Michelle M. Cain, The Daily Record Newswire
Liquidity is crucial for not-for-profit entities to have the right amount of liquid and non-liquid resources available when needed to accomplish an organization's mission.
Defining liquidity
Liquidity is a multifaceted concept that encompasses many different meanings. Liquidity is typically defined as how much cash and/or assets (such as short-term investments) that an NFP holds that can easily be converted to cash for use in the immediate or near future. An entity is thought to be liquid if it has ready access to cash to meet its needs. An entity may be described as liquid because it holds cash directly or because it holds other liquid assets such as money market accounts, certificates of deposit or other short-term investments that can readily be converted to cash.
Some might describe an NFP as liquid if it has access to cash (borrowing power, lines of credit, etc.). Access to cash through borrowing may create liquidity, but it is more akin to financial flexibility and clearly is not a liquid asset that can be communicated in the statement of financial position at the measurement date.
Current accounting requirements
The guidance for NFPs (ASC Topic 958) requires that an NFP report assets and liabilities in reasonably homogeneous groups and sequence or classify them in ways that provide relevant information about their interrelationships, liquidity and financial flexibility. Some might interpret this requirement to mean that an entity might only need to sequence its assets according to their nearness to cash and its liabilities based on the timing of their maturities. This could be correct for some small, less-complex NFPs.
However, for more complex NFPs with endowments and sinking funds, for example, it could be misleading to classify the endowment with the NFP's unrestricted investments and to combine the sinking fund cash with the NFP's unrestricted cash and cash equivalents. If items were grouped together solely by the nature of the asset (cash, investment, etc.) or liability, the users would get a different picture of the NFP's liquidity than reality, even if further details are provided in the notes.
In order for the users of an NFP's financial statements to understand the NFP's liquidity, they must be able to understand the restrictions, whether donor, contractual or legal, on the NFP's use of particular assets.
It has been our experience in speaking with creditors, credit rating agencies, grantors and donors of NFPs that they would like to know how much cash and/or liquid assets (such as short-term investments) an NFP holds that can be easily converted to cash for immediate or near-term use. That is because they would like to know what liquid assets are available to pay for current or future programmatic activity, debt service and other activities.
Some have argued that you can get to liquidity through analyzing an NFP's net assets, but net assets is solely a residual of assets less liabilities and does not convey liquidity. For net assets themselves to be able to convey liquidity, they would have to be able to be converted to cash or used to settle an obligation based on the definition of liquidity. Therefore, it would be difficult to use the components of net assets to communicate what net assets are available, for what purpose the net assets can be used and whether the net assets are with or without donor-imposed restrictions.
NFPs currently have flexibility under generally accepted accounting principles in telling their story regarding liquidity to the users of their financial statements. The various ways NFPs currently can discuss their liquidity are:
a. Sequencing assets according to their nearness of conversion to cash and sequencing liabilities according to the nearness of their maturity and resulting use of cash
b. Classifying assets and liabilities as current and noncurrent
c. Disclosing in notes to financial statements relevant information about the liquidity or maturity of assets and liabilities, including restrictions on the use of particular assets
Even with these options, it can still be difficult to understand an NFP's liquidity. Additionally, there are even difficulties in comparing liquidity within particular industries of the NFP sector. Reasons for that include the following:
a. Complexity of restricted contributions and designations by the board of directors
b. Lack of information presented in the notes to the financial statements related to the board of director's policy on investments specifically around pooled investments that include both restricted and unrestricted amounts
c. Lack of disclosures about how the organization will meet its short-term liquidity needs
The most significant issue for an NFP around liquidity is the aggregation by type (nature) of assets in the statement of financial position versus the presentation of the components of assets based on their nearness to cash or how the assets are expected to be used. It is believed that a liquidity measure would benefit the users of NFP statements and address this issue.
What does the future hold for NFP liquidity?
In April 2015, FASB issued an exposure draft of the Proposed Accounting Standards Update, Not-for-Profit Entities (Topic 958) and Health Care Entities (Topic 954): Presentation of Financial Statements of Not-for-Profit Entities. This proposed ASU addresses the issue of how an NFP should disclose information regarding liquidity.
Specifically, the ASU proposes that an NFP disclose both quantitative and qualitative information about the liquidity of assets and near-term demands for cash as of the reporting date, including (1) the amount of financial assets at the end of the period; (2) the amount that, because of restrictions or other limitations on their use, is not available to meet cash needs in the near term; (3) the amount of financial liabilities that require cash in the near term; and (4) information regarding how an organization manages its liquidity, including the time horizon it uses in the management of liquidity as well as any other sources of cash (such as lines of credit) during that time horizon. It's believed that this information will significantly improve users' ability to assess NFPs' liquidity risk.
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Michelle M. Cain, a Certified Public Accountant, is a partner with Mengel, Metzger, Barr & Co. LLP. She may be reached at Mcain@mmb-co.com.
Published: Wed, Dec 09, 2015
