Why add a cash flow–based approach to supplement our existing system? Before you read on, you may want to buy your bookkeeper a bottle or two of over-the-counter heartburn medication. Then it will be ready when you announce that you are considering adding another level of financial record keeping to that already busy schedule. You can imagine the warm embrace we receive from our clients when we strongly urge them to do just that. What we often hear in response to our request is that they already have a perfectly fine system of accounting that has been mandated by the Federal Accounting Standards Board (FASB). Our answer to this objection is that cash flow budgeting, forecasting, and monitoring make it possible for everyone, not just the accountants and members on the Finance Committee, to understand what is going on. Using cash flow budgets, forecasts, and reports to complement an existing system of financial management may at first seem like an added chore. After all, having an accrual basis accounting system in place generates lots of information in the form of balance sheets, income and expense statements, statements of changes in net assets, and statements of cash flows. The difficulty is that not everyone is comfortable with the information provided. Accrual basis accounting is a system that recognizes income when it is earned and expenses when they are incurred, rather then when cash actually changes hands. To someone versed in finance and accounting the accrual basis system is finely detailed and comprehensible. To those without a financial management background, accrual basis accounting can be something of a challenge. Accountants and lots of other people understand accrual accounting and consider it the appropriate standard for all financial environments. Accrual basis accounting uses a system that identifies payables and receivables in a virtual time frame. So, if you have been notified that a grant has been awarded, your bookkeeper “books” the amount at the moment of the award. But if, as sometimes happens, the grant is slow in arriving, and your fiscal year ends, you still have the receivable on your books. You account for it within the fiscal year time frame, but you still do not have the money that was meant to be spent on the program for which the funds were designated. For folks who understand this approach, it makes sense; they have a mental model that allows for everything to balance in the institution’s accounts over time. As that popular source “The Motley Fool” noted in November 2006: “Be Careful When It Comes to Accruals.”
Unless you understand that the money in the last report may not be money in the bank, you can find yourself in financial trouble. The problem, as we see it, is that the way for-profit businesses almost universally use this system of accounting gives it a lot of authority, but people in business generally know that there can be a disconnect between receivables and sales. In the nonprofit setting the impact of booking third-party-payer revenues well in advance of receipt of funds can be much more problematical. The typical line we hear is, “Well, we got the grant, so what’s the problem?” Well, the problem is that if the grant or contact check has not arrived, or the funds are restricted— something that does not happen in business—then other funds on hand may not be available for either operations or programs. The same thing happens with endowments or restricted cash reserves. The money is there on the balance sheet, but that does not mean that it can be spent to deal with today’s expenses. On the other hand, income and expense are empirical phenomena—that is, you can see them as they happen—in cash flow thinking. Everyone may be aware that money is coming, but until it lands in the bank, it is not booked. The same is true with expenses paid. This is familiar from daily life: the float attached to your credit card purchases means that you don’t feel the actual impact on your wallet until you write the check to pay off your bill. Cash flow thinking requires reporting only those events that involve the exchange of cash. It acknowledges but sets aside any transactions that do not involve cash, such as depreciation or amortization. Cash flow budgets, reports, and forecasts merge actual time with real money. They are dynamic—unlike conventional budgets and balance sheets. A balance sheet is a snapshot of a fiscal moment in time. A cash flow budget, report, or forecast is like watching a movie in which income and expense costar with time to express the ebbs and flows of your organization’s financial position. With accrual basis accounting, income and expenses are posted before they are received or paid. This creates a virtual world that can sometimes be confusing. For example, when multiple-year pledges that have been posted do not arrive on schedule, your organization can be much poorer than it looks on paper. Our cash flow approach focuses exclusively on the income that arrives at your door and the expenses that are recorded as checks as they sail off in the mail. A sense of practical reality accompanies cash flow thinking. Because these two systems (accrual and cash basis accounting) treat money in relation to time differently, a cash flow approach must be kept separate from your accrual basis accounting system. To make the separation easy, simply use the Cash Flow Forecaster tool that comes with this book. That will be much better for the bookkeeper than all that heartburn medication.
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