Question

1. For a not-for-profit organization, what are the two classes of owners’ equity?

2. Why might the excess of revenues over expenses be of particular interest to a financial statement user, rather than the increase in net assets without donor restrictions?

3. What does the statement of cash flows tell us that looking at the change in cash on the balance sheet does not?

4. Should each of the sections of the cash flow statement show an increase in cash for a healthy organization?

Answer 1

1. Non profit organizations do not have ay owners hence the owners equity is the excess of assets over liabilities known as the net assets. These net assets re classified in to two types viz., (I) Net assets without donor restrictions and (ii) Net assets with donor restrictions.

2. The excess of revenue over expenses will be of interest to the financial statement user since it helps in fulfilling the non profit organizations mission. Also it helps in determining how the entity spends its resources. An increase in net assets without donor restrictions is merely represents an increase in assets of the entity which not be an indication of the financial strength and the progression of the firm towards achievement of its objectives.

3. The statement of cash flows helps us to analyze the cash in flows and out flows and considers the non cash items as well such as depreciation. An analysis of the cash balance as per the balance sheet may result in erroneous interpretation and very little explanation as to how the balance has changed. The statement of cash flows details the sources of funds and the utilization of the funds and the accurate liquidity position of the entity.

4. A increase in each section of the cash flow statement may not necessarily indicate healthy position of the entity. For instance, if the cash flow from financing activities shows a positive balance it may show that the firm is borrowing or issuing common stock and can be overleveraged and this may strain its operating profits in the future due to debt obligations. An negative operating cash flow can indicate that the entity is expanding and is turning profitable since under accrual method revenues are recognized irrespective of receipt of cash however cash flow is prepared as per actual receipt of cash. A negative cash flow must be assessed with caution by understanding the reasons therein and does not necessarily reflect of a poor financial position.