In this article we will outline how you can determine what your financial cushion is, what is an appropriate level of financial cushion for the organization and, finally, examine some strategies for building, maintaining and, where necessary, reducing your financial cushion.

Determining your financial cushion
For purposes of this article, when we talk about a financial cushion we refer to assets of an organization that are likely to turn into cash within one year, less liabilities of the organization that will have to be paid within one year. This net amount represents the financial cushion that is actually available to the Board of Directors if funds are required for a financial emergency. The concept of financial cushion is often referred to as Net Assets, Accumulated Surplus or Fund Balance in a statement of financial position.

Net assets in the following example are $50,000. This is the amount that assets exceed liabilities. That is not to say that the organization has $50,000 to spend in the event of a financial emergency. You will notice that $40,000 of net assets is made up of capital assets.

These assets could be furniture and equipment, leasehold improvements, or a playground. They are not usually easily convertible into cash in the event of a financial crisis.

In this example, the truly useable financial cushion is the excess of current assets over current liabilities, in this case, $10,000.

An additional wrinkle must be added. Certain assets may have restrictions placed on them by private donors or government funders. Examples are donations given for specific projects such as research and an endowment fund to be held in perpetuity. In this case the true financial cushion available for day-to-day use in an emergency may well be less than the total of current assets over current liabilities. You should review your organization’s financial statements to determine the actual amount of net assets that are unrestricted and available to your organization.

Appropriate levels for a financial cushion
There is a common misconception in the not-for-profit sector that organizations are not allowed to have a financial cushion as they are “not-for-profit”. In this context it is useful to remember that not-for-profit organizations are also “not-for-loss” organizations. An organization cannot sustain losses over the long term without ceasing to operate or going bankrupt. Likewise, it is very challenging to run an organization with next to no financial cushion. Managing funds in this environment becomes very time-consuming and is bound to distract from the organization’s objective of providing service to its community. If you run your car with a close to empty gas tank all the time, you are likely to run out of gas at some point in the year. The same is true if you have too small a financial cushion. At some point you are bound to run out of money.

Having established that a financial cushion is essential, the question becomes, how much should it be? The unwritten guideline in the not-for-profit community in Ontario seems to be that a financial cushion of between one and three month’s expenses is an acceptable range. Organizations in a stable financial environment with secure funding can often function well with a cushion toward the lower end of the range. Organizations operating in an unstable financial environment would be better off operating with a financial cushion toward the upper end or even above that range.

It is important to note that there are relatively few statutory constraints on the level of financial cushion that an organization can maintain. The following is a brief survey of the requirements in legislation applicable to many not-for-profit organizations in Canada:

a) The Ontario Corporations Act and Canada Corporations Act do not specify lower or upper limits of financial cushion that must or can be held by not-for-profit organizations. The level of cushion is left up to the Board of Directors.
b) Canada Revenue Agency (CRA) requires that all registered charities obtain permission from CRA to “accumulate funds”. There is no definition in the Tax Act as to what constitutes an “accumulation” of funds. Past experience would indicate that a cushion of up to six months expenses would probably not contravene CRA’s guidelines. If your organization is a registered charity accumulating significant funds for a major expenditure such as the purchase of a building, you should obtain CRA’s permission to accumulate the funds prior to undertaking the fundraising project.
c) In the child care field, Toronto Children’s Services has an administrative policy whereby accumulation of net assets (this would appear to include capital assets and restricted funds) in excess of three months of operating expenses may result in a reduction in subsidy per diem rates. In our experience, Toronto Children’s Services bends over backwards to avoid reducing per diem rates and always discusses such a situation with a childcare centre before taking action.
d) Provincial funders such as the Ministry of Health and the Ministry of Housing often have policies whereby any excess of approved revenues over expenditures must be returned to the Ministry on completion of either a funding year or a specific project. In this situation, no accumulation of financial cushion for a Ministry-sponsored project is allowed. Financial cushions must be built from other sources of revenue.

Managing the level of your financial cushion
Managing the level of the financial cushion of your organization is an important part of the financial management process. Prior to managing the cushion, the Finance Committee or its equivalent should first determine what the current level of the financial cushion is and then specify what the ideal level of cushion for the organization should be. Determining the ideal level will require you to take into account the current financial environment as it now exists and future expectations. Once the current level of the cushion is known and the desired level estimated, you can then proceed to achieve the desired objective.

Increasing Your Financial Cushion
Planning to increase a financial cushion is not a complicated concept. You have to focus on generating an excess of revenue over expenses over a given period. In theory that’s easy. As many Boards of not-for-profit organizations know, generating a surplus is usually easier said than done.

Generating an excess of revenue over expenses entails increasing revenue and/or decreasing expenses. Grant revenue is often fixed or increases in grant revenue must be matched by identical increases in expenditures. Consequently, many organizations must turn to fundraising for increasing revenue. For many service-based organizations salaries account for the lion’s share of expenses. Expense reduction most commonly translates into reducing staff costs by either increasing program efficiency (i.e. increasing revenue without a concurrent increase in staff costs) or reducing staff compliment.

Finance Committees should be careful not to try to accumulate too large a surplus all at once. The process should be spread out over a number of years to minimize stress on personnel and ensure that the quality of service provided does not decline significantly during the process.

Reducing Your Financial Cushion
Periodically not-for-profit organizations find themselves in the enviable position of having too large a financial cushion. In our experience planned reduction of a financial cushion can be much more divisive to an organization than increasing the cushion. Reducing a cushion involves spending more that your organization takes in over a period of time. People often have strong and differing views on how this should be done, if at all. To reduce internal conflict we recommend that you discuss and approve at the Board level the ideal amount of financial cushion and the time frame over which the organization will operate at an annual excess of expenses over revenues until this target is reached. Many Boards of Directors are highly reluctant to operate an organization at a deficit even though it is a “planned” deficit. Consequently, agreement must be reached at the Board level to avoid misunderstandings when management operates the organization at a loss. In our experience there is no easy way to reduce a financial cushion in the absence of clear, honest and frequent discussions between management and the Board of Directors.

Summary
In summary, not-for-profit organizations should have, as a guideline, a financial cushion of between one and three months of expenses. This cushion should exclude capital assets, related long-term liabilities and funds restricted as to use by donors. It is important for an organization to determine the level of its current financial cushion and set a desirable target. Once the target has been met the organization should plan a course to increase, maintain or decrease the financial cushion as appropriate.

Defining Risk
The Canadian Institute of Chartered Accountants’ publication Learning About Risk: Choices, Connections, and Competencies defines risk as “the possibility that one or more individuals or organizations will experience adverse consequences from an event or circumstance”. This definition is flexible enough to be useful in commercial and not-for-profit organizations alike.

The Board of Directors of a not-for-profit organization is responsible for establishing the objectives for the organization and then making sure that these objectives are met by management. Risk, then, is the possibility that an event or circumstance will cause an organization not to meet the objectives established by the Board of Directors.

The greater the probability that an event or circumstance will result in an organization’s objectives not being met, the greater the risk of the situation. Note that high risk does not relate to the magnitude of the consequence but rather to the probability that the event or circumstance will occur.

Risk suggests a negative or adverse consequence. The opposite of risk is opportunity. Opportunity is the possibility that an organization will benefit from an event or circumstance. Inability to identify and exploit opportunities would be considered a risk where that inability could prevent the organization from reaching its objectives.

The risks an organization must deal with can be internal or external. It is often easier for an organization to manage the internal risks. For example, an organization might identify as a risk the possibility of losing government funding. If poor internal policies such as inefficient program delivery or poor monitoring of results could result in the loss of funding then strengthening internal processes could mitigate this risk. However, an organization may be helpless when faced with a loss of government funding caused by a shift in political thought.

Managing Risk
For most not-for-profit organizations it is the Board’s responsibility to ensure that a framework is in place to manage risk. The four processes involved are:

1. Identifying conditions that must exist for an organization to achieve its objectives
2. Identifying factors that could interfere with these conditions
3. Assessing the probability of these factors occurring (i.e. determining risk)
4. Taking action by either accepting the risks (and perhaps putting in place systems for damage control should the adverse consequences occur) or reducing risk to an appropriate level.

A. Identification of Conditions Needed to Meet Objectives
The first step in the process of risk management is identifying the conditions that must exist for an organization to meet its objectives. We assume for purposes of this article that an organization has already clearly stated its objectives through a strategic planning or other similar process. The conditions that must exist in order for an organization to meet its objectives could include:

• provision of a quality of service to clients consistent with standards established by the Board of Directors
• provision of services that continue to be relevant to clients (i.e. adapting services to meet the changing needs of the organization’s clients)
• continued access to sufficient funding to provide the necessary resources, financial, personnel and otherwise, to meet established objectives
• management of resources including volunteers, cash, other financial assets and networking resources

B. Factors That Could Interfere With Meeting Objectives
Once your organization has determined the conditions that are critical to meeting its objectives, you need to determine the events or circumstances (“factors”) that could interfere with these conditions. Using the four conditions in the previous section, the following factors might be identified.

Factors that could result in failure to provide high quality services:

• Inadequate financial resources, which could limit the organization’s ability to recruit sufficiently experienced and capable staff
• Insufficient monitoring of the quality of service provided (e.g., failure to keep track of outcomes, measure complaints and/or undertake periodic internal evaluations.

Factors that could result in failure to offer services relevant to clients:

• No system in place to regularly monitor clients’ needs
• No system in place to regularly monitor the needs of principal or potential funders

Factors that could result in inadequate sources of funding:

• Lack of attention to the political climate and how it might affect government funding and/or private donations
• Inadequate management and/or volunteer skills with respect to grant writing
• Insufficient attention to the organization’s image and reputation within its fundraising community

Factors that could result in the organization’s failure to manage resources:

• Failure to set efficiency benchmarks (e.g., number of cases handled per caseworker, cost of meals per day per child) and to monitor actual results
• Failure to set annual/monthly budgets and regularly follow-up with a comparison of actual to budgeted results
• Failure to assess the degree of satisfaction experienced by volunteers as a result of their role in the organization
• Ability to obtain resources external to the organization through networking (i.e., ability to get resources at a nominal cost).

C. Assessing the Probability that Adverse Factors Will Occur
So far you have identified your organization’s objectives, the conditions that must exist in order for your organization to achieve its objectives and the factors that could interfere with these conditions. The next step is to assess the likelihood that these factors will occur.

Take as an example the ability of an organization to receive sufficient funds where the majority of funding comes from government sources, which in turn is contingent on the organization’s ability to write grant proposals. If the organization relies on one key staff person with the ability to write grant proposals it would be critical to assess the likelihood of that person leaving. Similarly, if your organization is dependent on a single source for the majority of its funding (e.g. receiving money from the Ministry of Health for provision of a mental health program) then what is the likelihood that the political climate will change and your organization will be faced with cutbacks in funding?

Assign a risk factor of, for example, 0 to 10, to each of the critical factors that could interfere with achievement of an objective (0 representing the least likely factors and 10 the most likely factors). This will help you to determine which risks are most critical to your organization and will prepare you for the fourth step.

D. Taking Action to Mitigate Risks
At this point adverse factors that could prevent an organization from meeting its objectives have been identified and the likelihood that each of these events will occur has been estimated. It is now up to the Board of Directors to determine if it is able to live with the risks or if it must take action to decrease the likelihood of the factors occurring. The decision of whether or not to take action will depend on the cost associated with the action weighed against the likelihood of the adverse factor occurring coupled with the severity of the consequences.

For example, if one of the risks identified is that of an insecure political environment resulting in possible cancellation of an entire grant program, the organization needs to determine whether it wants to spend the resources required to influence the political environment or, instead, to try to diversify its funding sources. In all likelihood an organization would attempt to do the latter as the length of time required to affect a political solution to a funding problem is often too great and the outcome too uncertain.

As another example, if the consequences associated with failing to provide high quality service are considered critical, then the organization may want to develop benchmark performance measures against which quality of service can be compared. Reporting of results to management/the Board of Directors on a regular basis would hopefully flag whether the quality of service offered meets the established criteria or falls short. In this case the cost of developing benchmark performance measures must be weighed against the cost of losing clients and/or related funding from the poor quality of services.

Summary
Risk management by not-for-profit organizations is a part of continuing to be able to provide service to clients over the long term. Establishing a framework whereby your organization clearly:

• articulates its objectives
• identifies the conditions that must exist to achieve those objectives
• identifies adverse factors that could prevent your organization from meeting its objectives
• assesses the likelihood of these adverse factors occurring
• takes action to either accept the risks or implement standards to mitigate the adverse consequences

will go a long way to enabling your organization to efficiently and effectively carry out its mandate.

Safeguarding your cash resources is vital. This is especially important as banking becomes less personal and access to ATMs and Internet transactions increases.

Your organization should implement at least the following policies to safeguard your financial resources:

• keep all blank cheques in a secure and preferably locked place
• never have pre-signed cheques in the office and, if you are a signing officer, never agree to pre-sign a cheque
• keep the signed cancelled cheques that are returned from the bank locked away in a safe place to minimize the opportunity for forging of signatures
• make bank deposits regularly to avoid having significant amounts of cash and cheques in the office
• consider having a deposit only debit card to make ATM deposits easy to do frequently
• keep petty cash safely locked up. If theft of petty cash is a problem consider purchasing a small safe from your local hardware store for about $200.
• maintain petty cash and petty cash receipts on hand at a constant amount (the “imprest basis”). Replenish the petty cash float only on submission of an itemized expense report with all receipts attached. For more on petty cash see December, 1996 [Volume I, Issue 11, p. 55].
• deposit all loose cash received directly in the bank and not in the petty cash box.
• Implement the same controls over authorization of Internet payements as you have over payment by cheque (i.e. have the same signing officers sign approve each Internet transfer prior to payment).

Implementing the above procedures will help minimize the opportunity for theft and the attendant aggravation and upset that goes with it.

Types of Revenue
Revenue in the not-for-profit sector can be divided into two major categories. The first is revenue earned by an organization through the provision of services and the sale of goods. The second is revenue received from contributions for which no direct provision of services or goods is expected.

Earned revenue
Revenue in both the for-profit and not-for-profit sectors is recognized when goods have been delivered or services rendered and when payment for the good or service can be reasonably assumed. Earned revenue can come from sources such as the sale of goods, the provision of services or the use by others of an organization’s resources yielding rent, interest, or royalties.

A membership organization charging its members fees for services rendered would recognize the fee revenue as earned over the membership period. An organization with a June 30 year end charging membership fees on a calendar basis would determine what portion of the services had been rendered by June 30. If payment for a full calendar year of services had been received before June 30 then the portion of fees to be earned between July and December would be deferred to the following year.

Contributions
Contribution revenue is unique to the not-for-profit sector. Contributions are transfers of money and other assets to a not-for-profit organization with no expectation of service being provided directly to the person making the contribution. Contributions can be government grants, donations of cash and other assets, or cancellation of liabilities. It is the timing of recognition of contribution revenue that typically creates confusion.

Methods of contribution revenue recognition
In Canada not-for-profit organizations may use the following two methods to recognize revenue from contributions:

• Deferral method: Under the deferral method, revenue is recognized when expenses directly related to the revenue are incurred.
• Restricted fund method: The restricted fund method is a specialized type of fund accounting whereby funds are segregated by type of donor restriction, typically into restricted, endowment and unrestricted funds. Note that the restricted fund method is not the same as an organization reporting on a program-by-program basis. Rather, the grouping is based on the type of restriction the contributor places on the resources. Under the restricted fund method contribution revenue is generally recognized in the period contributions are received.

Types of contributions
There are three main types of contributions: restricted, endowment and unrestricted. Following is a description of each type of contribution restriction and the difference between for accounting purposes reporting with the deferral and restricted fund methods. The proper classification of donor restrictions is critical to determining how contributions are accounted for. Most restrictions will be explicitly stated by the contributor at the time of giving.

Restricted contributions
A restricted contribution is a contribution that comes with a specific condition or restriction imposed by the donor. The organization must use a restricted contribution for the purpose specified by the donor. For example, a donor may give a contribution specifically for purchase of a capital asset or for use in a specific type of program. Failure to do so would typically result in the funds being refunded to the donor.

Deferral method
Restricted contributions, under the deferral method, are recognized as revenue in the period in which the related expenses are incurred. Contributions for expenses not yet incurred are, therefore, deferred to a later date. For example, donations for capital assets such as computer equipment or a building must be recognized over the same period that the assets are charged to expenses. Consider the case of a contribution to an organization for the purchase of a computer. For accounting purposes computers are often assumed to have a life of three years. The organization would both write-off the computer over a three year period and recognize the contribution as revenue over the same three year period. Similarly, purchase of a building with an expected life of forty years would result in contributions for the purchase of the building being deferred in the year of donation and then recognized over a forty year period.

There is another significant rule under the deferral method. Donations of land and other assets that will not be amortized at any time are never recorded as revenue. They are instead recorded as a direct increase in net assets, similar to an endowment contribution.

Restricted fund method
Restricted contributions are recognized as revenue in the year received. As an example, a donation of a million dollars to a building fund would be recorded as revenue of the building fund in the year received.

Restricted contributions received for which there is no designated fund should be recognized in the general fund under the deferral method. As a result, revenue may be recognized under both the restricted fund and deferral methods in a single set of financial statements. It is crucial that you read the notes to the financial statements to ensure that you fully understand which methods are being used.

Endowment contributions
An endowment is a special type of restricted contribution. Typically, an endowment contribution specifies that resources contributed be maintained permanently by the not-for-profit organization. Interest earned by endowment contributions may usually be used by the organization either for a purpose specified by the donor or for general purposes. A contribution to a scholarship fund is an example of an endowment contribution. Original donations are usually kept in perpetuity and interest earned on donated assets is used to fund the scholarships.

Deferral method
Under the deferral method endowment contributions are reported as direct increases in net assets. As with donations of land, endowment contributions are not recorded as revenue at all under the deferral method. For example, an organization receiving a million dollars for a scholarship endowment would record the million dollars as a direct increase in the net assets (e.g. accumulated surplus) in the year the donation is received.

Restricted fund method
Endowment contributions are recognized as revenue of the endowment fund in the year received. If an individual donates $500,000 to a scholarship endowment fund then, under the restricted fund method, this amount would be recognized as revenue in the year of the donation. This treatment is significantly different than that under the deferral method where the endowment contribution is never recognized as revenue.

Unrestricted contributions
Unrestricted contributions are donations that fit in neither the restricted nor the endowment categories. A typical example of an unrestricted contribution is that of a cash donation made by an individual to an organization for general use.

Deferral method
Under the deferral method unrestricted contributions are recognized as income in the period they are received. An organization with a December 31 year end receiving an unrestricted contribution in December would recognize it as revenue in the year of receipt regardless of whether or not the amount was actually spent by the year end.

Restricted fund method
Unrestricted contributions are recognized as revenue of the general fund in the year received. This is similar treatment to that under the deferral method.

Summary
Revenue from the provision of services and the sale of goods is accounted for by not-for-profit organizations in the same way that it is in the for-profit sector. Contributions made, for which the donor does not expect to directly receive anything in return, may be accounted for under either the deferral or the restricted fund methods by not-for-profit organizations. The timing of recognition of contribution revenue depends on whether there are externally imposed restrictions placed on the contributions. For both the deferral and restricted fund methods, unrestricted contributions must be recognized as revenue in the period received.

Structure of Financial Statements
The annual financial statements of not-for-profit organizations normally include:

• a statement of financial position (sometimes called a balance sheet or a statement of net worth)
• a statement of operations (often called a statement of revenue and expenses)
• a statement of changes in net assets (the term “net assets” is often referred to as accumulated surplus or funds). For many organizations this statement is combined with the statement of operations.
• a statement of cash flows. This is often omitted if information regarding the cash flows for the year is readily obtainable from the other statements.

Audited financial statements include notes to provide additional information about the method of financial statement preparation and about the organization itself. The notes may also include supporting schedules that are cross-referenced to the statements noted above.

The financial statements of seemingly similar organizations may use different titles for the various statements. For example, one organization might have a statement of revenues and expenses while another might have a statement of operations. The purpose of these statements is the same despite the difference in names.

Content of Financial Statements
Financial statements are generally limited to quantitative financial information about transactions and events as opposed to more qualitative statements regarding financial condition and well being. For example, a statement of operations may show an excess of expenses over revenue (i.e. a loss) of $20,000 for the year. The statements will not comment on the future effect that the loss may have on the organization. It is up to the reader to interpret the information.

Financial statements are based on past rather than future transactions and events. Readers often look to historical information contained in financial statements to help predict the future cash flows of an organization. Predictions are, however, not an objective of the statements. Instead, the statements are intended to reflect what has already happened. In the example above, the existence of a loss does not provide sufficient information for a reader to determine if there is a serious cash flow problem or if the loss was an anomaly. The fact that a loss happened should, however, be reason for a reader to question whether a problem might exist in the future.

Financial statements form only a part of the financial reporting of an organization. Other important sources of financial information include annual reports, budgets and funding proposals. Readers wanting more information than that contained in the organization’s financial statements will often be able to obtain it by referring to these other sources.

Objectives of Annual Not-for-Profit Annual Financial Statements
The primary objective of annual financial statements of not-for-profit organizations is to fulfil the information needs of members, contributors (i.e., funders) and creditors regarding the organization’s financial position.

Members, creditors and contributors to not-for-profit organizations are not generally kept informed of daily operations and ongoing finances unless they are members of the board of directors. Members require some form of external communication of the not-for-profit organization’s economic information to determine whether their contributions and fees are being spent as expected. Similarly, a not-for-profit organization’s creditors and funders often need external reports.

Financial statements are used to provide information about:

• what the organization owns and what it owes;
• the changes over the period in what the organization owns and what it owes;
• whether the organization operated at a surplus or a deficit over the period.

Owned or Owing
The statement of financial position (a.k.a. balance sheet or statement of net worth) contains information at a specific date – typically the fiscal year end of the organization – about:

• what the organization owns and what is owing to it (assets);
• what the organization owes (liabilities). This includes amounts owed to others or amounts to be spent on the operations of a future period (e.g. deferred grants).
• the accumulated surplus or deficit from prior years’ operations (net assets/deficit). The difference between the assets and the liabilities is the amount of the net assets/deficit.

The statement provides a measure of the net worth or solvency of the organization. This snapshot of assets, liabilities and accumulated surplus (i.e., net worth) usually includes a comparative snapshot as at the prior year end.

Surplus or Deficit
The statement of operations (a.k.a. statement of revenue and expenses) contains information regarding:

• how much revenue was earned by the organization during the year. This will include both cash received and revenue earned but not yet collected (i.e. amounts receivable).
• the expenses the organization incurred such as those for wages, operating costs, etc.
• the difference between the revenue and expenses, which is the organization’s surplus or deficit for the year.

If the statement of financial position presents a snapshot at the beginning and end of the fiscal year, the statement of operations paints a picture of the year itself.

The statement of operations contains information concerning where revenues come from and how they were spent. The excess (or deficiency) of revenues over expenses is the number that people refer to as the “bottom-line”. This number tells readers whether the organization was able to match its expenses with revenue or if expenses outweighed revenues during the year.

Changes in What is Owned and Owed
The statement of cash flows provides information about how the organization generated and spent its cash during the year. It compliments the first two statements. The statements of financial position and operations provide a snapshot of the financial position of an organization at a specific date and a sense of its economic performance over the period but do not always clearly show why there were changes in assets, liabilities, and net assets. For example, an organization receiving a capital donation to buy a piece of land or a building would not normally reflect that donation as revenue. Instead, it would be shown as an increase in capital assets on the statement of financial position and, typically, shown as a direct increase in net assets. Another example is that of repayment of debt. If an organization pays off a bank loan, that payment is not an expense. It would result in a direct reduction of a liability. In both of these cases the transactions would be disclosed in a statement of cash flows.

Note that for many small operations, the changes in an entity’s assets, liabilities, and net assets can generally be seen from the statement of operations. As a result, many not-for-profit organizations without significant debt, capital assets and deferred grant balances often do not prepare a statement of cash flows.

What Goes into Financial Statements
As discussed above the objective of financial statements is to provide users with an idea of an entity’s financial position, its economic performance over a period and its changes in assets, liabilities, and net assets. We will now take a detailed look at the more common categories that appear in financial statements.

Assets
The first section of assets represents the current assets. Current assets comprise cash and other assets (e.g. short-term investments and accounts receivable) that would usually be converted into cash in the normal course of operations within the year.

Cash
Cash includes petty cash on hand, and cash in bank and credit union accounts. Note that the cash balance is adjusted for:

• cheques written before the year end that are not cashed until after the year end
• cash deposited in the bank after the year end that was received by the organization before the year end.

These two adjustments ensure that the cash balance represents the actual cash on hand and available to the organization at the reporting date.

Short-term investments
Short-term investments include items such as term deposits, guaranteed investment certificates, mutual fund money market holdings, and, in some cases stocks and bonds. It is important to note that, as with all other assets, these investments are recorded at their original cost to the organization. Subsequent gains are not recorded in the accounts. The notes to the statements often disclose market value of the investments. You should read the notes to see if the market value disclosed is greater than or less than the cost amount of the investments recorded in the statements.

If, in the eyes of the organization, an investment has suffered a permanent impairment in value (i.e., has declined in value below the original cost and the value is not expected to recover) then the securities will be written down in the financial statements to the now lower market value. Subsequent increases in market value will not be recognized in the statements.

Accounts receivable
Accounts receivable are amounts owing to the organization at a specific date for services rendered and goods sold. Examples of accounts receivable are amounts owed by parents for child care fees and workshop fees earned by an organization but not received until after the year end. Accounts receivable may also include other items due to the organization such as GST refunds, interest receivable on investments and grants receivable from government organizations for services rendered by the organization prior to the reporting date.

An important question to ask regarding accounts receivable is: “Will the amounts receivable actually be received by the organization?” An implicit assumption in financial statements is that the amounts included in accounts receivable will be recovered by the organization. Amounts on the organization’s books that are not expected to be recovered are often either fully written off or are offset by an allowance for uncollectible debts.

Inventory
Inventory comprises goods and supplies (assets) held by the organization for resale. An implicit assumption in financial statements is that inventory can be sold at an amount at least equal to its cost to the organization. A question to ask regarding inventory is: “Is it saleable in the foreseeable future?” If the answer is no, then the inventory should not be included as an asset in the financial statements.

Capital assets
Capital assets are assets held for a period longer than one year and comprise items such as land, buildings, furniture and other equipment. Capital assets are held for use by the organization in delivery of its services and are not intended for sale in the ordinary course of operations. The financial statements reflect capital assets at their original purchase price. The statements do not attempt to disclose fair market value or disposable value or any type of value other than cost. Consequently, while capital assets may be listed at $20,000, that is not to say that they could be sold for $20,000 or that it would cost $20,000 to replace them. The information disclosed is that the assets originally cost the organization $20,000.

Accumulated amortization
Financial statements disclose not only the cost of capital assets but also an item called accumulated amortization. Assets are usually recorded as an expense over a number of years (e.g. three years or five years). This is the accountant’s way of trying to spread the cost of an asset over its useful life. Accumulated amortization is the accounting term that explains how much of the assets have been recorded as an expense since their purchase. The excess of original cost over accumulated amortization of capital assets is termed “net book value”. The net book value of capital assets represents the remaining value of assets to be written off as an expense in future years.

Note that land is not amortized as the usefulness of land generally does not diminish with time in the same way that, for example, a computer does.
Analysis of assets
When reading a balance sheet we recommend that you focus on the following:

• collectability of accounts receivable (i.e. will amount recorded actually be received);
• the difference between the market value of securities/investments and their recorded cost;
• if inventory on hand is saleable in the foreseeable future;
• whether all significant capital assets of the organization are recorded on the balance sheet
• whether the organization plans to or needs to replace capital assets in the future .

Liabilities
Like assets, liabilities are divided into current and long-term categories. Current liabilities are those which are owed and due to be paid within one business cycle, usually a year, such as accounts payable and accrued liabilities and deferred grant revenue. All other liabilities to be paid over a period longer than a year are classified as long-term liabilities.

Accounts payable and accrued liabilities
Accounts payable and accrued liabilities are obligations that have been incurred by the organization before the year end but have not yet been paid. The following are examples of some of the more common amounts payable:

• unpaid salaries and wages at the year end where the pay date does not fall on the year end date
• vacation pay earned but not taken by employees as at the year end
• goods and services such as utilities, food and professional fees that have been purchased and/or consumed by the year end but have not yet been paid for.

Liabilities are generally recorded at the amount that the organization expects to pay to discharge them. If a potential liability exists but it cannot be valued (e.g., in the case of an outstanding item such as a lawsuit whose outcome is in doubt at the year end) then this situation will often be disclosed in the notes to the financial statements. This is yet another example of why you should always refer to the notes when looking at a set of financial statements.

Deferred grant revenue
Deferred grant revenue represents grants received by an organization before the year end where the related expenses have not yet been incurred. As an example consider an organization that receives a salary grant in advance of the year end for salaries to be incurred the following year. The unspent portion of the grant at the year end would be recorded as deferred grant revenue in the liabilities section of the financial statements.

Loans, mortgages and other debt
This caption represents the amount of debt, such as mortgages and multi-year bank loans, owed by the organization to third parities. Again, reading the notes is very important for understanding the impact the debt will have on the future cash flows of the organization. The notes will generally disclose the loan payment terms, interest rates, and, very importantly, the security pledged by the organization. For example, if an organization pledged its accounts receivable and inventory as collateral for a bank loan then this will be disclosed in the notes to the financial statements.

Analysis of liabilities

• Compare current liabilities with current assets. The organization should have sufficient current assets (the sum of cash, inventory, accounts receivable, etc.) to cover its current liabilities. If it does not then you should question how the organization will pay the amounts owing in the upcoming year.
• Review the terms and conditions of loans and other debt to determine whether any large payments are due in the near future.
• Read the notes to the financial statements to determine whether there are any potential liabilities that could not be quantified as at the year end.

Net Assets
The next major caption in a balance sheet is that of net assets. This caption often appears as accumulated surplus (deficit), net worth, or funds. Regardless of the name, in all cases it represents the excess of the book value of what an organization owns (assets) less the book value of what the organization owes (liabilities).

Net assets are often subdivided based on the nature of the restrictions placed on the net assets by an organization’s donors and funders. There are four common subdivisions of net assets: restricted, designated, invested in capital assets and unrestricted.

Restricted
This caption reflects assets given to the organization on which the funder or donor has placed explicit restrictions. The organization has a duty to use these funds in accordance with the specified purposes or the funds could have to be returned to the contributor. An example would be where donations have been given specifically to fund the purchase of a building. The organization must use the money to buy a building; it could not turn around and spend the money to cover operating or other non-building expenses.

Designated amounts
Designated amounts usually represent amounts the organization has set aside to fulfill a specific function. Designated amounts come to the organization without restrictions on their use but are subsequently designated for a specified use by the Board of Directors. A common example would be where an organization notionally or physically sets aside an amount to purchase a new asset such as a building or to repair or renovate an existing asset such as a playground. Designated amounts could also be set aside for possible costs in the event of wind up of an organization or to provide a cushion in the event of unexpected financial requirements.

It is important to note that, unlike funds with externally imposed restrictions, the requirements to spend designated amounts can be changed by the organization without the funds having to be returned to anyone.

Invested in capital assets
This amount represents the net book value of capital assets in the financial statements less the value of liabilities related to those assets. For example, if an organization had a building with a net book value of $1,000,000 against which there was a $250,000 mortgage then the amount reflected as “invested in capital assets” would be $750,000.

Unrestricted funds
What is left over after restricted, designated and funds invested in capital assets are so called “unrestricted” funds. These are funds that can be used for the general operating purposes of the organization. Note that even though use of the funds is classified as unrestricted they must still be used in accordance with the legal mandate of the organization as set out in its incorporating statutes or similar documents.

The amount of unrestricted funds provides an indication of the solvency of an organization; solvency being the ability of an organization both to fulfil its current obligations and fund its future operations for the foreseeable future. For many not-for-profit organizations the combination of the unrestricted and designated net asset items should typically be within the range of one to three months of operating expenses. This is only a very general guideline. There are circumstances that would warrant a level of unrestricted and designated net assets outside of that range. Circumstances include extreme financial uncertainty (which could justify a level of net assets in excess of the range) or, on the other hand, excellent financial stability (which could justify a smaller than average level of net assets).

Analysis of net assets

• Compare restricted net assets with the level of current assets less current liabilities. Does the organization appear to have sufficient resources to cover these specified spending requirements?
• Review the total of unrestricted and designated surplus amounts. Compare this total with total operating expenses. If the combined surplus is less than a month’s worth of operating expenses or more than three months’ worth of operating expenses then you might question whether the surplus is appropriate.

Revenues
Revenues represent the earnings of an organization during the reporting period. For example, an organization entitled to receive $1,000 in a year for providing services to its community would report the $1,000 as revenue. It is important to note that the revenue would be recorded whether or not the organization actually received the cash. Note that any revenue earned by not received at the reporting date would be included in accounts receivable under current assets in the balance sheet.

Donation revenue
Donation revenue usually comprises donations actually received in the year. Donors do not enter into a contract with the organization when making a donation. The revenue is, therefore, generally only recognized in the reporting period in which the donations are actually received.

Pledges to donate that have not yet been honoured by the donor at the year end are generally not set up in the financial statements. Because the pledge agreement is not a legally enforceable contract the organization has no legal way to enforce collection. You should read the notes to the financial statements to see if the organization has a policy of recognizing as revenue donations pledged but not yet received at the year end.

Grant revenue
Grants, unlike donations, are generally characterized by a legally binding contract between the funder and the organization. Grant revenue comprises funds earned by virtue of the organization carrying out programs specified by the funder in a grant contract. Revenue earned does not necessarily equal cash received from funders during the year. For example, an organization receiving $1,000,000 in cash before the year end for a program that was only three quarters over by the year end would typically record grant revenue of $750,000 in the statement of operations. The remaining $250,000 would be reflected as deferred grant revenue under the liabilities section of the statement of financial position. Consequently, grant revenue, unlike donation revenue, reflects grants “earned” by an organization and not just cash received.

Analysis of revenues

• Review changes in revenue from last year to this year. Management should be able to explain significant changes if the reasons for those changes are not evident from the financial statements themselves.
• Review accounts receivable in conjunction with revenue. A significant increase in accounts receivable might indicate either problems with collectability of revenue or a significant increase in activity toward the end of the fiscal year.

Expenses
Expenses during the year represent costs incurred by the organization to carry out its services. Again, as with revenue, it is important to note that expenses will include amounts for services provided or goods received that have not yet been paid for by the organization at the reporting date. Note that unpaid expenses will be reflected as part of accounts payable and accrued liabilities in the statement of financial position.

Salaries and wages
Salaries and wages are typically the single biggest expenditure item for most not-for-profit service-based organizations. Personnel related expenses should include the amount of any pay equity obligation for the year whether or not the organization has actually paid staff their pay equity entitlement. Organizations should also include the expense of unpaid vacation pay over the period if this is a significant item.

Analysis of expenses

• Compare the change in expenses from last year to this year. Review the notes to see if explanations for significant differences are noted.
• Review the notes to the financial statements to determine whether there are potential expenses that have not been recorded because the amounts were not reasonably determinable at the year end.

Statement of Cash Flows
This brings us to a review of the statement of cash flows. This statement is a very important one for organizations with a significant amount of deferred revenue, long-term debt and capital assets. The statement of cash flows categorizes and summarizes the actual cash receipts and cash disbursements for the year. Unlike the statement of operations, this statement excludes the effect of amounts receivable and amounts payable by the organization at the year end. The statement discloses, among other items, cash spent for purchase of capital assets together with cash spent to retire debt.

Cash transactions occurring in the year are typically divided into two captions:

Cash from operations
This caption includes cash received and cash spent during the year on an organization’s operations. For example, if an organization receives a $1,000,000 grant before year end but only spends $750,000 of it by the year end then the statement of cash flows will reflect the full $1,000,000 grant receivable under the caption cash received from operations. Cash used for operations will show the $750,000 in cash spent.

Financing and investing
This caption includes cash received from and cash paid out for investments in the year such as marketable securities, equipment and land and buildings. These items would not appear in the statement of operations as they result from an exchange of one asset for another (i.e. cash for an investment) and are, therefore, not expenses. The statement also includes cash received from or paid to reduce debt. For example, if an organization paid $250,000 to purchase a building, then the full amount of the $250,000 would appear in the statement of cash flows as a building purchase.

Analysis of statement of cash flows

• Take net cash actually received or spent on operations from the statement of cash flows and compare it with the surplus or deficit for the year as recorded in the statement of operations. The two amounts should be similar unless liabilities or receivables have changed significantly over the year. If the two amounts do not closely correlate then ask why. Understanding a discrepancy is especially important when an organization with a healthy excess of revenue over expenses has received significantly less cash from operations. The discrepancy might indicate cash flow problems that could lead to financial difficulties.

Conclusion
The above is a brief overview of the information portrayed by financial statements with a few tips for questions you might want to ask management. We would be happy to hear if you have ideas and suggestions regarding the review and analysis of financial statements of not-for-profit organizations. We will share ideas and suggestions with our readers wherever possible.

This article provides both an overview of the merger process and a guide to help you merge successfully.

Does a merger make sense for your organization?
As with any major change in direction, your organization and its board of directors should first determine whether a merger is desirable and/or appropriate. Continuing to fulfil your organization’s mission and goals should be a primary consideration in any merger.

Positive outcomes of a merger

• A larger entity is able to spread volunteer hours over a broader base thereby reducing the burden on existing volunteers.
• A larger organization can often reach a broader public than a smaller entity.
• With a strategic merger your organization may be able to offer additional services with a consistent philosophy. For example, a children’s mental health organization might consider merging with a similarly sized not-for-profit childcare operation. The organization would then have regular childcare facilities to offer to clients of the mental health branch and, conversely, families needing ongoing childcare could take advantage of the mental health services. Clients receiving services in one area could expect to receive services with similar standards and philosophy in other areas.
• Merging organizations may reduce administrative costs. The bulk of these cost savings typically result from a reduction in senior personnel (e.g. the elimination of one executive director position and possibly the reduction of one or more senior mangers in non-program areas) as well as a reduction in occupancy costs. In our experience, savings in administrative areas are often significantly less than expected as most organizations have already aggressively cut these costs.
• Maintaining funding can sometimes be dependant on organizations merging. We are aware of several recent instances in Toronto where continued funding was contingent on a group of organizations merging into one. The motivation for the “forced” merger was ostensibly to reduce administrative costs.
• A well chosen merger can often revitalize a waning organization. Organizations sometimes just run out of steam. A merger can bring new creative energy along with financial stability to programs.

Possible negative effects of a merger

• Having dissimilar philosophies at the board and staff levels of prospective merger partners is the most significant barrier to a successful union. Community-based organizations are usually created to fulfill the needs of a very specific public. Finding another community with compatible needs and desires can be difficult. If two entities with incompatible philosophies are forced to merge the result could well be the death of both organizations.
• So-called mergers of entities of dissimilar size, financial wealth or social stature can be more akin to a takeover by the dominant entity. The “weaker” of the two entities may wither and die from disenfranchisement. In this situation it may be better for an entity to wind-up and let its community seek services elsewhere.
• The whole organization can suffer in situations where one arm of a merged organization is not financially viable at the outset. For a merger to be successful, each entity should be solvent in its own right for the foreseeable future.

How to structure a merger
Once organizations have decided they are compatible they need to consider how to best structure the joining. There are at least three distinctly different ways of merging. Each will result in an organization with a distinct and unique flavor. We strongly advise you to get legal advice to determine the responsibilities and liability positions of the boards of directors of each of the merging entities.

Amalgamation:
Two or more not-for-profit organizations can be legally amalgamated into one. In this process the assets, liabilities and all other attributes (both positive and negative) of each of the organizations are melded into one organization, the amalgamated entity. Legally speaking this “new” entity is not new at all. It is the sum of the parts of all the amalgamating entities. The amalgamated entity fully inherits all the pre-amalgamation entities’ duties and obligations in existence prior to the start of the amalgamation. As an example, liabilities for severance pay, in the event that employees are terminated, are not extinguished by an amalgamation. The pay equity obligations of all entities are also fully passed on to the amalgamated entity.

A legal amalgamation is most appropriate when organizations with similar abilities, attributes and risk profiles want to join together. Significant due diligence should be carried out by boards and senior staff of both organizations prior to amalgamation. This process will help the boards of each of the organizations ensure they are not inheriting a closet full of legal liability skeletons.

Transfer of assets:
An alternative to amalgamation is the scenario where one organization is chosen as the successor organization and the other organization(s) sell or transfer all assets to the successor. The other organizations are then formally wound up. Only the assets are generally transferred to the new entity. Major funders should be contacted well in advance to determine whether services and related funding can be transferred from one entity to the other without undue effort.

This form of merger works best in situations where one or more of the entities has significant liabilities and/or future obligations that the merged organization does not want to assume. Make sure you get legal advice as to how best to deal with the liabilities left behind.

Note that a transfer of assets only works where the successor organization is registered as a charity as articles of incorporation clauses often state that not-for-profit organizations can only transfer assets to a registered charity.

A friendly takeover:
A third option is the friendly takeover where the board of directors of the successor organization replaces the board(s) of the other organization(s). All legal entities continue to exist and operate although they would be managed by one board of directors. The associated organizations may be able to share space and combine certain non-program staff costs in order to save money.

This setup is often of biggest advantage in situations where it is either not possible or extremely inconvenient to have program funding contracts transferred from one organization to another. Discussions with funders are, again, critical well in advance of committing your organization to such a “merger”.

Executing the merger
Following is a practical guide to aid in the merger process. The guide must be tailored to your specific situation and, again, getting good legal advice is essential.

Are the organizations compatible?
Organizations planning to merge should first determine the primary objectives for merging. Are the objectives diversification of services, becoming financial solvent, broadening the membership base of the organization etc.? If merging will better accomplish reaching these goals then consider setting up a committee to seek out an acceptable partner and initiate the process.

To facilitate a smooth merger process we recommend that formal joint strategic planning sessions be initiated at both the board and staff levels of all entities to be merged. Consider then holding a joint session at the completion of the two processes for all participants. These meetings will help determine whether a merger will meet the needs and objectives of both entities. We strongly recommend that an individual independent of both organizations facilitate this process to bring to it some objectivity and clarity.

In successful mergers that we have been associated with, these discussions have occurred over a significant period of time, often up to a year or more prior to the joining. The discussions can be intense and serve to test the ability of the entities to get along. It is always better to call off a questionable merger before the deal has been signed than to suffer through a poor partnership, which may lead to a deterioration of services provided by both of the entities. If you can’t get through the betrothal period you will probably face difficulties after the marriage.

Will the new entity be financially viable?
You must determine whether the entity to be created by the merger will be financially viable. You can, however, only evaluate the financial viability after you have determined what services will be offered. As a result, the financial implications of a merger should follow the often more difficult determination of the strategic objectives of the new entity. Regretfully, many organizations often jump to analyzing the finances first.

To analyze the financial implications of a merger we recommend that all of the involved organizations prepare budgets for the upcoming three year period under their existing service models. Using existing models as a base, adjustments can be made to reflect changes in the service model. Typically, staff costs amount to in excess of 70% of budgets for not-for-profit service organizations. Consequently, much of the financial exercise will be to determine the optimal staff complement and estimate salary levels.

To prepare the budgets we suggest you break operations down on a service program by service program basis. Administration and fundraising can be handled as separate program-like departments. For each of the departments estimate direct revenue from known sources (e.g. grants, membership fees, and fundraising campaigns where outcomes can be reasonably estimated). Costs should then be estimated based on the organization’s future service plans. You will end up with an estimated excess (deficiency) of revenue over expenses for each of the departments. Hopefully the combined budget for the amalgamated entity will have a positive cash flow. The following chart illustrates what a completed budget might look like. For illustrative purposes only one service program has been included. Your budget will undoubtedly have many more.

Note that to minimize arbitrary allocations among departments, costs should be directly allocated to departments wherever possible. For example, even though the executive director works on services, albeit indirectly, the whole salary could be allocated to administration for purposes of the internal budget. This will generally result in a less complex and more easily understood internal budget and should make it easier to spot costs that could be shared by organizations planning to merge.

This form of budget will generally not be appropriate for presentation to external funders as it is often both critical and appropriate to include a share of administration in program costs when reporting to outsiders.

Once the individual budgets of all the departments have been prepared, they can then be combined and analyzed to determine whether the combined entities will be solvent and whether savings can be realized.

Administrative steps to execute a merger
Following is a list of steps that should be performed in the execution of a merger. Again, the list must be customized for your specific situation.

Setting up “Lights-Out” Committees
We suggest that for each merger entity you consider setting up a small committee to manage the orderly closing down of operations. After the merger date, each of these committees would be responsible for paying pre-amalgamation bills, collecting receivables and dealing with the administrative tasks and inevitable headaches associated with the closing of any operation. Each of these committees would ideally include the executive director of the pre-amalgamation entity together with its chair and possibly its treasurer.

Cash
All petty cash on hand should be deposited in the bank accounts of the respective entities just prior to the date of the merger. New petty cash funds can be started where needed and these should be funded out of the bank account of the merged entity.
All bank accounts should be reconciled as at the date of the merger. All unusual reconciling items should be identified and followed up as soon as possible.

An estimate should be made of the amount of cash needed for finalization of the pre-merger affairs of each merging organization. This cash, managed by the lights-out committee, should be kept in a bank account specifically for the purpose of settling those obligations. The remaining contents of pre-merger bank accounts should be transferred to the main operating account of the merged entity on the effective date of the merger.

Consider leaving the name of the pre-merger entity on the wind-up account and leaving this account open for a while to make it easier to deposit cheques made out in the “old” name. Late deposits such as GST refunds and other items in the name of the pre-merger entity can more easily be deposited in an account bearing that name.

Investments
Compile a list of all term deposits and other investments held by each of the organizations as at the merger date. Prepare written notification of any name change for the financial institution(s) holding the investments. In cases of amalgamation, Articles of Amalgamation may have to be submitted to each of the institutions together with a revised list of signing officers.

Accounts receivable
Identify all amounts owing to each of the pre-merger organizations just prior to the date of merger. Determine when each amount is expected to be collected and identify those for which collection is doubtful.

File for a GST refund, where applicable, as at the date of amalgamation for each for the pre-merger entities.

Insurance and capital assets
Write to all insurers requesting cancellation of insurance effective as of the merger date. Prepare a list of all capital assets of the new amalgamated entity and forward this to the insurer of the merged entity.

Lease obligations
Prepare a list of all equipment under lease (telephones, photocopiers, vehicles, etc.) for each of the individual entities. The planning committee should review lease terms of all equipment under lease and determine what options for use and/or disposal are available to the organization.

Obtain copies of all premises’ leases. Review your options, preferably with a real estate lawyer.

Accounts payable
On or before the merger date pay all invoices relating to the period up to the date of the merger. Prepare a list for the new entity’s administrator of amounts to be paid for which invoices will not be received by the date of merger. All other amounts should be referred back to the lights-out committee.

A list of all amounts payable as at the date of amalgamation that are in dispute or in the process of being negotiated/settled should also be prepared. This list should be reviewed periodically by the board of the new entity.

Payroll related items for pre-merger entities
There are a number of often difficult merger tasks specifically related to personnel and payroll. Seniority, pay equity and collective bargaining agreements are just a few of the issues that need to be dealt with early on in the process. We strongly advise that all organizations attempting a merger seek the counsel of a lawyer experienced in labour law generally and in the nuances of the not-for-profit sector specifically.

a. General

• Prepare notices of name change of the employer and/or termination for all employees of the pre-merger entities.
• Arrange for all staff and the Receiver General to be paid up to the date of merger. The staff should be paid by their respective pre-merger entities.
• Cancel all but one of the payroll services used effective the date of the merger.
• Transfer all personnel files to the new location.

b. Non-statutory benefits

• Advise all benefit plans of termination of existing coverage effective the date of the merger
• Advise all employees of their change in benefits plan coverage and procedures on or before the merger date.

c. Revenue Canada

• Prepare T4 and T4A supplementaries and summaries for all employees and merging entities from January 1 to the date of merger.
• Prepare the last payroll remittance to Revenue Canada and arrange for it to be received at the appropriate date (e.g. by the 10th or 15th of the month following the last payroll date).
• Cancel the Revenue Canada payroll number for all pre-merger entities but one, effective the date of the merger. Written notification on the back of the payroll remittance form is usually sufficient for Revenue Canada.

d. Ministry of Finance of Ontario

• Prepare the EHT return(s) effective the date of the merger.
• Cancel all EHT number(s) but one effective the date of the merger.

e. Workplace Safety and Insurance Board

• Determine which entities are covered. Arrange for coverage to be transferred to the new entity.
• If coverage is to be cancelled, contact the WSIB in advance to determine the amount of the cancellation penalty.

Post merger payroll tasks
a. General

• Prepare employment contracts for all full and part-time staff effective the date of the merger.
• Establish the pay period (e.g. bi-weekly, semi-monthly etc.).
• Have all employees complete and sign TD(1) forms establishing the amount of tax to be withheld.
• Set up direct deposit accounts for employees, if applicable.
• Set up personnel files.
• Set up all new employees on the payroll service (internal or external).
• If a semi-weekly payroll period is adopted, set the second Friday of January as the first bi-weekly pay day of every year.

b. Non-statutory benefits

• Contract with an insurance carrier to provide benefit coverage effective the date of the merger.

c. Government requirements

• Obtain a business number from Revenue Canada for the merged entity. With an amalgamation Revenue Canada will generally allow the continuation of one of the business numbers provided a copy of the articles of amalgamation are filed with them.
• There is also generally no need to obtain a new Ministry of Finance of Ontario EHT account number. Again, the Ministry will generally allow the continuation of one of the EHT numbers provided a copy of the articles of amalgamation are submitted.
• Set a year end for the amalgamated entity that makes sense for business purposes. Factors to consider include when you would like to hold your annual board of directors elections (i.e. the AGM) and the year end of the organization’s major funders.
• Appoint an auditor for the year end audit.

A cautionary note: Books and records should only be destroyed after you have carefully reviewed the statutory requirements covering your organization. If you have any doubts you should contact the applicable government departments. Please note that the Corporations Act (Ontario) does not specifically address the issue of record retention. In most cases compliance with Revenue Canada’s requirements should suffice.

Revenue Canada requirements
The most comprehensive documentation regarding requirements to keep books and records is maintained by Revenue Canada. These requirements are clearly spelled out in Revenue Canada Taxation Information Circular 78-10R4. A copy of this circular can be obtained from any Revenue Canada office or read on line at http://www.cra-arc.gc.ca/E/pub/tp/ic78-10r4/ic78-10r4-e.html. We urge you to obtain a copy and review it.

Organizations covered by Revenue Canada regulations
The Revenue Canada regulations cover all organizations required to pay or collect taxes, registered charities and registered Canadian amateur athletic associations. Not-for-profit organizations that are not charities, collect no GST and are not employers are also covered as they must maintain records to substantiate their tax exempt status. In short, all not-for-profit organizations are covered.

What records should be kept
Revenue Canada Taxation does not specify precisely what records should be kept. However, the guidelines suggest that at least the following records must be maintained:

• all deposit books together with documentation supporting who the funds were received from and to what they relate
• a record of all cash disbursements, proof of payment such as cancelled cheques and documentation, such as invoices, to substantiate disbursements
• payroll records in sufficient detail to substantiate calculations of amounts withheld from employees and those amounts remitted to Revenue Canada Taxation
• sufficient documentation to substantiate receipts given to individuals and organizations donating money and gifts-in-kind to charitable organizations
• all documentation relating to ten-year-gifts received by charitable organizations and foundations.

If Revenue Canada Taxation audits your organization and determines that inadequate records have been kept then they will, as a minimum, specify what books and records they require you to keep in the future. Note also that the books and records must be kept at your organization’s place of business. It is not acceptable to Revenue Canada to have your organization’s books and records maintained off-site. In situations where a volunteer treasurer or bookkeeper maintains the books off-site, a backup copy must be maintained at the organization’s place of business.

How long records must be kept for Revenue Canada
Revenue Canada divides records into categories which must be kept for:

• the organization’s lifespan plus two years
• six years from the end of the fiscal period to which the records relate
• two years from the end of the calendar year to which the records relate

The lifespan plus two years rule
Revenue Canada specifies that certain financial records must be kept for the duration of the life of your organization plus an additional period not less than two years from the dissolution date. These records include:

• a copy of all Board minutes
• annual audited financial statements
• general ledger
• annual adjusting journal entries
• any significant contracts and agreements entered into documentation and duplicate receipts relating to ten-year-gifts to registered charities. These records must be kept for a period of two years from the earlier of the date the charitable registration is revoked or the organization is dissolved.

For many smaller not-for-profit organizations this information will fit in a cardboard storage box each year. The box should be filed somewhere dry, safe and secure.

Keep for at least six years
Most books and records not covered by the lifespan plus two years rule must be retained for a minimum of six years from the end of the fiscal period to which they relate. This category includes, among other information, bank statements, invoices and payroll records. In 1998, organizations with a December 31st year end can therefore destroy those books and records not covered by the lifespan plus two years rule for the 1991 fiscal year and before.

The rules get a bit more complicated for records supporting deferred grants. Documentation regarding a grant received in 1991 but deferred in the financial statements until 1992 must be maintained until 1999. This is because the retention requirements refer to six years “from the end of the last fiscal year to which the documents relate”. Documents relating to long-term contracts such as mortgages and multi-year funding agreements may, therefore, need to be kept for substantially longer than the traditional six year period.

Under the Employment Insurance Act and Canada Pension Plan, the retention period is defined as six years “from the end of the calendar year to which the books and records relate”. Therefore, in 1998 an organization with a March 31st year end can destroy payroll records not covered by the lifespan plus two years rule for 1991 and prior calendar years.

Keep for at least two years
Duplicate donation receipts issued by a registered Canadian amateur athletic association or a registered charity, other than those relating to ten-year-gifts, need only be held for at least two years from the end of the calendar year in which the donations were made. In 1998, registered charities can therefore destroy duplicate donation receipts from 1995 and prior calendar years.

Early destruction
Books and records can be destroyed at an earlier date with advance written permission from the Minister of Revenue. Your organization must complete a Revenue Canada Taxation form T137, “Request for Destruction of Books and Records”, in order to obtain permission. Please refer to Information Circular 78-10R2 for full details.
Note: All of the above comments on document retention assume that your organization is not about to be wound up or dissolved. Boards of Directors planning a wind-up or dissolution should refer directly to Revenue Canada Information Circular 78-10R2.

Record retention for amalgamated entities
Any organization involved in an amalgamation must ensure that all the amalgamated entities fully comply with Revenue Canada’s record retention requirements. The books and records of all the organizations prior to the amalgamation must be kept according to the appropriate regulations as well as those of the new amalgamated entity. This is because the organizations have not dissolved, they have merely been amalgamated into one legal entity.

Specific record retention requirements of Ontario statutes
We have briefly reviewed the record retention requirements of a number of Ontario statues. It would appear that in most cases adherence to the Revenue Canada Taxation requirements will result in compliance with the regulations of other statutes. Note, however, that this applies primarily for the retention of financial books and records. Retention requirements for other types of documents such as medical records are often quite different. Again, we urge you to review the requirements of the statutes governing your organization. A summary of the retention requirements of the statutes we are most familiar with follows:

Day Nurseries Act (Ontario)
Enrolment documentation and records regarding individual children enrolled in a centre are stipulated in Sections 48 and 49 of the Act. Records must be maintained for at least two years after the discharge of a child. This requirement could result in documents being maintained for longer than the six year period required for financial books and records. For example, you would have to retain enrolment and related records for nine years in the case of a child enrolled at the centre for a seven year period (seven years of enrolment plus a two year post-enrolment period). Practically speaking, we recommend that you maintain enrolment and related records for a period at least two years longer than the longest period for which a child could be enrolled in your program.

Sections 64 through 66 of the Day Nurseries Act specify that financial records are to be maintained by every operator governed by the Act for a period of “at least six years from the time of their making”. Compliance with the Revenue Canada regulations should, therefore, ensure compliance with the Day Nurseries Act requirements for financial documents.

Charitable Institutions Act and Homes for Retarded Persons Act (Ontario)
A written record and file for each resident of a charitable institution or home for retarded persons [sic] must be kept for at least twenty years after the last entry in the record with respect to the resident or, where the resident dies, for a period of at least five years after the death of the resident. [O. Reg. 814/81, S.5.]

Homes for Special Care Act and Nursing Homes Act
Any record relating to a trust account (i.e. details of deposits and withdrawals) must be kept for a period of six years from the date of the making of the record. Again, compliance with the Revenue Canada regulations should ensure compliance with the requirements of the Homes for Special Care Act and the Nursing Homes Act.

Public Hospitals Act
Patient medical records must be kept for a minimum of ten years after which time each facility can determine its own policy.

Retention of insurance policy documentation
It is important to note that insurance claims are covered by the insurance company engaged by your organization at the date the insurable event occurs, not the date at which it is reported. Maintaining a record of your insurance carrier and details of the policy in force for six years may seem sufficient however cases of alleged abuse may not surface until well after the six year period is over. As a result, we recommend that you maintain copies of all of your corporate insurance policies for your organization’s lifespan plus two years along with your minute books, general ledger, financial statements etc.

The Trade-off Between Autonomy and Control
Internal controls must be matched to your organization’s philosophy and operating structure. The first step in designing a set of internal controls is for the board of directors to decide on the degree of control that it wants to exercise over branch operations. A substantial range is possible.

At one end of the spectrum is an autonomous organizational structure where each of the branches functions independently of the main organization or head office. An autonomous structure downloads the costs of controls to the branch operations. In this situation the branches would be able to:

• appoint their own board members
• have control over their own finances including record keeping and the raising and spending of money
• issue their own charitable receipts, if applicable.

At the opposite end of the spectrum is an organizational structure where the head office has complete control over branch operations. In a more controlled structure, organization and administrative costs are transferred from branch locations to the head office. In this situation:

• local branch board appointments are approved by the head office
• all financial transactions are run through the head office
• financial and other critical systems are all administered and controlled by the head office

Reality typically lies somewhere between these two extremes. Financial and other controls in a fairly autonomous branch network tend to vary greatly as they are designed by and for the needs of the individual branches. A potential risk to the organization as a whole is that a problem in a branch resulting from inappropriately designed or maintained systems and controls could result in bad publicity. Bad publicity could seriously taint the rest of the organization.

In a more highly controlled environment, the board of the head office would exercise the degree of control they are comfortable with by setting policies for the branch locations. In addition, the head office would have greater assurance throughout the year that policies are being followed provided, of course, there is regular monitoring. The downside of the more highly controlled system is the significant amount of resources (money and volunteer and staff time) required to design, implement, maintain and report on a system of controls for operations at the various branches.

There is no one correct philosophy. We recommend that your board determine the degree of control it needs to exercise over its branch operations at a strategic planning session. Once this decision has been made then appropriate accounting controls and systems can be implemented.

Following are a number of issues we are frequently asked about by organizations with multi-branch structures.

Issuing Donation Receipts
Controls over the issuing of donation receipts are especially important in multi-branch environments. Board members of the registered entity (often only the head office) are responsible for ensuring that all donation receipts issued under its name meet the criteria set out in the Income Tax Act of Canada. Failure to adhere to these regulations could result in the deregistration of your charity. Organizations granting autonomy to branches, while at the same time offering to issue charitable donation receipts on their behalf under the umbrella name of the organization, must ensure that sufficient controls are in place at the branch level to correctly issue receipts. The following areas must be addressed when designing controls:

• receipts must only be issued for donations received and regulations for in-kind donation receipts must be properly followed
• donation receipts must not be issued for any donations where the identity of the donor is not known (i.e. loose collections)
• an accurate and up-to-date donor database should be maintained to promote efficiency of future fundraising
• all donation receipts issued must be reported to Revenue Canada on the annual Registered Charity Information Return (T3010)
• you should have the ability to track sufficient and accurate information to complete the T3010′s sections on non- charitable expenses, political activities, fundraising, etc.

Monitoring Branch Finances
The board of the head office needs to determine the level at which they will monitor the financial operations of the branches. A combination of the following procedures could be implemented depending on the degree of control that a head office wants to exercise:

• establish mandatory budgeting, accounting and reporting standards for all branches. A written policy manual is essential.
• require periodic reporting of financial results and budgets to the main branch (monthly, quarterly or annually)
• require detailed head office review of periodic branch financial submissions for accuracy, timeliness and compliance with head office policies
• establish head office policy of visits to branch operations by board and/or staff members to review head office expectations, branch results to date and to provide suggestions for changes and/or improvements.

Control Over Cash Disbursements
Head offices wanting to exercise significant control over branches will accept responsibility for and administer cash disbursements for the branches. In this situation all branch financial transactions would be conducted through the head office bank account and the head office would be responsible for authorizing all disbursements (i.e. signing the cheques). Alternatively, head offices not needing to exercise the same level of control could consider allowing branches to set up their own bank accounts and authorize their own disbursements. Doing so entails appointing branch personnel (staff or branch board members) as signing officers of the organization. The head office board should consider obtaining legal advice to determine its legal liability in this case.

Summary
Determining the degree of control to be exercised over a multi-branch operation requires a board to have a firm grasp on its strategic plan of operations. Only once this plan is known can the appropriate controls be implemented. We strongly recommend that you consult legal counsel to ensure that the liability position of your organization, head office and local branch boards is well understood.

Different rules and regulations for reporting on funds spent apply for the various levels of government. These rules range from the very detailed annual reports required by the Ministry of Community and Social Services (the Annual Program Reconciliation Reports) to no financial reporting requirements at all (many of the municipal grants). You need an internal grant monitoring system that will work for a wide variety of grants.

We recommend that for each grant program you prepare a summary including:

• The fiscal period covered by the grant.
• Expected amounts to be received and the date these payments are to be received.
• Reporting requirements at the end of the grant program and the date the reports are due.
• Situations that will result in repayment of grant monies.

The grant summaries should be reviewed periodically throughout the year. A month or so before the end of each grant program you should take necessary steps to ensure all money that should be spent has been spent. Action before the expiry date of a grant program is essential.

Allocation of administrative expenses
Organizations with a multitude of funding sources should appropriately allocate administrative (i.e. non-specific) expenses across their various grant programs. Expenses such as the Executive Director’s salary, telephone and bookkeeping are all necessary for your organization to function. Consequently, you are justified in allocating a portion of these costs to your program unless doing so is expressly prohibited by grant regulations. Remember that all allocations are arbitrary. There is no correct amount or percentage to allocate. Consequently, make an allocation that is both reasonable in the circumstances and results in the desired result in your organization’s funding reports.

Following are some planning ideas to help you manage grants received from some of the more common funding sources. We would appreciate hearing your experiences with grant programs not listed as well as additional suggestions for programs discussed below. We will share suggestions and tips with our readers.

Municipal government salary grants
Direct Operating And Wage Enhancement Grants
Salary grants for childcare workers are issued on an April to March basis. By May of each year all organizations must complete a Grant Utilization Form (“GUF”). On that form organizations must list amounts received and amounts paid out. Any unspent funds will be deducted by the Ministry commencing in the fourth quarter (i.e. January to March) of the following calendar year.

Many childcare organizations pay out less grant money than they receive as a result of temporary reductions in the size of their childcare programs. To minimize these shortfalls consider the following:

• Ensure you have at least 10% of the grant allocated to statutory benefits and administrative costs. We are aware of some cases where the Ministry allows 15% on an annual basis.
• Consider giving existing staff a one-time bonus to use undistributed amounts resulting from temporary staff reductions. Note that salary grants, exclusive of pay equity, to any one staff person cannot exceed approximately $9,000 per year.
• Starting in 1997, the Ministry is allowing centres to allocate undistributed amounts resulting from temporary staff reductions as “non-mandatory” benefits. Amounts on the non-mandatory benefit line in the GUF cannot exceed actual non-mandatory benefits paid (e.g. payments for the medical, dental and RRSP plans). Please note that claiming an amount on this line could have repercussions for preparation of your Metro Children’s Services budget.

Ontario Ministry of Children and Youth Services and Ministry of Community and Children’s Services
Grants Requiring An Annual Program Expenditure Report
Many programs funded by the Ministry of Children and Youth Services require a Transfer Payment Annual Reconciliation (“TPAR”) to be filed and in some cases audited. The report must generally be filed no later fourth months after your organization’s year end. The TPAR essentially requires listing of grant money received and related expenditures made during the funding period. The funding period generally follows an April to March fiscal year. Be careful not to factor in inadmissible expenses when calculating allowable expenses paid under Ministry grants. Inadmissible expenses include, among other things:

• Vacation pay accruals
• Accruals for retroactive collective bargaining provisions
• Amortization and other non-cash expenses

See the technical notes attached to the TPAR for details.

We strongly recommend that all organizations required to file an APER carefully review actual receipts and disbursements related to their grants in February of each year. Relevant program expenditures should then be made in March if there are unspent funds available.

The Ministry is currently requiring a refund of any surplus on a dollar-for-dollar basis. The Ministry’s request for repayment of unspent amounts is delayed until the TPARs are analysed. Currently Ministry analysis is running up ot a full year after submission of the reports. This delay in the timing can have very unfortunate repercussions, especially where organizations have fallen on lean times making repayment of past surpluses in the current year difficult or next to impossible.

Ministry of Housing
Ministry of Housing reporting requirements and forms are complex. The fiscal period is generally April to March. Amounts under spent are currently recovered by the Ministry on a dollar-for-dollar basis. In addition, if under-expenditures are thought to result from a permanent downsizing in a project then the Ministry will permanently reduce ongoing funding.

Advanced planning in February of each year is essential to ensure that actual expenditures are at least as great or greater than planned.

Ministry of Health
Program funding for non-institutional care generally requires completion of a reporting form similar to the TPAR (see above) on an annual basis. The funding year is also generally April through March. Expenditures reported must correspond with those reported in the audited financial statements except for inadmissible expenses, which include reserves for items ordered but not yet received, vacation pay accruals, amortization and other non-cash expenses. Organizations should ensure the appropriate HST percentages are included in the expense accounts as reimbursement rates vary.

For many years organizations were not permitted to move expenditures between lines. For example, overspending in salaries was not permitted to be offset by under spending in the office and administration category. Recoveries were a regular occurrence. The Ministry appears to have relaxed their requirements and is now more focused on the excess or deficiency of expenses over revenues for the entire program. Recoveries of any total excess of revenues over expenses are generally required on a dollar-for-dollar basis. Any deficit, of course, must be covered by the organization.

Toronto Children’s Services
Most childcare centres are familiar with the circumstances that will result in a reduction in per diem rates or a recovery of amounts previously received. Unlike the province, Toronto ‘s fiscal period is based on the calendar year. Following is a brief summary of events that could lead to a recovery or reduction in amounts received:

• Centres reporting expenditures less than 90% of those budgeted will automatically trigger a complete retroactive reworking of their annual budget by Toronto Children’s Services. Toronto will recalculate per diem rates using actual expenditures and, as importantly, actual enrolment levels. If the revised per diem rate based on actual expenditures and enrolment is lower than that actually paid, the excess will be clawed back.
• If your organization’s accumulated surplus exceeds three months of operating expenses then a recalculation of per diem subsidy rates will be done and could result in a recovery. In our experience Toronto bends over backwards to avoid a recovery in these circumstances. Centres are able to carry forward a surplus to the following year if a loss was subsequently incurred. In addition, in some cases recoveries can be forestalled where a centre provides Toronto with a plan for spending the excess.
• In certain circumstances a reduction in fees charged by a centre to its full-fee paying parents can result in a claw back by Toronto Children’s Services even if subsidized rates are well below the full fee rates. Be sure to review any planned fee reductions with your Toronto consultant prior to implementation.

• All information must be relevant.
• Financial information must be understandable.
• The information presented must be reliable.
• Financial information must be timely to be useful.

Reported information must be relevant
The Finance Committee and/or Board of Directors should determine what financial information they require to monitor the organization=s financial progress. Information should include a summary of results of operations (revenues received and expenses incurred), financial position (assets and liabilities) and key statistical data such as present and expected enrolment to help the Board determine the financial outlook for the future. Specifically, monthly financial reports should at a minimum include totals for:

• Revenue from fees, grants and other sources.
• Salary and benefits expenses.
• Food costs, if significant.
• Other expense information as the Board considers necessary.
• A summary of significant assets at the end of the month including cash, accounts receivable, accounts payable (outstanding invoices) and grants not yet paid out.
• For childcare centres, enrolment statistics by age-group and/or room.

The above information should give you an idea of the organization’s current financial status and progress since the last Board meeting.
A comparison of actual with budgeted results is also very useful. Actual-to-budget comparisons will enable the Board to determine whether approved financial policies are being followed (Is the centre operating at a break-even level as directed by the Board?) and whether corrective action needs to be taken. The actual-to-budget analysis is most useful when accompanied by a brief narrative explaining significant variations.

Some Boards require monthly as well as year-to-date information for actual and budgeted revenues and expenses. The amount of detail reported is, of course, up to the Board of Directors.

Following is an example of a two page monthly report to a Board:

Other financial information such as uncollected parent fees and enrolment statistics should be reported in a format agreed upon by the Board of Directors.

Reported information must be understandable
Your monthly financial reports should neither be so summarized as to be superficial nor so detailed and voluminous as to be unintelligible. The ideal amount of information reported to the Board will be a function of the culture of the Board members together with the level of their involvement. Some Boards require reams of detail while other Boards prefer a simple one page summary assuming that all of the details have been taken care of by the staff. The ideal amount of information reported usually lies somewhere between these two extremes.

One strategy to determine the appropriate amount of information is to start with a fairly summarized report (e.g. the two page variety presented here) and then add information as requested by Board members. For example, if your Board wants details of advertising and professional development expenses reported each month then expand your initial summarized version of the report to include these amounts. If your Board requests a copy of the monthly bank reconciliation then attach that to the statement of financial position presented. You might want to revisit the content of monthly financial reports with each newly appointed Board of Directors.

Reported information must be reliable
Financial reports to Boards of Directors are only useful if the information is reliable. You do not have to have a monthly audit to achieve reliability. It is generally sufficient that the bank be reconciled to the accounting records each month and that the reconciliation be reviewed periodically by the Treasurer or another member of the Finance Committee. The Finance Committee or the Treasurer might also periodically (once or twice a year) make sure that amounts reported actually agree with those in the financial records.

While a bank reconciliation will help ensure that all cash transactions are reported, it will not guarantee that all transactions have been classified properly. For example, an invoice for play supplies for $2,571 may be inadvertently misclassified as a food expense. Significant misclassification errors should, however, be detected by a comparison of actual to budgeted amounts. If, in the above example, the monthly food budget was $2,500, the misclassification would result in the monthly food expense being twice that budgeted. Hopefully the Board would question this variance at the monthly meeting.

In summary, to help ensure that data reported is reliable you should:

• On a monthly basis reconcile all bank account balances with those reported to the Board of Directors.
• Compare actual to budgeted amounts and explain variations. This procedure will help determine whether significant expense or revenue transactions have been misclassified.
• Periodically (twice a year) compare amounts reported to the Board with those in the underlying accounting records.

Reported information must be timely
Reporting the results of operations and financial position on time is essential if corrective action is to be taken by the Board. For example, if you report September activity in January it may be too late to adjust salary expenses and/or fees to avert a pending financial crisis resulting from a drop in enrolment. Timely financial reports are essential!

Reporting financial information more than two months in arrears should raise warning flags for the Finance Committee and/or Board of Directors. Steps should be taken immediately to make sure that financial information reported is no more than one month old.

In this issue we will lay out a financial management framework enabling you to use the skills you already have to adapt quickly to changing financial circumstances. For more detailed information on specific skills please refer to articles in prior issues.

Summary of the framework
Dealing effectively with change requires that your organization:

• Clearly understand its operating objectives and distinguish between core programs and discretionary programs.
• Develop both an annual budget of financial resources and a twelve month cash flow forecast that clearly maps out how the organization expects to finance its objectives.
• Set up a reporting system capable of providing your Board with relevant, understandable, and reliable information on a timely basis.
• Regularly compare actual with budgeted financial and operational results. Have volunteers and staff capable of dealing quickly.
• and effectively when change is needed.
• Establish effective internal controls to safeguard your organization’s resources and ensure resources on hand are used efficiently in delivery of service.

Set performance benchmarks
Your organization most likely already has a budgeting system, good internal reporting and a mechanism to follow-up progress throughout the year. How does uncertainty affect this process? It is critical that you are able to determine when your organization needs to take rapid financial action in response to changes. Specifically, you need to set performance benchmarks to know just when to kick into high gear and react to the changes. For example:

• A childcare centre might set its benchmarks based on various enrolment patterns. If enrolment drops below a specific number of children in a room (for example, below 14 preschoolers in a room with a capacity for 16) then that might trigger a marketing campaign to increase enrolment and/or a review of the staffing model to see if costs can be reduced to match the drop in revenue.
• A drop in occupancy rates at a women’s shelter might trigger a review to see if greater intake efficiencies could be realized.
• Cash and investments dropping below a certain predetermined amount might trigger a review of the budget for the upcoming six months to see if a serious cash problem could occur.
• Reduction of a single source of revenue might trigger a review of expenses to ensure that costs can be met for the foreseeable future.

Your Finance Committee/Board of Directors must clearly articulate a set of financial and service benchmarks that can be monitored fairly easily and on a regular basis. Failure to achieve these benchmarks should result in a review to see if corrective action is needed. This is when you can use the financial processes you already have to bring about needed change.

Revisit organization objectives
Your organization should have an agreed upon set of objectives.

A clear set of objectives or priorities will help your organization focus on what needs to be changed in order to meet key financial benchmarks. Make sure that in setting these objectives you differentiate between core and discretionary services. As an example, consider an organization that runs a full-time childcare centre, a summer camp, a nursery school and a parent drop-in centre. If the full-time childcare centre is deemed to be the essential service then it will be allocated funds first if funding sources diminish.

Setting corporate objectives is best done through a formal process. All Board members, senior staff and possibly general members and the community at large should participate in the process. The outcomes should be well documented and communicated to all members.

Develop a plan to meet the objectives
Your organization already has an annual financial budget and may also prepare a monthly cash flow forecast for the upcoming year. If financial benchmarks are not met your organization must quickly revisit its budgets.

The revised budget should focus on ensuring that core services can continue to be provided. Surplus financial resources, when available, can be allocated to non-essential programs. When preparing the budget concentrate on ensuring that:

• core programs have sufficient financial resources to function throughout the year.
• financial resources are allocated to non-essential programs only after core program resources are secured.

The revised annual budget should be approved by the Board of Directors. Use the approved annual budget to help you prepare an updated monthly cash forecast for the upcoming year. Compare the monthly forecast with actual results throughout the year. Review again the revised monthly cash forecast if the organization continues to fall short of set financial benchmarks.

Budgets should be dynamic and should be seen by the Board of Directors as one of the most critical elements of financial management used by the organization.

For specific guidance on budgeting see The Art of Budgeting. For comments on what constitutes an appropriate level of surplus/net worth see Managing Your Financial Cushion.

Monitor the results of your plan
Clearly stating your organization’s objectives and establishing and approving a revised budget will help you know where you are going and help you react to change. Your organization also needs clear information as to where it stands financially so it can determine whether it is on track or further adjustments need to be made. Monthly financial reports should continue to be prepared for your Board of Directors for this purpose. The information reported must be:

• relevant to running the organization.
• sufficiently summarized to be readily understood by Board members. Information must also be comprehensive enough to provide Board members with sufficient information to make decisions.
• accurate and correctly reported. The underlying books and records must be accurate and sufficiently well organized to permit reliable financial reporting.
• reported within reasonable time frames (e.g. within three weeks of month end).

Financial reporting to the Board should be done at least monthly if your organization is in a state of financial flux. You can get by with less frequent financial reports only if your organization is blessed with financial stability and if that stability is unlikely to change in the near future.

For a detailed review of aspects of monthly financial reporting to your Board of Directors see Monthly Financial Reporting to Your Board.

Evaluate results and revise your plan
Each month compare actual results with those estimated. Doing the comparison is easy. Acting on the information is more difficult. Your Board must have the will to adapt quickly to changes in revenue and expense patterns. Specifically, if revenue is less than expected then your organization must determine whether:

• to operate at a deficit (assuming the financial cushion is sufficient to permit this).
• additional sources of funding should be sought, and/or
• service levels must be reduced.

To deal with change quickly and efficiently your Board needs the best resources available. Specifically, you need to recruit capable and understanding Board members with the ability to make difficult decisions and implement change. We recommend that your organization set up a Finance Committee and appoint to that Committee capable Board members and outsiders if necessary (see Finance Committees).

Change staffing models with caution
In most not-for-profit service organizations staff salaries and benefits account for between 75 and 85 percent of expenses. In times of funding reductions controlling staffing costs is the most effective way to meet financial objectives.

Reducing salary and benefit costs is a complex process that must be properly handled. We strongly recommend that you either recruit a labour lawyer to your Board or, if that is not possible, consult a labour lawyer before making any significant changes to existing staffing models. Failure to do so before laying off staff or reducing their hours or salaries can result in significant unexpected monetary settlements with staff, bad staff morale and use of significant and unproductive amounts of volunteer and paid staff time.

Controlling your organization’s financial assets
It is important that your Board/Finance Committee devise a set of financial controls to ensure that the organization’s financial resources are used only as intended.
Internal financial controls should be applied in the context of the culture of your organization. The Board of Directors sets the tone of internal control at an organization. Consequently, if your organization wants to maintain a set of internal controls for effective financial management then the Board must be prepared to follow up on a regular basis to ensure that the policies and procedures are being followed. Strong support at the Board level for appropriate controls generally results in effective financial management.

For a detailed summary of internal financial controls see, click here.

Given that your incorporated not-for-profit organization must have an annual audit you might as well ensure that it is as productive a process as possible. Following are a few suggestions to help.

Have the audit completed soon after year end
The auditor is presenting an opinion as to whether the financial statements of your organization represent fairly its financial position and changes in financial position for the year. It is generally helpful to get that opinion sooner rather than later. To ensure the audit is done on a timely basis call your auditor in advance of your year end and coordinate his/her efforts with those of the person responsible for your organization’s bookkeeping. Generally there should be no problems completing an audit within three months of the year end assuming that the books and records are ready for audit within six weeks of the year end. If the books and records are not ready within six weeks it may indicate an underlying problem in the organization with respect to timely financial reporting.

Request the same people each year
Maintaining continuity of audit personnel on the audit for at least two or three years in a row will reduce the amount of time required to explain to the auditors the unique characteristics of your organization and industry. Also, having the same person for several years gives you an opportunity to develop an ongoing relationship so that you can draw on their financial expertise throughout the year as the need arises.

Find an auditor who knows your industry
It is always helpful for your auditor to be familiar with your major funders and their reporting requirements. Auditors who are thoroughly knowledgeable about the characteristics of your industry will generally be in a better position to advise you on matters relevant to your organization such as how to maximize your revenue and use your financial resources as effectively as possible.

Accumulate a list of financial questions throughout the year and discuss your concerns with your auditor during the audit. This need not take long and could provide you with some valuable financial advice. Alternatively, call periodically throughout the year to resolve financial issues prior to year end.

Have the audit done at your premises wherever possible
Performing the audit at your organization will allow you to answer the auditor’s questions as they arise. This will avoid the annoying and all too frequent games of telephone tag that can occur during the audit process. Having the audit performed on site also reduces the inevitable hassles of sending additional information to and from the auditor’s office. It eliminates the inconvenience of being without your books and records for an extended period of time and also greatly reduces the risk of losing documents.

Discuss fees in advance
Attempt to obtain a firm fee quote and ask that any additional work that could possibly result in a fee increase be approved by you in advance of the work being performed. This will give you an opportunity to control the audit fees and to deal with problems in a cost effective manner (e.g. have the additional work performed by a bookkeeper as opposed to a chartered accountant).

To help reduce audit fees consider asking your auditor for a list of information that he/she requires from you prior to the audit being conducted. If necessary, request a planning meeting to ensure you understand their requirements. The information can then be prepared by you in advance of the year end audit visit.

Expect quality service
Finally, if you are unhappy with the relationship with your auditor and feel your organization is not being serviced appropriately then speak to your auditor. If you feel your needs are still not being met consider changing auditors. Select an auditor who you believe will provide superior service, has substantial knowledge of your organization’s specific field and with whom you think you can develop a productive working relationship.

Your Board of Directors is ultimately responsible for ensuring that resources are used appropriately. The major issue is the control of cash as it can most easily be used inappropriately. Play supplies and food are generally not as much of a concern. For example, used building blocks have a limited use outside of a childcare setting. A monthly review of play supplies and food purchases will generally highlight significant changes in use patterns that can be followed up. Cash, on the other hand, can be used to buy anything and misuse is often difficult to detect.

Make Sure All Cash Received is Recorded
It is critical that at all times you know who has and who has not paid user fees. This applies equally to parent and government payments. Most fees are paid by cheque. Making sure all cheques are deposited and recorded generally is not difficult. We suggest the following:

• Cheques received by staff from parents should immediately be given to the Supervisor. The Supervisor should also open the mail.
• The Supervisor should enter cheque amounts in the deposit book noting the amount of the cheque, the parent/child’s name and the period the deposit relates to.
• Details of non-parent related deposits should also be entered in the deposit book including the period a payment applies to and the funding/subsidy program (e.g. subsidy receipts, GST refunds).
• Deposits should be made at least weekly.
• Controlling cash payments received is trickier. To help make sure that all cash received is deposited and can be traced back to the person paying we recommend:
• Parents should be directed to pay cash directly to one and only one person – generally the Supervisor. Cash payments should only be accepted by this person.
• Parents should receive a receipt for all cash payments at the time of payment. Consider having the parent initial the receipt when issued to prevent misunderstandings as to actual amounts paid and accepted.
• All cash received should be deposited directly into the bank account with the regular weekly deposit. A photocopy of parent receipts issued should be attached to the duplicate deposit book sheet. This will provide a trail from the payee to the deposit.
• No cash received should ever be put directly in the petty cash box. Cash not deposited directly into the bank account is almost impossible to trace.

We are often asked whether organizations should photocopy cheques and cash received. Generally, keeping photocopies of cheques does not help ensure that all amounts received are deposited. If questions come up you can always ask the payee for a copy of the cancelled cheque to provide proof of deposit. Photocopying cash itself is considered counterfeiting and is illegal in Canada. It also does not help you determine who paid the money.

Make sure all cash spent is for approved purposes
It is important to make sure that only approved purchases are made and that amounts paid are reasonable. Discounts should be taken whenever available. Purchases are generally made by cheque, with petty cash or by credit card. To help make sure that only approved payments are made for appropriate amounts we suggest:

Payments by cheque
You should authorize purchases before ordering the goods. If you wait until the goods are delivered it is too late as the organization is already committed to the purchase. All non-routine expenditures in excess of a set amount (e.g. $1,000) should be authorized by the Board of Directors. A Board might consider giving the Supervisor permission to authorize purchases less than the threshold amount provided the purchases are within the organization’s budget.

We strongly urge not-for-profit organizations to have all cheques signed by at least two signing officers. At least one of the signatories should be a Board member. The person preparing the cheques for signature should include an invoice approved for payment by the Supervisor. Note the cheque number, the word “paid” and the date on the invoice.

Registered charities must have two signatures on each cheque as Revenue Canada deems the ability to sign cheques with only one signature as making resources available for personal use and is grounds for de-registration.

Do not make payments from supplier statements. If you always insist on invoices for support of payments then you will greatly reduce the chance of paying amounts twice.

As a general rule cheques should never be pre-signed by a signing officer. Pre-signing effectively eliminates the need for two people to review supporting documentation. If you permit pre-signing you might as well have only one signatory. It is worth the inconvenience of having to arrange for two signatures to prevent the potentially devastating effects of misuse of a pre-signed cheque.

If a cheque must be pre-signed, generally only in situations where the amount to be paid will not be known until it is time to pay (e.g. when paying for a food purchase at the store by cheque), then consider the following:

• The cheque should be made out to a specified payee prior to it being pre-signed.
• The inscription “Not to exceed $xxx” should be written below the space for the amount of the payment.
• The cheque to be pre-signed should be accompanied by a supplier purchase order or a note from the Supervisor indicating precisely what the cheque is for and why it must be pre-signed.
• The file of unpaid invoices should be reviewed at least monthly by the Treasurer. Invoices unpaid for more than a month should be followed up to determine whether there was a problem with either authorization of the expenditure or quality of the goods and/or services received.

Payments by cash
Cash payments (i.e. petty cash expenses) are often the most difficult to control. Thankfully petty cash expenses generally do not exceed $300 a month at most organizations. To help make sure petty cash payments are only for authorized expenditures we recommend the following:

• A petty cash float should be maintained on an imprest basis. An imprest basis is one where the total of the cash on hand and receipts at any point in time equals a preset amount (e.g. $300).
• The petty cash float should only be replenished by cheque on submission of an itemized expense report with all receipts attached.
• Under no circumstances should cash received from other sources (e.g. parents paying fees with cash) be put directly in the petty cash box. If this is done then the sum of expenses and receipts will not equal the preset amount.
• The Treasurer should review the petty cash box once or twice a year to ensure the sum of invoices and cash on hand equal the preset amount. Minor differences should be corrected in the next reimbursement cheque. Major differences should be followed up immediately.
• Keep petty cash in a locked box tucked away in a safe drawer. Leaving cash in the open invites problems and inappropriate temptation.
• Where security is a problem consider buying an inexpensive safe for the petty cash. A small safe from your local hardware store costs about $200.
• Consider reimbursing unreceipted expenses only with approval from a Board member. A note should be included indicating what the purchase was for, why the receipt was lost or not obtained, and signed by the person being reimbursed.

Credit card purchases
Some organizations use credit cards for purchases. The primary problem with credit cards used by not-for-profit organizations is not payment of outstanding balances but authorization of transactions. It is important that authorization procedures remain well controlled. To help reduce unauthorized purchases we recommend:

• Have very specific policies for what can be purchased with a credit card.
• Require that all staff credit card purchases be pre-authorized by a Board member.
• Have low credit limits on all cards to prevent problems in the event a card is lost or misused ($500 or less may be appropriate).
• A copy of every credit card receipt together with the actual invoice and a note authorizing the purchase should accompany the monthly credit card statement when preparing the monthly payment.
• Cancel credit cards that are not essential.

Review of cash transactions
The above procedures all deal with individual transactions. An overall review of receipts and payments for the month is also critical as it can help you identify unusual trends and irregularities. At a minimum the following monthly review procedure should be carried out:

• All bank accounts should be reconciled monthly to the accounting records. The bank reconciliation should be reviewed periodically by someone other than the person doing the reconciliation (at least twice a year).
• As a minimum the cash balance at the most recent month end together with a statement of cash received and disbursed since the previous report should be presented at each Board meeting.

If a statement of cash receipts and disbursements is presented to the Board and the cash balance at the end of the month is correctly reconciled then misclassification in the statements is the worst that can happen. Significant misclassifications will hopefully be spotted on review of the monthly statements.

This article presents a framework for preparation of your budget, several time saving tips and a few tricks of the trade.

What to budget
Before preparing a budget you have to know your organization’s objective. Remember that your budget is meant to provide a road map of where your organization is going. Your Board provides the objective and your job is to plot a route there.

Assuming that ongoing solvency is the objective you would budget revenues and expenses for the year. Depending on the size of your financial cushion and the direction the Board wishes to take you could plan to break-even, generate a surplus or operate at a deficit. To permit your Board to monitor levels of cash in more detail throughout the year you could prepare a budget of monthly cash flow. The objectives of budgeting revenue and expenses and budgeting monthly cash flow are different. This newsletter examines techniques for preparing each of these types of budgets.

What period/cycle to use
The period covered by your budget depends on your circumstances. If you have a ten month program from September to June then it would make sense to prepare a budget for the ten month period. If, on the other hand, you have a year-round program with little change in enrolment you should consider preparing a budget from January to December.

Should you estimate revenues or expenses first? It really doesn’t matter. Estimate one then the other and if your objectives are not met then estimates for one or both will have to be adjusted.

Annual revenue and expenses budgeting
The primary objective of an annual budget of revenue and expenses is to provide your Board with the information required to operate the centre using resources as efficiently as possible. First, your Board should determine on an annual basis whether you want to:

• run at a break-even level for the year (assuming the financial cushion is adequate)
• operate at a small surplus for the year (assuming a larger financial cushion is required)
• operate at a deficit (assuming the financial cushion should be reduced).

Estimating revenue for the year
Revenue comes to your centre from several sources: parent fees, municipal fee subsidies, salary and other grants, GST rebates, fundraising and interest. In childcare, parent fees and municipal subsidies are by far the most significant component of revenue and should be the focus of your efforts.

Parent fee and Metro subsidy revenue is calculated by multiplying the expected number of children in the program by the fees to be charged. This calculation is best done on a program by program basis (e.g. infants, toddlers, etc). While the calculation itself is not hard, predicting actual revenue can be very difficult as enrolment can fluctuate substantially over the course of the year. Accuracy is difficult so simply estimate enrolment as best you can and carry on with the rest of the budget. Periodically throughout the year (i.e. at least quarterly) revise revenue estimates taking into account changes in expected enrolment.

Following are a few points to take into account when estimating fee revenue:

• Focus on total levels of enrolment. Don’t spend a lot of time differentiating between full-fee parents and those receiving subsidy unless rate differences are quite significant. Generally rate differences are not nearly as serious as enrolment fluctuations.
• If you are doing an annual budget then you normally need not take into account parent deposit policies as deposits are either used up by the end of the year or are carried over to the next year. (However, parent deposits will be a significant factor in a monthly cash flow budget.)
• Take into account fee fluctuations resulting from special rates charged for PA days and March and Christmas breaks.
• Factor staff and multiple child fee discounts into revenue estimates if applicable.
• Estimate summer revenue as best you can. In April or May you should revisit enrolment level and fee estimates once details of the summer program have been settled.
• Factor some allowance for uncollected fees into your revenue estimates. You will generally be better off using past experience at your centre instead of industry averages.

Salary grants
Direct operating, wage enhancement and pay equity salary grants funded by the Ministry of Community and Social Services flow through the centre to the staff. If you choose to include salary grant revenue in your budget then you must also include in expenses the related amounts paid to staff. You can also choose not to include both the salary grant revenue and the related salary expenses in the budget. The net effect on the excess of revenue over expenses for the year should be nil using either method.

Other income
A centre with approximately 50 children typically generates annual revenue in excess of $250,000. Revenue from fundraising, donations, interest and GST rebates is seldom greater than 1% of the total. Consequently, don’t waste time estimating income from other sources. This is not to imply that other income is not important, just that for budget purposes you should estimate it quickly and move on to the next area.

The following table outlines an estimate of annual revenue. Estimates should be updated periodically for changes as necessary.

Estimating expenses for the year
All not-for-profit organizations have a myriad of expenses including salaries and related costs, rent, play supplies, food, office supplies, insurance, etc. The task of estimating expenses can be daunting at first. To make the task more manageable focus your efforts on estimating the most important items. Areas of less financial significance such as office supplies and travel costs can be either lumped together or quickly estimated individually.

Salaries and benefits
Salaries and benefits typically comprise between 70% and 90% of the expenses of most service organizations. A mistake here will throw off the whole budget. You should spend most of your efforts estimating these expenses.

Estimating gross salaries is relatively straightforward. List all of the staff positions at the centre and estimate the gross salary for each position for the upcoming year. For staff paid an annual salary you should refer to Board approved salary levels. For staff paid on an hourly basis you will have to refer to approved rates and estimate the number of hours likely to be worked by staff in that position during the year.

Remember to include vacation pay costs including those for hourly paid positions. Some centres running a ten month operation pay staff vacation pay at the end of the school year. You must factor this annual payment into your forecast if it is applicable.

Replacement staff
Absent staff must be replaced to maintain minimum required staff to client ratios in childcare centres, youth hostels, shelters and other care giving organizations . You must factor into your budget the cost of hiring these replacement staff. A guideline we have found useful is to assume that you will require five weeks of replacement staff for each permanent position. (Typically if staff take two weeks vacation a year then they are sick for three weeks. If they take three weeks paid vacation a year they are often sick for only two weeks). As each week represents approximately 2% of the annual salary budget you could estimate an even 10% for replacement staff.

Take into account the specifics of your organization and its replacement staff experience. Some unionized centres require significantly higher levels of replacement staff and other centres require lower levels as staff are required to take vacations at times when client service levels (e.g. child enrolment) are low.

Estimating staff benefits
Statutory benefits can currently be estimated at 9.16% of salary costs.

Canada Pension Plan (CPP) and Employment Insurance (EI) are payable only on amounts up to statutory maximums. Employer’s Health Tax (EHT) is charged on a fixed percent of 1.95% of all Ontairo gross-salary compensation over $400,000 (not that the $400,000 exemption applies to most but not all organziations operating in Ontario). Worker’s Compensation rates often vary from centre to centre for reasons we have difficulty comprehending. For the sake of simplicity we recommend that you apply a straight 11% of gross salary as an estimate of all statutory benefits.

Non-statutory benefits should be estimated at twelve times the monthly premium currently being paid. In the absence of actual information you could use 4% of gross salaries as an estimate.

Salary grants
Provincially funded salary grant payments to staff should be included in an amount equal to that included in your revenue estimates.

By putting all of the pieces together you can estimate total salary and benefit costs for the year as follows:

Food costs
Food costs are typically the second highest expenditure of a childcare centre’s operation. They usually vary between 5% and 10% of total expenses. One way to estimate the cost of food is to determine what was spent in the prior year and, in the absence of program changes, estimate the same amount for the upcoming year. Costs for centres preparing their own food are typically between $1.60 and $2.00 per child per day excluding staff time. Costs for those centres using catering services are typically between $3.00 and $3.60 per child per day.

Remember that food costs are small in comparison with salaries. If you are off by 20% in your food budget it will result in a variance of about 2% of total expenses. Compare this to staff costs where an estimating error of 20% will result in an 18% variance in total costs.

Other expenses
Other expenses can be based on prior experience and current Board expectations. We frequently advise Boards to only estimate individual expense categories expected to exceed $4,000 per year (e.g. play supplies). All others categories could be lumped into an “other” category which can be estimated based on past experience. “Other” expenses can typically be estimated at approximately 8% of total annual expenditures.

Pulling it all together
Summarize the revenue and expenses budget (see table below) and determine whether the budget achieves the objectives of your organization. If your budget predicts a deficit when a surplus is required then you will either have to reduce expenses (typically this requires a reduction of salaries and benefits) or endeavour to increase revenue by either boosting enrolment or increasing parent fees.

Budgeting monthly cash flow
Preparing a budget of annual revenue and expenses is important. However, because of fluctuations in monthly revenue and expenses throughout the year you could run out of money in August even though your annual budget shows you will still be solvent by the end of December. Centres can experience significant fluctuations in outlays for salary and benefits expenditures (e.g. months with three pay periods). Also, timing of certain receipts such as Direct Operating Grants (received quarterly) may not coincide with the respective payments (salaries paid out by-weekly). Consequently, a large cash balance in the bank may not necessarily indicate financial health several months down the road.

For most childcare and shelter related organizations preparing a twelve month cash flow budget is not a difficult exercise. Start by dividing your annual estimate of revenue and expenses into twelve equal monthly amounts (ten if you don’t operate in the summer) and then adjust each of the line items for monthly fluctuations. Consider:

Monthly revenue variations

• Adjust monthly revenue for anticipated changes in enrolment and/or fees to be charged. For example, adjust March and December if additional fees are charged during school holidays and adjust July and August if you anticipate significant enrolment declines or changes in the summer fee structure.
• Be sure to take into account the timing of parent deposits. Budget for collection of deposits/last month’s fees in the month received and, equally importantly, adjust cash to be received downward in the month that these deposits will be paid back or credited to fees. This is especially important for ten month programs where the first and last month’s revenue is received in September and no cash is received in June.
• Salary grants are usually received in January, April, July and October.
• Consider leaving “other revenue” out altogether unless it is either predictable or expected to be significant.
• Allow for timing differences in collection of government fee subsidies in situations where you have less than a full year program or you experience significant monthly enrolment changes.

Monthly salary and benefit variations

• If staff are paid on a bi-weekly basis then ensure that you allocate 20 of the 26 annual pay periods to 10 of the months and 6 of the 26 to the remaining 2 months. Use a calendar to determine which months will have three pay periods. If you don’t do this you will receive a nasty surprise when, twice in the year, your monthly payroll is a full 50% higher than expected.
• If salary grants are paid out quarterly then ensure you record the timing of the payouts and related statutory benefits accordingly.
• If you run a ten month program record vacation payments in the period they will be paid out.
• Receiver General payments are larger in the month after large payrolls (e.g. three pay period months and months with lump sum salary grant payouts).

Other expense variations

• Record one-time annual expenses such as insurance, audit, large capital asset purchases and renovation expenses in the appropriate months.
• Allow for additional trip, activity and play supply expenses in December, March and the summer months if appropriate.

Once you have split annual expenses into their monthly slots make sure you tie them into the actual cash balance of the centre. An example of a monthly cash flow budget is as follows:

The above budget format readily lends itself to being produced on a computerized spreadsheet such as Excel and Lotus 1-2-3. The spreadsheet makes it easy to adjust the forecast for changes in enrolment levels and expense assumptions.

The advantage of a monthly cash flow budget is that you can anticipate serious cash problems throughout the year and act in advance to prevent a surprise dip in bank balances. Again, it is essential to update the monthly cash flow budget on a regular (quarterly) basis as a budget is only as good as the accuracy of its assumptions. It is the responsibility of the Board to review the monthly cash flow budget on a regular basis and make adjustments whenever necessary.

The financial management framework
First it is helpful to put financial management into a framework. There are four main components in the financial management cycle:

• setting overall objectives
• establishing budgets
• regular monitoring of your financial position
• comparing where you are financially with where you want to be and adjusting appropriately.

A useful analogy for the financial management of a not-for-profit organization is that of taking a voyage. The first step is to figure out where you want to go (clearly setting out your objectives). If you don’t know where you want to go you will likely spend a great deal of time going nowhere. These objectives must be established by the Board and management of your organization and are commonly created through a strategic planning process. A common objective for childcare centres is that of providing affordable high quality childcare. Articulation of objectives can be a long and complicated process. However, it is critical that the organization spend the time and go through the process periodically to ensure a common focus and direction. It is also critical that overall objectives be documented, especially if there is little continuity of Board members from year to year.

Once you have decided where you are going you must chart your preferred course as there are usually several ways to reach an objective. To use the trip analogy again, you have to determine whether you want to take the scenic route, and perhaps run out of funds, or take the most economical route possible. Your centre should prepare a budget of financial resources estimating what you will need to spend to reach your objectives and, as importantly, how you expect to obtain the resources to get there. This could take the form of both an annual budget and a monthly cash flow forecast.

The next step is to periodically monitor where you are on the voyage. In the context of the financial management of an organization, this entails having an accounting system which permits you to determine where you are financially at regular (monthly) intervals. You may also need to obtain information such as current and estimated future enrolment levels to help you determine whether your budget is still a reasonable one.

Now that you know where you are and where you want to be you have to compare the two and change course as needed to reach your destination. For your childcare centre this involves comparing your actual financial position with that previously budgeted. Changes to revenue and expense patterns can then be made to help you work towards attaining your financial objectives at the end of your reporting period.

Increasing efficiency and effectiveness
We all know that there are more and less efficient ways of achieving objectives. Good control over the financial management framework can help you achieve your objectives with as little effort as possible. Failure to tend to the financial management process can result in your getting lost (going broke) along the way. Designing sensible internal financial controls helps to make the process as efficient and effective as possible.

What is internal control?
Internal control is the term used to describe policies and procedures designed by the Board and management to help ensure that the organization’s objectives are achieved. In a childcare setting internal controls include the policies and procedures developed to ensure that high quality care is delivered at the most affordable cost possible. Two signatures on each cheque, review of monthly bank reconciliations, preparation of an annual budget and presentation of a monthly financial report at each Board meeting are examples of internal control procedures designed to help a Board know whether finances are being efficiently managed. Establishment of a finance committee and monthly reports at Board meetings to discuss areas such as child development, upcoming meal plans and finances are examples of internal controls designed to provide the Board with information required to assess the quality of care being delivered.

Internal controls go beyond accounting and financial systems. Appropriate internal controls are essential if a Board is to monitor all facets of an operation including quality-of-care issues such as personnel management, child behavior management and program development. While our newsletter will focus on the financial aspect of controls, non-financial internal controls are just as critical for a Board to efficiently achieve its objectives (delivery of services).

Internal controls should be creative and need to be applied in the context of an organization’s culture. For example, some Boards may feel more comfortable with extensive and formal documentation of all aspects of policies and procedures. A voluminous manual may suit the culture of the organization. In other organizations such a manual may be seen as unnecessary and a less formal policy and procedure document may suffice. No single set of controls can be designed and applied to every organization. It is up to your organization to determine what is appropriate for its specific needs.

The Board of Directors sets the tone of internal control at the organization. If your organization wants to maintain a set of internal controls to keep financial management effective then the Board must be prepared to follow-up on a regular basis to ensure that the policies and procedures are being followed. Strong support at the Board level for appropriate controls generally results in effective financial management.

Limitations of internal control
There are inherent limitations to internal control and its ability to ensure that corporate objectives are met:

• Good financial management and internal controls are not possible if an organization does not have a clear idea of what it is attempting to achieve. Imagine trying to design an efficient vehicle not knowing what a journey involves. You may design an all-terrain vehicle when what you really need is a school bus. Once your organization has clearly articulated its purpose and goals then you can begin to design appropriate internal controls.
• Internal controls cannot prevent an organization from making operational and/or strategic errors and mistakes. They are designed to ensure that actions taken or not taken by management are followed up and reported to the Board. Internal controls are not designed to manage the organization. People manage.
• Internal controls can help minimize errors and irregularities but cannot eliminate them. Internal controls may cease to function as a result of human error. A purchase in excess of an amount budgeted may be made and not caught by an organization’s internal controls. Also, two or more people can deliberately decide to override controls.
• An organization must take into account the costs of implementing internal controls and compare the costs with the benefits. Costs include volunteer time. As internal controls can never provide absolute assurance that policies and procedures will be followed the Board must determine what constitutes an acceptable risk and controls must be designed accordingly. Once again, this requires judgment on the part of the Board and must take into account the culture of the organization.

Control systems
Internal controls can be classified into two broad categories or systems. The first category includes controls designed to collect, record and process financial data and prepare timely reports. People often do not think of data collection, processing and reporting as part of their organization’s internal control system. However, if you do not have an effective information collection, processing and reporting process then all the controls designed to ensure accuracy won’t be worth implementing. Controls in this category include:

• Assigning responsibility for various tasks such as the centre’s bookkeeping.
• Creating reports to be understood by Board members and management. Overly complex or simplistic reports will result in poor communication of financial data.
• Designing an appropriate attendance system to make staff aware of when children arrive and when they depart.
• Designing systems to ensure that data such as supplier invoices and accounts receivable are recorded accurately and on a timely basis.

The second category of internal controls includes those designed to enhance the reliability of the data reported. These procedures and policies include:

• proper authorization of transactions (prior authorization of major expenditures)
• adequate segregation of duties
• establishment of a finance committee
• proper controls over petty cash
• designing of appropriate forms
• controls to safeguard assets (two signatures required for all cheques)
• controls to verify financial records (monthly reviews and annual audits)

We have enclosed a financial management checklist with this newsletter for your information. You might find it useful to review the items listed and determine whether you feel there are areas in which your centre could do with improved controls. The next few newsletters will go into each of the areas in more detail. Making internal controls work
We conclude our overview with a brief discussion of some of the factors that can enhance the effectiveness of internal controls in place at your centre. Again, we will be going into this area in more detail in subsequent editions.
Good control factors include:

• Establishment of a finance committee of the Board to spearhead planning and monitoring of financial activities and reporting. The finance committee would report to the Board and take primary responsibility for managing financial resources throughout the year.
• Design of an effective organizational structure (i.e. who does what, who is responsible for what and to whom). An organizational structure with clear reporting responsibilities that take into account the culture of the organization is critical for effective financial management. A poor organizational structure with unclear reporting responsibilities will invariably result in controls being missed, misapplied or misinterpreted.
• Effective assigning of responsibilities. This includes clear articulation and documentation of job descriptions. This would also include articulation and clear documentation of responsibilities of various committees of the Board and the Board itself.
• Effective management controls including methods of financial planning and budgeting, reporting of actual results to the Board and follow-up of variances between budgeted and actual amounts.

Following are a few early warning signs that, in our experience, generally precede financial difficulty. Any one or a combination of them can often be dealt with and rectified over a number of months. The trick is to identify financial difficulties and act promptly as a problem identified six months in advance can almost always be resolved.

Declining enrolment
The most obvious indicator of financial difficulty is one of persistent declining enrolment. Actual declines in enrolment are preceded by a shrinking waiting list. Boards should insist on a monthly report on the status of the waiting list as well as on actual enrolment levels.

Waiting lists must be tended. At least once a quarter every family on the waiting list should be contacted and families no longer needing care should be deleted. We know of one centre which closed its waiting list down at 120. Eighteen months later there was an unexpected vacancy in the toddler room. Not a single parent on the waiting list was still interested in care. It took the centre two months to fill the vacancy at a cost of $1,600 in foregone revenue.

Increasing Salary Costs As A Percentage of Fees
Centres typically have a fairly stable ratio of salaries to fees. For most centres this ranges between 70% and 90% with 80% being typical for multi-age programs. Increasing salary costs as a percentage of fees results from:

1. dropping enrolment levels without adjustment of staff costs;
2. rising staff costs resulting from factors such as maternity leave, increased use of casual staff and, in some cases overstaffing.

Regularly reviewing the percentage of staffing costs to parent and Metro fees can give you an indication of your centre’s financial health.

Declining Financial Cushion
A healthy childcare centre will generally have an accumulated surplus or financial cushion (the excess of current financial assets over liabilities) of between one and three months’ expenses. For example, if you have a centre with a $360,000 expense budget, an adequate financial cushion is in the range from $30,000 to $90,000. If your surplus declines below one month’s expenses then you have limited resources to carry you through financial difficulties such as losses in the summer or a sharp decline in enrolment.

Typically, centres build up their accumulated surplus when they are at or near full enrolment and steadily reduce this cushion when enrolment drops below 95% for an extended period of time.

If your accumulated surplus is below one month’s expenses then you should attempt to budget a small surplus on an annual basis until the cushion is built up again.

Increase in accounts receivable
Steady increases in accounts receivable from parents and Metro can be indicative of financial problems. Failure to monitor and collect parent receivables is a sign of a lack of attention to finances at the centre. Consistent lateness in receipt of subsidy from Metro almost always results from lack of attention to bookkeeping and financial matters in general.

Insufficient and/or late reporting of financial information
If you are receiving insufficient financial information to determine whether you are in financial health on a monthly basis and/or if the information provided is more than one month old you have no way of knowing whether problems await you further on in the year. A current financial report should be prepared for each Board meeting. Financial reports should ideally consist of a report on enrolment trends together with a brief financial statement showing performance for the past month, current financial position and a comparison of actual results with the budget approved by the Board earlier in the year.

1. Do you prepare an annual budget?
2. Is it prepared before the year starts?
3. Is it approved by the board?
4. Is it updated periodically?
5. Do you have a monthly cash flow forecast?
6. Is it used by the board in settling fee/expense policy?
7. Enrollment expectations are reviewed by the board at least quarterly?
8. Are you advised of changes in financial legislation (tax) and regulations?
9. Does your board/finance committee meet regularly and discuss financial matters?

Do you know where you stand today?
A. Cash

1. Are deposits made regularly?
2. Are parent names and period covered by fees deposited marked clearly in the deposit book?
3. Cancelled cheques are returned by bank
4. Are all bank accounts reconciled monthly to the accounting records? (not first to the cheque stubs).
5. Is the board is advised monthly of cash on hand.

B. Receivables

1. A monthly list of parent and metro receivables is prepared and shown to the treasurer.
2. Receivables from Metro Children’s Services, MCSS, GST, etc are monitored monthly?

C. Payables

1. A file of unpaid invoices is kept?
2. Bills are paid promptly?

D. Grants and government rebates

1. You know each month how much is owing to staff for salary grants received but not yet disbursed?
2. All grant forms for the last year have been submitted on time?
3. You are advised of new funding sources on a timely basis?
4. You know your eligibility status for GST rebates and, if eligible, you have received a rebate in the last year?

Are your assets safe?

1. Purchases of significance are approved in advance?
2. Two signing officers sign all cheques and review supporting invoices.
3. Bank accounts are reconciled monthly and someone other than the bookkeeper reviews the reconciliation.
4. Parent receivables are promptly followed up at the board level on a regular basis.
5. All Revenue Canada remittances have been submitted on time?
6. All payroll payments have been made on time?
7. Your last T4 and EHT returns were filed on time?

Corporate Governance

1. You have had an audit within the last year?
2. Filings with Consumer and Corporate affairs are up to date?
3. You have filed a tax return/charity information return within the last year?

• Assemble payroll information for T4/T4-A preparation

FEBRUARY

• Final date for T4/T4A submission is month end
• Review monthly cash flow assumptions and adjust monthly cash flow forecast if necessary (*)

MARCH

• Annual financial statement should be finalized and approved by the board (*)
• If eligible, prepare application for GST rebate (*)
• Complete and submit EHT annual return by March 15

APRIL

• Prepare cash flow forecast for summer period

MAY

• Prepare Worker’s Compensation return if applicable

JUNE

• Final date for filing of Revenue Canada returns (T2/T3010/T1044) is June 30 (*)
• Annual General Meeting held before month end (*)
• Update/finalize summer period cash flow forecast
• MCSS grant utilization forms due (DOG/WEG) (*)(**)
• Provincial Annual Return and Special Notice filings due (*)

JULY

• Review summer cash flow forecast assumptions and adjust budget if necessary

AUGUST

• Enjoy well deserved rest!

SEPTEMBER

• Assemble information for Metro Children’s Services budget (Metro Toronto only)(**)
• Update monthly cash flow forecast for changes in enrolment/service levels (*)

OCTOBER

• Complete Metro Children’s Services budget by month end (**)

NOVEMBER

• Assemble information for next year=s monthly cash flow forecast

DECEMBER

• Finalize and obtain board approval for next year’s monthly cash flow forecast (*)
• Review staff salaries and fees charged (*)

NOTES:
* This schedule assumes a budgeting process based on a calendar year. If your budget is for a different period, for example from April to March, then you should adjust the items marked with an asterisk accordingly.
** Applies to childcare centres only.