second, the difference between current and capital financial flows, particularly as it intersects with prin­ciples of endowment management, continues to perplex not only observers of the nonprofit sector but also many nonprofit administrators and board members.

Restricted versus unrestricted revenues: the debs dilemma

In 1988, Barbara Debs took over an institution in acute financial crisis. The Society had run deficits in eleven of the previous thirteen years, and its fiscal 1988 deficit was its largest ever: 83.7 million on a total budget of approximately $7 mil­lion. During her four years in office, Debs, her staff, and the Society's trustees man­aged to raise over $23 million—an extraordinary accomplishment. That success notwithstanding, the Society still ran significant deficits in each year. In fact, when Debs stepped down in September 1992, the Society was financially worse off than it had been when she assumed office. Although annual deficits had been reduced, endowment available to help pay for general operating expenses had declined, and the Society had incurred an external debt of $1 million.

The Society's fiscal 1990 financial records exemplify the complexities involved in trying to ascertain the financial condition of a nonprofit. In that year, the Soci­ety brought in approximately $11.1 million, while it spent only $8.2 million. Nev­ertheless, the Society had an operating deficit of $ 1.8 million. How did this happen?

The answer lies in the nature of the funds flowing into the Society and the fact that only a portion could be used to pay for ongoing operating activities. Of the $11.1 million raised, $2.4 million was a capital inflow, designated for the endowment. Since only investment income from an endowment can be used to pay for current operating expenditures (and then only if the expenditures match any restrictions), very little new money actually flowed to the operating account. Although the remaining $8.7 million could be categorized as current revenues, $4.1 million was restricted to specific uses. These funds were dedicated to such purposes as the Society's "Why History?" program, public outreach initiatives, library and museum collections conservation, and museum exhibitions. Only $4.6 million, 42 percent of the total funds raised, remained to pay for the Society's gen­eral unrestricted operations. Operating expenditures (including administrative salaries, building maintenance, utilities, insurance, security, consulting fees, and general administration) amounted to approximately $6.2 million. Hence the nearly $2 million operating deficit.