Kate M: Once upon a time...

Kate H: Kate, are you going to read us a story? I love a story that begins like that.

Kate M: I am. Once upon a time, there was a committee that thought their finances were fine and dandy.

Kate H: The treasurer read the numbers aloud at every meeting. Income this month, bit over 24,000. Expenditure, 19,000. Surplus, better than $5,000 Everyone nodded. The president said, great. Thank you. The report was approved.

Kate M: But nobody looked at the balance sheet. Nobody noticed that current liabilities had been greater than current assets for three months in a row.

Kate H: The organisation was technically insolvent and unable to pay its bills from available funds. The story the numbers were telling was right there. Just nobody knew how to read it.

Kate M: This fairy tale does not have a happy ending, but your organisation's story can.

Welcome to The Committee Room.

Kate H: Welcome back to The Committee Room. I'm Kate Hartwig.

Kate M: And I'm Kate McPhee. We help small, time poor, volunteer led committees run better meetings, make better decisions and build stronger structures and systems with less stress and less mess.

Kate H: We are in our Financial Confidence series. Last episode, we covered who's responsible for what and the governance structures that protect the money. The members' money, the sponsors' money, the grant money. Remember, it's all other people's money. Today we're getting into the reports themselves using a framework that makes them much easier to follow than a page full of just numbers.

Kate M: Your financial reports are telling you a story. Every month three chapters land on your committee table. Each one tells you something different about how the organisation is doing and you need all three to understand how that story is unfolding.

Kate H: Chapter one is the balance sheet. Chapter two is the profit and loss. And chapter three is the cash flow. Each chapter has its heroes, the numbers that tell you when you're on track, and its villains. The red flags that mean something needs attention.

Together, they tell you whether your organization is heading for a happy ending or whether the plot is about to take a very unwelcome turn.

Kate M: Listeners, as a committee member, you don't need to be an accountant. I don't find this number stuff easy at all, but I've learnt what to look for, and you can too. So a quick note before we start. This podcast is for general information on best practice governance for small to medium associations. It is not legal advice, and it is not financial advice. Okay. Let's open the book.

So, dear listeners, we are going to a magical kingdom far, far away, or perhaps just down the road, where the king and his counselors are discussing the affairs of the realm. And yes, there is a court jester at the table. You will recognize that court jester immediately. The court jester nods at everything, laughs at the right moments, and has absolutely no idea what the numbers mean. We've all sat next to the court jester. Some of us actually have been the court jester. Yeah, no judgment. But that's what today's session is for.

Kate H: But before we open chapter one, let's talk about which edition of the book you're reading.

There are two accounting methods your organisation might use and the difference changes the story significantly. Cash accounting records income when it's received and expenses when they're paid. Very very simple but it can give you a misleading picture whereas accrual accounting records income when it's earned and expenses when they're incurred, regardless of when the money actually moves in and out of your organisation. So a $15,000 grant received in January that funds a year long program isn't really January's income. Under accrual, it's recognised across the year as it's earned.

Accrual accounting shows your financial position and your financial performance more accurately than cash can. It's the truer version of the story.

Kate M: Kate, every time you say accrual or I have to try and remember that word, I've taught myself to think of Cruella de Ville from 101 Dalmatians because that helps my non number y brain remember that is accrual accounting that we should be using because I now know that accrual accounting is what gives the clearest picture of the story of your finances. And that's the right one or the better one for incorporated associations to be using. That's what we're gonna use for the rest of our story today, accrual accounting.

Kate H: Cruella de Vil accounting it is. Okay.

Kate M: So back to our chapters. Chapter one is the balance sheet, also called the statement of financial position. So think of it as the foundations of the kingdom. It's a snapshot of the organization on one particular day. So always check the date at the top of the report.

If you're looking at a June 30 end of financial year balance sheet in November, you're looking at a picture that's five months old and a lot can have changed in five months.

Kate H: It certainly can Kate. Now in that balance sheet there are three sections: assets, liabilities and equity. First, assets. Now that's what the kingdom owns. Current assets can be turned into cash within twelve months. So cash, money owed to you, stock, that type of thing. Non current assets are held longer. So property like your castle, equipment, vehicles.

Second, liabilities. That's what the kingdom owes or anything that imposes an obligation on it. Current liabilities are those that are due within twelve months. So bills, short term loans, unearned income like grants received in advance. Non current liabilities are longer term obligations, something like superannuation for employees or anything else that doesn't need to be paid within the next twelve months.

And third, equity. Very simply, equity equals assets minus liabilities. Equity is what the realm would be worth, at least on paper, if it were conquered today.

Kate M: In a not for profit organisation, that equity stays with the organisation. It can't be distributed to the members. So you remember from last episode, we talked about making profit for purpose. So this profit, this surplus, does two jobs.

It builds your buffer against a rainy day, and it pays for the things in your strategic plan. So the heroes of chapter one are the four questions your committee should ask every month. Question one, do we own more than we owe? Are our total assets greater than our total liabilities? Question two. Can we pay this month's bills? Are our current assets greater than our current liabilities? Question three. Do we have a buffer? Is our equity at least three months of our operating costs?

And the last question, question four, are we getting stronger? Is equity growing year on year? So if the Committee can answer yes to all four of those questions, your organisation is in good shape. All is well in the kingdom for now.

Kate H: Question three is the one that I'd underline. Three months of operating cost is your absolute minimum buffer against a rainy day, and we all know that it does rain. The other thing, of course, is that it gives confidence to your members and your suppliers and your investors that you are a going concern and that you're in good financial shape.

Kate M: That's the three little pigs in the story, you know, the houses made from straw and sticks and bricks. So your buffer is your bricks. The big bad wolf turns up eventually. And whether it's a grant that doesn't get renewed or a repair bill nobody budgeted for or a pandemic that lands on your doorstep, the effort you put in during the good times is what protects you in the bad times. You want to be in the house that's still standing after all the huffing and puffing is done.

Kate H: But there are some villains here too, Kate. Current liabilities exceeding current assets means you can't pay your bills from available funds. And that's the red flag our Committee in the opening story completely missed three months in a row. Total liabilities exceeding total assets means the organisation is technically insolvent. And high unearned income grants or fees received in advance Sitting alongside low reserves mean obligations are coming that might not be coverable. Villains can be tricky, hiding in plain sight just like the wolf in grandma ma's night clothes waiting for a naive little girl in a red cloak. The villain was there in the numbers all along. Nobody read past the first page. The court jester smiled, nodded, and moved to approve the financial report.

Kate M: Chapter two is the profit and loss, also called the statement of financial performance or even just the P and L. Think of it as the chronicle of the year. The balance sheet that we've just talked about is one page. The profit and loss is all the pages you've read so far this year. It shows how the organisation performed over a period, usually the month and the year to date. So it's income minus expenditure and that equals surplus or deficit.

Kate H: But the P and L only becomes truly useful when it's shown against a budget with a variance column. The variance column is the plot twist. It tells you where the story has deviated from the plan. If income is above budget, that's good. If spending is below budget, that's good too.

The variance column tells you which way each line has moved. Now the reverse isn't automatically bad. Some plot twists have a perfectly good explanation. Sometimes it's just timing. A bill that arrived early or a grant that hasn't come through yet. The question is always why? And it's your job to ask the question.

Kate M: Let's give three cheers to the heroes of chapter two. They are a surplus tracking ahead of budget, income lines performing as planned, and expenditure under control, and the year to date column that says the story is still going according to plan.

Kate H: And the villains of chapter two? An unplanned deficit that turns up at the meeting with no warning and no explanation. That's not a plot twist, that's a governance failure. Another villain is income that's always falling short of the budget. Now new ideas can often be the suspects in this. A first time event or a new program and an over enthusiastic committee.

New events can often bring in less than the committee hoped. Then there's one of your big costs running over budget month after month. That's a villain you need to watch out for. And the sneakiest villain of all is the poisoned apple. Shiny and perfect on the outside, trouble on the inside.

That's an overall surplus that looks healthy while one part of the organisation is quietly losing money. Let's say your hall hire is bringing in a healthy profit, but that's just hiding the fact that the bar is losing thousands of dollars. The bottom line looks fine, but the problem is buried in the detail. So always read the line items, not just the total.

Kate M: So one bad month can be just timing. The insurance bill came in with a whopping increase or a grant payment was a month later than promised. That stuff usually sorts itself out. But when the profit and loss statement heads the wrong way three months running, that's a storyline and it's a bad storyline. So your job is to work out what's going wrong and fix it now, or you'll end up with an ending that nobody wanted.

Kate H: Now one thing that P and L cannot tell you, whether you can pay your bills right now. That's chapter three's job.

Kate M: Chapter three is the royal coffers, the truth about what came in and what went out. So that's your cash flow report, and it shows the actual movement of money, what came in, what went out, and what's left in the accounts. This is where the profit and loss story meets reality, and the stories don't always match up, which is why you need both reports.

Kate H: And it's why a bank reconciliation every month is a must have. The cash flow information comes from the bank statements, And if you're not reconciling regularly and properly, as we mentioned last week, you're reading a story that might not be true.

Kate M: Chapter three has just one hero. No surprises. Cash comes in and goes out the way you expected. Some months more goes out than comes in, like when you run a major event or you pay a large annual bill. And that's fine as long as you saw it coming and you have the reserves to cover it. So you want the royal coffers to match the story told by the other two chapters. Yay.

Kate H: And there's just one villain in chapter three. More money going out than coming in when nobody planned for it. That needs looking into straight away. It could mean income is lower than expected or people who owe you money haven't paid or in the worst case money is going somewhere it shouldn't.

This is the chapter where cautionary tales begin. You can have a beautiful P and L with the surplus, income on track and spending under control and still be heading for a crisis because the cash isn't there when the bills arrive.

Kate M: Chapter one tells you where you stood on the date of the report. Chapter two tells you how the story is going. Chapter three tells you if you'll make it to the next chapter.

Kate H: Reading the whole story cover to cover, unlike our committee at the start of this episode, That's what good governance looks like. So what does a good story look like? In Chapter one, a balance sheet with current assets comfortably more than current liabilities and equity growing year on year. In Chapter two, a P and L tracking ahead of budget with no nasty surprises hiding in the line items. In chapter three, royal coffers where the cash is doing what the plan said it should.

Three chapters telling the same story and it's a good one. Even the court jester knows what they're nodding at. And that's how you get your happy ending, not once, but every month when you read the story.

Kate M: And the unhappy ending, a committee that only reads the headline from chapter two. Surplus of $5,220. Great. Thank you. Meanwhile, the villain is creeping closer in chapters one and three. The scary story was always there, written in the numbers, but nobody read it, and now the bills are due and the money isn't in the coffers.

Kate H: And across all three chapters, watch for red flags, and when you see one, ask about it. As we said back in episode six and we'll say again and again, questions are gold. If something looks unusual, ask what it is. If an answer is woolly or incomplete, ask again. If the treasurer's nose appears to be growing like that little wooden boy, make sure you get the question right.

A woolly answer is a red flag in itself, and if reports arrive the night before the meeting instead of five days before, that's a governance problem too. You can't meet your duty of care without timely, complete financial information, and you can't read the story if no one will give you the book.

Kate M: Kate, remember the emperor's new clothes? You know? Everyone admired clothes that weren't there, and it took a little kid to go, hey. He's got no pants on. So, listeners, don't be the court jester. Be the brave kid. Asking the hard questions about the numbers is not being difficult. It's doing your job.

Kate H: So here's the synopsis, dear listeners. Three chapters, one story. Chapter one, the balance sheet is one page on one date. What you own, what you owe and what you're worth. Ask the four questions every month.

Chapter two, the P and L, is the pages you've read so far this year income, spending and how you're tracking against budget. Watch for trends and always read the line items. Chapter three, the royal coffers, is the truth about where your money went and when. More going out than coming in is fine if you planned for it, but if you didn't, find out why. And across all three chapters, ask the questions. Woolley answers are red flags too.

Kate M: The numbers are telling your organisation's story. Learn to read it, and then you get to write the next chapter.

Kate H: Your challenge this week, dear listeners. Before your next committee meeting, get hold of the financial reports and read all three. Pick one question from each chapter, something you want to understand or clarify, and ask it at the meeting. That's how you stop being the court jester and start governing.

Kate M: So we've put a freebie financial reports checklist in the show notes. That's a one page guide to the four questions for each report, the red flags to watch out for and what to do when you find them. So download that, keep it in your committee folder and use it every month.

Kate H: If your organisation's financial story is one you're not sure how to read, or if you've had a nasty plot twist, that's the kind of thing we help committees with through our businesses and through Fresh Allsorts. Details are in the show notes.

Kate M: If you've got a governance question you'd like us to tackle on the show, the contact form is at the committee room dot com dot a u, and we'll do our best to answer it for you.

Kate H: And, Kate, we're about to launch a new way to contact us and others in the not for profit community. Very excited about this development, so stay tuned for more next week. If today was useful, subscribe wherever you get your podcasts so you don't miss out on any episodes and share it with someone on your committee, maybe the court jester. You might even have more than one. Show notes are at thecommitteeroom.com.au.

Kate M: What's coming up next? Well, now that you know how to read the financial story, you'll want to know how to write your organization's next chapter. Budgeting, cash flow planning, the assets register, and so on, and how to make sure your budget actually connects to your strategic plan. And if you don't have a strategic plan, contact us because we can help you make one. And that is one that will actually work.

Until then, I'm Kate McPhee, Kate One.

Kate H: No, you're not.

Kate M: I'm Kate McPhee, Kate Two

Kate H: And I'm Kate Hartwig, Kate one.

Kate M: And this has been The Committee Room. Remember,

Kate H: you don't need good luck if you've got good governance.