Friday, October 12, 2012

The Story in the Numbers

On Financial Narratives and Financial Footnotes: The Truth Is in the Fine Print

Guest Beneblog by Teresa Throckmorton, Benetech's CFO and VP, Finance

In a previous blog post, we shared the Seven Benetech Truths: the core values that define our identity and culture, that guide our work, and that tell our story. As Benetech’s Chief Financial Officer, I’m pleased to take this opportunity to give you some insight into what these core values mean to me when it comes to our daily financial management and to setting up overall financial direction for a sustainable social enterprise. Let me focus here on two of our Truths: Right Stuff Right and Open Over Proprietary.

From my perspective, to do what’s right in the right way means not only to conduct business ethically or to get the accounting done to the highest standard. It also means to get the narrative that emerges from our financials right, to communicate that narrative effectively to our stakeholders, and to help other social enterprises better convey their own financial stories. Valuing open over proprietary then means not only to make our financials available for anyone to peruse, but also to be transparent about our financial story and to help others interpret it correctly. The blog you are reading now is the result of putting these principles into practice!

Our financials are more than numbers: indeed, they tell our story. It’s a story that connects mission, capacity, and capital. It’s a story that reflects the turning points in our past, describes where we are at present, and indicates where we are positioned to go in the future. Without a solid financial story, the impact our programs have made, and will continue to make, would not be possible.

Our financial story begins with Benetech’s forward thinking funders: our users, individuals, foundations, corporations, partners, and government agencies. Those who envision what could be possible by having Benetech apply innovative technology to the areas of Literacy, Human Rights, and the Environment, and who enable us to explore new opportunities for creating social good. As a nonprofit, different types of funding fuel our work. This, in part, is why a nonprofit’s financial statements can raise significant questions about its financial story. Recurring questions funders have asked us about our own financial story are: Why do some years show Benetech to be profitable and other years show a loss? Why do your net assets seem to be small for an organization with a budget of over $10 million – is there something we’re not seeing?

In fact, the answers to almost all of questions are found in our financials. But it takes more than just the bottom line of the consolidated standard statements in order to glean our true financial story in its entirety. Benetech’s financial statements are carefully prepared in accordance with generally accepted accounting principles (GAAP) and are rigorously audited annually. However, the standard financial statements alone don’t contain all the information needed to understand the underlying operational and financial realities of an organization; important data is cited in the statements’ footnotes. These are a treasure trove of information that, if overlooked, might mislead one into developing an inaccurate financial story.

We’d like to point out here some of that additional footnote information that is integral to our audited financial statements. By doing so, we hope not only to help our stakeholders better understand Benetech’s financial story, but also to encourage other nonprofits to better communicate their own financial narratives.

Our bare standard financial statements might create the appearance of declining reserves. Yet we emphasize that we have not run deficits, nor have we had declining reserves. Let me explain why this is so.

There are two GAAP issues that create the appearance of declining reserves. The first issue is multi-year grant funding, which might create the illusion of a profit in the initial grant year and an offsetting deficit of the same amount spread over the later years of the grant. For example, our 2008 major human rights grants from the Oak Foundation and the John D. and Catherine T. MacArthur Foundation led to an apparent gain of $1,569,623 in the first year followed by average apparent deficits of roughly $500,000 annually for the years 2009-2011. The two grants, however, were intended to cover multiple years of activities, and we charged each grant with expenses over its lifetime. Thus, following GAAP created the illusion of a big gain followed by losses. The entire multiple years of funding are listed as part of our restricted assets. In such cases, as we satisfy the restrictions and use the funds, these assets move off our balance sheet from restricted to released.

The second GAAP issue is the accounting method of capitalization, which delays the recognition of an expense by recording it as a long-term asset and then depreciating or amortizing it over its expected lifetime. As an example, in 2008, we accounted for $1,772,761 in capitalization of a major website upgrade for our Bookshare library. As with multi-year grants, this created an illusory surplus in 2008 and contributed to an illusory deficit of over $500,000 in each of the years 2009 through 2011. These expenses, however, were reimbursed in their entirety by a major funder in 2008, so that meeting the capitalization accounting standard had no impact whatsoever on our financial reserves or cash. Footnote 6 of our 2011 audited financials (“Intangible Assets”) explains this matter. When you control for these two GAAP issues, it becomes clear that our actual reserves increased in 2011. Thus, what appears to be a story of declining reserves is, in fact, a story of reserves growth. But you see this story only if you read the fine print in addition to the core income statements, balance sheets, and statements of cash flow.

The financial statements in an annual report are supposed to be clean and easy to follow. This means that crucial information, including revenue, doesn’t appear on the balance sheet. Such is the case with a major portion of Benetech’s revenue. Over 80% of our revenues are structured as “pay-as-you-go” contracts, rather than grants. This form of revenue is typically booked at the same time as the associated expenses. For example, our largest single funding arrangement is a competitive award by the U.S. Department of Education that enables us to provide the Bookshare library services for free to all qualifying U.S. students with print disabilities. To consider another example, one of our largest human rights funders is the U.S. Department of State, which similarly structures our award as a cooperative agreement, not a grant. The government makes cash available to cover our actual expenses within three days of when they are incurred. At the end of 2011, Benetech had over $14 million in funding commitments of this type, over $10 million of which is available for spending in 2012. Under GAAP, however, these funding commitments cannot be recognized on our balance sheet (or elsewhere on our financial statements), because we can't recognize revenues due to providing services before we render the services. To see the big picture, one needs to read the financial statements’ footnotes and understand the major activities of an organization, which explain the practices and reporting policies of our accounting methods and disclose additional information that can’t be shown in the statements themselves. When this additional information is taken into account, it is clear, once again, that what might seem to be a story of deficit spending is, in fact, a story of significant revenue.

Pick up any financial report and you'll always find footnotes to the financial statements. These expand on the quantitative financial statements by providing qualitative information necessary for understanding a nonprofit’s true financial performance over a certain time period and for establishing the organization’s true financial story. Informed investors and donors dig deep into the data. Ask questions that arise from digging in!  I encourage each of you to read the fine print of Benetech’s financials that are always available on our website, dive into the financial notes and auditor statements, and then read about our accomplishments – together, they’re a great story.

Teresa Throckmorton, CFO

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