Surplus or Deficit? What can you live with?

In the financial lifecycle of nonprofit organisations, July and August are the busiest months as a new financial year commences.

Budgets should already have been approved by the Board and embedded in the reporting software, so that the organisation starts the year tracking performance from the get-go.

Audits are conducted during this period and, depending on any adjustments they make, the official financial reports will declare the surplus or deficit for the year just passed.

To get a sense of accounting humour, a business owner might ask their accountant, as they approach year-end, what is their profit or loss likely to be… With the apocryphal response being: “What would you like it to be?”

Applying interpretations of the accounting standards, some changes can be made within the adjustments to move the result a little north or south, and thereby impacting the return to owners, implications for tax, and the resulting value of the organisation (equity).

For nonprofit organisations, not only are there multiple implications of making a surplus or deficit, but also there are repercussions on the size of the result compared to their income.

Let’s look at four scenarios.

Say your organisation ends up with a small surplus.

Questions the Board might ask are: Was this budgeted? Did we think this is where we would end up? If not - for example, if we had budgeted for a larger surplus - then what happened? What are the implications for our plans to build reserves (for the rainy day) or to get us out of negative equity? How did the monthly reporting not provide a signal to amend the spending? 

If we were expecting a deficit, does this surplus mean we have under-delivered in our programs? Were clients declined a service where they could otherwise have been assisted? What are the implications for unspent grant funds, and have these been adequately accounted for in the Balance Sheet? Have we underestimated our expenses, particularly for staff entitlements? A surplus might be a good outcome when a deficit is planned, unless its omitted expenses which will come back to make a claim in a future year. 

Scenario 2, and we achieve a substantial surplus. Again, is it on budget? If a large surplus was planned or not, what are the implications now when approaching funders? Can requests for support be defended when there appear to be surplus funds going into the coffers? Were all grants fully expended, or are there future risks of returning funds which are not being quarantined in the Liabilities? Will staff understand why its important to build reserves at the same time the organisation might be winding back programs for clients?

Scenario 3, is a small deficit. The Board might review whether this is a one-off or an ongoing sequence of ‘small deficits’ eating into the reserves of the organisation. Is a small deficit ok when no deficit can be tolerated? And what if a significant surplus was planned, and the result is a big swing away due to out-of-control spending?

And finally, the Large Deficit. How can this be explained? and what are the implications for the future viability of the organisation? Are there performance issues for the CEO if this was unplanned? And where was the oversight from the treasurer and the board as it received financial reports throughout the year. Does a large deficit begin to have implications for solvency in the future? Can the organisation sustain a repeat, and what are the implications for the budget which was just approved?

The end of year result deserves a significant amount of airtime at the Board meeting, not only as it is an opportunity to reflect on the past year, but to engage the Board on what it must do in the new and current year to repair or build on the viability of the organisation. Each month the Board must review the Income and Expenditure report to Budget, to see where variations are starting to bite. This report has a critical role: Where there are concerning variations the Board must direct the CEO to 'change the budget or change the behaviour'. In other words: "Do something!"

The Board Members’ ultimate responsibility is to leave the organisation in a better shape than when they join, and to ensure the ‘over the horizon’ destination is a financially sound and viable organisation.