Practice Element 3A2: Board Financial Oversight

The board has the ultimate management and fiscal responsibility for the nonprofit corporation. Board responsibilities include oversight of finances and fundraising, operations, programs, long-range planning, staff and volunteer conduct and public relations. The board of an all-volunteer land trust takes on many of the day-to-day program and operational tasks. The board of a large, staffed organization will focus on setting overall policies and management oversight. Regardless of size, a board that understands and meets its basic responsibilities provides a firm foundation for the land trust, builds public confidence, paves the way for financial success and allows the land trust to focus its energies on creative, effective ways to accomplish its land conservation mission. A strong and informed board leads to a strong and effective organization.

The full board is ultimately responsible for the budget. Regardless of who prepares the budget, the entire board should be fully informed of the assumptions and implications of the budget and should review it, revise it if necessary and approve it. When board members approve the budget, they are accepting the responsibility to raise the funds and oversee the expenditures during the next year. If staff or a committee has prepared the work plan and budget, board members should ask questions regarding the assumptions used in preparation and any items they do not understand and challenge any approaches or assumptions they are uncomfortable with. Any additions to the budget made at the final review stage must be balanced by cuts in other items; the income side of the budget should be increased only if the land trust can realistically expect to raise the additional funds.

The Board’s Special Role in Budgeting

Your board’s approval of the annual budget constitutes authority for staff and volunteers to incur expenses and secure income according to the plan embodied in the budget. However, the board’s role goes far beyond authorizing revenues and expenses. The board’s discussion of the proposed annual budget is an important opportunity to reflect on a land trust’s goals and strategies. The discussion should allow board members to explore areas in which they may disagree, as well as areas of agreement.

Great board discussions of budget priorities don’t just happen. Your choices about the format for presenting the annual budget, the level of detail, the clarity with which you describe the different programs, management and fundraising activities and the funds that support them will influence the tenor of the board’s budget discussion.

Most boards include individuals who have widely varying backgrounds and levels of comfort with financial information. For some board members, your land trust’s annual budget document may be the first comprehensive organizational financial plan that they have ever seen. Other board members will have managed large and small businesses or be sophisticated investors skilled in analyzing financial projections. Even those with substantial business and government experience may find some aspects of your nonprofit land trust’s budget puzzling. Even board members with extensive previous experience on boards of other types of nonprofits may be perplexed by some aspects of land trust budgeting and accounting.

Many organizations find that the best way to build meaningful budget and financial oversight discussions at the board level is to establish a board finance committee to evaluate the many budget choices before the full board begins its discussion of the proposed annual budget. The board finance committee works with the person who leads the preparation of the budget document. In large land trusts, a chief financial officer may play this role. In midsized land trusts, this task is often shared between the executive director and the fiscal manager or accountant. In the smallest land trusts functioning without paid staff or with only part-time program staff, the board treasurer often acts as a volunteer fiscal manager to handle the technical side of budget preparation. Whatever the system, it is important to understand that the process of creating the budget requires multiple points of view, not decision-making by a single individual. Developing the annual proposed budget for board discussion requires identifying all the information needed to project income and expenses, which means soliciting input from different parties.

One common pitfall of board discussions of annual budgets is over-emphasis on discussion of minor details while failing to discuss the most important choices. Your board chair and finance committee can help your board have a meaningful discussion of the budget by providing some key discussion questions. You may also be able to focus your board’s discussion of the budget by asking board members to share their views about whether the proposed budget:

• Reflects the goals and priorities of the strategic plan

• Includes realistic projections of contribution and special event income

• Includes enough resources to ensure effective management of the organization

• Includes enough resources to move toward longer term funding goals

• Reflects the board’s commitment to build reserves

• Includes compensation levels for staff that will allow the land trust to attract and retain qualified individuals

You can help your board members have a much more meaningful budget discussion if you prepare your budget proposal in the functional format discussed in Practice 6A1. This format will allow board members to see the income and costs associated with each of your programs and projects, as well as your administrative functions and the cost of fundraising.

Ensuring the availability of the resources needed to accomplish your land trust’s mission is a key board responsibility. Like other board responsibilities, there are multiple approaches that boards use to address this challenge.

In small land trusts, board members are often the primary, or sometimes only, fundraisers, soliciting donations from individuals, foundations and governmental sources, as well as implementing any other fundraising strategies they can think of. As land trusts grow and acquire their first executive director, boards frequently prioritize fundraising in the job description, often without a great deal of clarity about either the strategies they anticipate the new director will pursue or the extent to which the board is prepared to play an active role in resource development.

Interestingly, some of that same lack of clarity may still exist in larger land trusts, even those with multiple staff positions, including at least one fund development position. So, it may help to step back and think through what approach will really work best for your land trust board. Because boards hold the ultimate authority for the direction and sustainability of the land trust, they must also take final responsibility for determining the most effective way for their organization to obtain the resources needed to achieve the mission.

Land trusts pursue a remarkable array of income-generating strategies (see Practice 6A3 for an overview of the variety of income streams that support land trust operations and the acquisition of fee land and conservation easements). While your land trust’s annual budget process will provide an opportunity to evaluate your current income streams, your strategic planning process can provide an opportunity to discuss longer term goals for diversifying your support and ensuring sustainability.

As noted in Practice 6A3, board determination of the most effective strategies for obtaining resources will require careful analysis of both the opportunities available to your land trust and the investments that will be needed to seize those opportunities and develop them into cost-effective income streams. Ultimately, the board will need to identify the mix of income streams it believes will be most effective and sustainable and select strategies to develop each of those streams.

Fulfilling the board’s responsibility for ensuring the availability of resources will involve a series of challenging decisions, including:

• Setting long-term targets for the proportion of operating income that will be obtained from individual donors, foundations, governmental sources, fees for services, investment income and other significant sources

• Identifying the staff, board and other resources that will need to be invested to achieve the targets the board has established

• Determining priorities for the use of staff and board time and energy

• Identifying progress indicators to monitor success (or failures)

• Evaluating progress and fine-tuning strategies to ensure your land trust obtains the resources needed to fulfill its mission

A common truism in securing financial resources is that there is no free lunch. Success in developing individual donor support requires building relationships and asking for continuing support. Foundation support requires relationship building, strategic proposal development and systems for tracking and reporting on how money is spent and what has been accomplished. Governmental funding requires the existence of governmental funding sources, relationship building and demonstrated capacity to manage government funds. Fee-for-service income requires identifying services or products for which there are customers willing and able to pay a reasonable fee, as well as developing communications plans for current and potential customers. Investment income requires effective management of funds, the existence of which is dependent on your land trust’s success in building the income streams described above to a level at which generation of surplus for investment is possible or donors are sufficiently dedicated to the land trust to provide large endowment contributions.

And, of course, success in all of the income streams is incredibly dependent on achieving the mission of the land trust and spreading the good news of your accomplishments (and the troubling news of the work yet to be done to all those who care about the land you are working to conserve.

Beyond the selection of the major strategies your land trust will use to generate the resources needed to fulfill your mission, your board will confront two incredibly significant decisions:

• What are your priorities for the use of staff time to generate income?

• What roles will board members play in generating income?

Successful fundraising requires active board involvement, starting with clear expectations that each board member will be a donor and will play some role in helping the land trust build the relationships needed to expand its donor relationships. There is no one right way to engage the board in fundraising, but there is one clear reality: Boards who are not engaged in helping the land trust build relationships with supporters and who are not supporters themselves seldom succeed.

In fact, board engagement in fundraising is so central to the success of most land trusts that rethinking your board’s expectations regarding board financial contributions and relationship building may be one of the most important discussions your board will have each year. Even land trusts with written board policies on fundraising and board contributions find it helpful to revisit expectations on a regular basis as board membership changes and the level of staff support for board engagement in fundraising shifts.

Beyond revisiting the board’s own role in resource development, boards of staffed land trusts must make critical decisions about the use of staff time for income generation. As a starting point for this discussion, your board will need to ask staff how they are currently spending their time and energy in relation to each major income stream that currently supports your land trust. Determining the right mix of funding streams and the right amount of staff time devoted to fundraising to achieve the land trust’s objectives will require some long-term thinking, as well as evaluation of immediate results.

Many of the major income streams that support land trust work are developed over time, growing through deepening relationships with donors, foundations and governmental entities. Emphasizing only short-term outcomes – what use of time will produce the largest income in the current year -- may slow or damage the process of building the longer term relationships that are needed to yielder larger results. On the other hand, the board must ensure that the land trust has the cash it needs to pay its bills today and throughout the year. So, short-term results do matter. Ultimately the tough board decision is finding the right balance between the organization’s efforts to yield current year income and those that are focused on expansion of longer term relationships.

Of course boards want both short-term and long-term results. But identifying and implementing strategies that will ensure that both goals are met can be very difficult. A common example of the difficulty of balancing efforts toward longer and shorter term goals is the issue of focusing time on seeking foundation grants versus expanding cultivation of individual donors. For land trusts that currently receive relatively small portions of their total income from individual contributions, the short-term results of foundation grant-seeking often will exceed the results that can be achieved in a single year of focus on individual donors. But continuing a pattern of investing the most time in seeking and managing foundation funding and relatively little time in building new donor relationships and deepening existing ones will almost certainly ensure that support from individual donors remains only a small portion of the land trust’s income.

Of course the board’s responsibility for ensuring the availability of resources extends beyond setting goals and establishing strategies. The board must monitor results, comparing funds generated to targets and determining whether course corrections are needed. Because the board seeks long-term as well as short-term outcomes from its income-generating strategies, it is particularly important to identify progress indicators that the board can use to determine whether longer term strategies are moving forward appropriately, even when the desired financial results will not be achieved immediately.

There are a number of ways a land trust can build the leadership of the organization to support fundraising.

• Create clear expectations about the board’s role in fundraising. To say the board is responsible for fundraising is not enough and probably is not entirely accurate. More specifically, board members should be asked to support those aspects of fundraising that take full benefit of the unique roles that board members can fill. These roles include building relationships with potential and current donors, connecting the land trust to foundations and corporations and organizing events, including “getting to know you” meetings in their homes or businesses. Expectations of board performance should be clearly stated in recruiting and orientation materials, including board member job descriptions.

Land trusts should be clear that all board members should make donations to the organization as appropriate to their individual circumstances.

• Establish and empower a board development committee to focus on building the board of directors, committees and any other supporting structures. Successful board development never happens by accident. It requires intentional and strategic thinking to ensure the right people are recruited and trained to support the needs of the organization.

• Use a profile grid or matrix to define the mix of skills and talents, connections and demographics desired within the organization. Use a grid to ensure that the recruiting process focuses on building diversity into the land trust’s leadership composition. In addition, some groups use the simple rule that their board needs to be constructed of equal parts of the “three Ws” — workers, wealth and wisdom — as a way to ensure it has enough of the right people to be successful.

• Consider alternative roles for potential fundraisers who are not board members. Many land trusts recruit leaders to be active on committees as advisors or as non-governance trustees. These fundraising roles can be great ways to identify and test the relationship of the leader and the organization before they makes the major commitment of joining the board. It can also be a great way to retain board members who are leaving the board, but who may be willing to stay involved in more limited, strategic ways.

• Clarify the role of board and staff members in the fundraising process. Define these roles to reflect the current and potential strengths that board and staff members bring to the organization. When hiring staff to support or lead fundraising efforts, make sure their job expectations and their talents are closely aligned.

While the board may delegate responsibility for in-depth review of the financial statements to the finance committee, the full board retains responsibility for ensuring the financial health of the land trust. All board members should have access to the complete internal financial statements. Whether the board or the finance committee takes responsibility for the in-depth review of the internal financial statements, all board members should receive and review a complete balance sheet (statement of financial position) and organization-wide income statement (statement of activities) periodically throughout the year.

Your board and finance committee must determine how frequently internal financial statements should be produced and reviewed. Staffed land trusts will almost certainly want to produce monthly financial reports, while all-volunteer land trusts should produce financial reports at least quarterly. Some boards will prefer having the finance committee review the monthly statements while presenting quarterly statements to the full board. This approach assumes that the finance committee will alert board leaders if monthly financial reports reveal significant issues that the full board should discuss before the planned quarterly presentation of financial information. Many boards of larger land trusts believe review of monthly financial reports is a critical board oversight function.

Key Issues in Board Review of Financial Statements

Board members’ review of financial reports should focus on preparing them to answer eight basic questions about the financial health and management of their land trust:

1.       How financially strong is our land trust? Review of the balance sheet or statement of financial position is the starting point for answering this question. The balance sheet presents the assets, liabilities and net assets of the organization on a specific date. It may also present a comparison of assets, liabilities and net assets at two different dates, for example, the end of the last fiscal year and the end of the most recently completed month. As a starting point for effective review of the financial reports, board members will need to be clear about the method of accounting used by their land trust (see Practice 6B for a discussion of accounting methods).

In land trusts following Generally Accepted Accounting Principles (GAAP), board members should look first at the total net assets line. Net assets represent the net worth of the organization at the date specified on the statement. It’s helpful to think of net worth as what would be left if the organization gathered in everything it owns of value (cash, investments, land, buildings and so forth), collected all that is owed to it (receivables) and then paid off everything it owes to others (wages, payroll taxes, payables, mortgages and so forth). Net assets are roughly equivalent to owner’s equity in business financial statements. The net assets provide a cushion to fall back on in hard times and can give your organization the reserves it needs to be able to take risks in undertaking new activities.

If the net assets amount is shown in <brackets>, the organization has a negative net worth, owing more than it owns. If it’s not shown in brackets, the organization has a positive net worth—at least on paper. Like businesses, nonprofits report their land, building and equipment at the amount they cost when purchased (or their fair market value if received as gifts), less accumulated depreciation. This book value can be far from market value, that is, what the land, building or equipment could be sold for today. If the market value is much higher than the book value, the net assets will understate your organization’s actual net worth. If the market value is much lower than the book value, the net assets will overstate your actual net worth.

2.       Can the organization meet its obligations on time? Simply having a positive net worth (net assets) doesn’t guarantee that your organization can pay its employees, its payroll taxes and its vendors on time. Paying obligations depends upon the land trust’s cash position or liquidity and the extent to which its funds have a restricted purpose. Look again at the balance sheet (statement of financial position). Create a subtotal of all the cash accounts and any receivables or investments that can readily be turned into cash. Next, look at the liabilities. Create a subtotal for those liabilities, such as accrued wages, taxes and other accounts payable that the land trust must pay within 12 months—this subtotal constitutes your current liabilities. Then compare your cash and cash equivalents subtotal to your current liabilities subtotal.

Does your organization have at least as much or more cash or items that it can readily turn into cash than current liabilities? If so, it will probably be able to meet its obligations on time. If not, it will have difficulty doing so. If it has significantly more cash than is required to meet current liabilities, it is in a good position to take on additional obligations through expansion or taking reasonable risks. Or it may be time to invest some excess cash in longer term investments or operating reserves.

If the balance sheet (statement of financial position) provides information about two points in time—the end of the current month and the end of the previous month or previous fiscal year—you can evaluate whether the cash position (that is, your cash available to meet obligations or invest) is improving or worsening. Compare the cash balances, the accounts receivable and the accounts payable. If the accounts receivable are increasing, find out why. Does the increase simply reflect a higher volume of service and higher amounts being billed, more pledges for contributions being recorded or does the increase reflect difficulty collecting what is owed to the organization? If the accounts payable are increasing, ask for an aging (a list that shows which of the amounts have been owed for 30, 60, 90 or more days). Then determine why payments have not been made and what will be the consequence of further delays.

The current ratio, calculated by dividing total assets that can readily be turned into cash by current liabilities, is a measure of the adequacy of your cash position but it is limited to a point in time. Some lenders require a minimum current ratio of 1.25, meaning that you have $1.25 in assets available to cover each $1 in liabilities. A better tool for making sure that your land trust will be able to meet its obligations on time is the cash flow projection. This projection helps you predict how much cash will be available and how much cash you will need to meet obligations for each of the next 12 months. If your cash flow projections shows that the land trust will not have enough cash to meet its obligations in future months, you will need to develop a plan to increase the cash that will be available or reduce the amount of cash that the land trust needs.

3.       Are there limitations on what the land trust can do with its resources? While having a positive net worth is clearly better than having a negative net worth, simply noting that the net assets line on the balance sheet is positive doesn’t tell the whole story. Board members will need to ask a few more questions.

Are there restrictions on any portion of your nonprofit’s assets? Your net assets should be summarized into two categories: net assets without donor restrictions and net assets with donor restrictions. You must distinguish between the net assets over which the board has complete discretion from those that must be used in compliance with donor restrictions.

The term restricted refers to a limitation placed on the use of a gift by a donor or funding source. For example, a donor may say “use my contribution only for an outreach program,” or a foundation award may state that the funds may be used only “to meet the costs of restoring a specific streambed” described in your proposal to the foundation. For some gifts, the donor intends that the organization will invest the funds and use the income generated through investment either for specific purposes or for general support of the organization’s activities. Such gifts are frequently referred to as endowment gifts. No matter the purposes of the gifts, the land trust must track the portion of your net assets that are subject to each type of donor restriction. This tracking includes the purpose for which the funds may be used or the timing for their use, as well as any restrictions making the gift an endowment or restrictions that land or other assets be held permanently for specific purposes.

As you think about the land trust’s overall sustainability, the net assets with and without donor restrictions represent different types of financial strengths. The net assets without donor restrictions comprise a cushion that your board has full authority to direct. Parts of it may be immediately available, while other parts are invested in fixed assets or have been designated by the board to function as reserves.

Your net assets with donor restrictions comprise resources that will be available for use in future periods, but donor restrictions will limit how or when your organization may use them. In most cases, donors that restrict the use of their gifts to specific projects or activities or use in specific time periods give with the intention that the land trust will spend their gift. In contrast, the portion of your net assets that donors have restricted to function as an endowment will not generally be available for the land trust to spend. Instead, the donor’s restriction expresses their intention that the land trust will invest their gift and only the income generated through that investment will be available, either with or without further restriction from the donor. Net assets subject to this type of donor restriction do contribute to overall financial strength by representing a future source of investment income to support your work.

If your internal financial statements do not separate net assets into assets with and without donor restrictions, you will need to ask whether a portion of the net assets is subject to donor restrictions. You will also want to learn what portion of your net assets without donor restrictions the board has designated for specific purposes, such as stewardship or an operating reserve. You may want to consider getting help to modify your internal statements so that the donor-restricted and board-designated portions of the net assets are presented clearly.

To fully understand your land trust’s financial health, you will also need to understand both the extent to which your board has full or limited ability to direct the use of the net assets. If the net assets are not donor-restricted, the board has full authority to direct their use. If the net assets are subject to donor restrictions, the board may direct their use only in accord with the restrictions. If the donor restrictions are permanent, the board must focus on its responsibility to invest the resources or care for the restricted assets wisely with the understanding that the restrictions are intended to continue in perpetuity.

Once you are clear about this major distinction between net assets without donor restrictions and net assets with donor restrictions, you will want to focus your attention on the net assets without donor restrictions to consider the extent to which they are available to meet the land trust’s operating costs.

Not all of your net assets without donor restrictions will be readily available to support your operations. The land trust will have invested some of these net assets in land, buildings and equipment (fixed assets). The board may have designated another portion of these net assets to function as reserves – for stewardship, for operations or for other purposes. To understand what portion of your net assets without donor restrictions is available to meet operating needs, you will need to subtract the portion of your total net assets that have been invested in land, buildings and equipment (fixed assets) and also subtract the portion of the net assets without restrictions that the board has designated for specific purposes, such as stewardship reserves or operating reserves. The remaining net assets without donor restrictions are available for operations.

The portion of the net assets invested in fixed assets will not be immediately available to support operations. The land trust would have to sell its fixed assets or borrow against them in order to obtain cash for operations use. As you look at the land trust’s investment in fixed assets, think about how essential these assets are to the organization’s ability to conduct its operations.

Many land trusts show the portion of the net assets invested in property, plant and equipment (sometimes listed as fixed assets or capital assets) on a separate line in the net assets without donor restrictions section on their balance sheet. If your statements do not show this line, you can still determine the portion of the land trust’s net assets that represent investment in fixed assets by finding all the asset accounts (land, buildings, equipment, leasehold improvements and so forth) and finding all the liability accounts related to these fixed assets (mortgages payable used to finance the purchase of property and buildings or notes payable associated with major equipment purchases). To compute the portion of total net assets invested in fixed assets, subtract the liabilities you identified from the assets.

Next, consider whether the board has set aside any portion of the net assets without donor restrictions for specific purposes. Many land trust boards also designate a portion of the net assets without donor restrictions to function as a stewardship or a legal defense reserve. The combination of the board-designated net assets for stewardship and any net assets with donor restrictions for stewardship is an important component of your financial health because, taken together, they indicate the extent to which the land trust has financial capacity to withstand stewardship challenges and maintain its commitment to ensuring the protection of the land in perpetuity.

Some boards decide to set aside a specific portion of these net assets to function very much like an endowment. The board wants to invest these funds so that investment earnings may be used to support ongoing operations or, in some cases, specific programs or costs. Such funds are described as board-designated long-term reserves. In the past, some boards referred to these funds as board-designated quasi-endowment funds, but this terminology often creates confusion because the appropriate use of the term endowment is for donor-restricted gifts. Because the board has created the quasi-endowment fund through its action, board action may change the fund’s use. This contrasts sharply with the endowment funds with donor restrictions, which the board cannot change.

If your board has designated a portion of the net assets without donor restrictions as a board designated quasi-endowment, these funds will not be immediately available for operations. Instead, your board will need to give very serious consideration to changing the designation and using these resources for current operations.

If your board is considering designating any portion of the net assets without donor restrictions for any purpose, it is important to remember that no board can tie the hands of a future board. What the board has designated can be undesignated by future board actions. Board designation of some portion of the net assets without donor restrictions can be very helpful as a way to document the board’s intention to set aside reserves for specific purposes, such as stewardship or special initiatives. If your board is considering creating such a designation, you will want to be sure that your board minutes record the exact nature of the designation, including the circumstances in which the funds may be used and any special board action that will be required to release funds from the board-designated reserves.

4.       Is our land trust complying with donor restrictions? In some land trusts, a substantial part of the gifts and grants received carry restrictions attached by donors or grant funders. The restrictions may be either fairly general (use this gift only for the outreach program) or very specific (use this money only to buy trail guides for the outreach program). The statement of activities (income statement) should show when the donor has established restrictions and when the land trust has fulfilled some of those restrictions by incurring the costs that the gift was restricted to cover.

If your land trust uses the standard GAAP reporting format, you will see a distinction between gifts with and without donor restrictions and grants on the statement reporting income and expenses. The gifts or grants that your organization received with donor restrictions will be presented in a column titled gifts with donor restrictions or in a separate section of the statement, clearly labeled as gifts or grants with restrictions. In both approaches, you’ll also see a line at the bottom of the income section that reports on amounts “released” from restrictions and added to unrestricted income. This line indicates that you have complied with the donors’ restrictions and used their funds ac­cording to their wishes.

Some land trusts choose not to use the GAAP format for their internal financial reports. If your land trust is not using the GAAP format, you should still be able to see evidence that you are tracking donor restrictions by looking at the balance sheet. There you will see a line item labeled deferred revenue—grants and restricted gifts received in advance in the liabilities section. This line item reports on funds that the nonprofit has received with restrictions that it has not yet used for the restricted purposes. When the land trust does use the funds for the purposes directed by the donor or grantor, the deferred revenue line item in the liabilities section will be reduced and the grant income line item on the statement of activities (income statement) will be increased by the same amount. This entry reflects the fact that the land trust has earned the right to use the restricted funds by incurring costs that meet the donor’s restrictions.

Understanding how nonprofits report on receiving and using restricted funds can be challenging, in part because different nonprofits use different methods for presenting this information. If you are not clear how you can see the receipt and use of funds with donor restrictions on your land trust’s financial statements, it will be worthwhile asking an accountant to explain your current system and help you think through whether a different method would work better for your organization.

5.       Is the organization breaking even? To answer this question, you’ll have to see the statement of activities (income statement). This statement reports on revenues and expenses over a period of time—a month, a quarter or a year. Expect to see both revenues and expenses broken down into separate line-item categories describing the type of revenue (grants, contributions, fees, interest and so forth) and the types of expenses (salaries, taxes, rent, supplies and so forth).

There are two important ways to look at this information. First, look at the bottom line—the net income, which may also be called the excess (deficit) of revenues over expenses or the increase (decrease) in net assets. If revenues exceed expenses, the net income will be positive. If expenses exceed revenues, the net income will be negative and shown in brackets. This positive or negative net income for the period you are looking at is really the explanation of whether the net worth (net assets) of the organization has grown or shrunk. A positive net income will result in an increase in the net assets (net worth). A negative net income will result in a decrease in the net assets (net worth).

Another important way to look at revenue and expense information is in comparison to the land trust’s budget for the time period. Hopefully, the land trust has a complete annual budget that shows all the planned sources of income and all the planned types of expenses (see Practice 6A1). You will want to compare the actual revenues and expenses reported on the statement of activity (income statement) to the planned revenues and expenses presented in the budget. Your questions will be, “Are things going as we had planned? Are we generating the income we thought we would? Are we controlling costs within the limits set in the budget?”

You will also want to look at your revenues and expenses in comparison to those you had in prior years. This can be particularly helpful when you have some revenues or expenses categories that do not occur evenly throughout the year. For example, if you have major fundraising activities every year in December, simply comparing your fundraising income and expense to your annual budget in October won’t really tell you if you’re on track. It will be more helpful to compare your current year to past years and especially helpful to think about what percentage of fundraising income was generated by October in previous years, compared to the percentage of your annual budget for fundraising income that has been generated by October this year.

Another useful approach for dealing with revenue and expense items that do not occur evenly throughout the year is to break your annual budget into monthly or quarterly segments. You can then compare your year-to-date income and expenses to your budget plan for this point in your fiscal year.

6.       Is our land trust using its resources wisely? This is perhaps the most important question of all. To answer it, you must be clear about your mission and the strategies you have agreed upon to achieve it, and the financial statements must give you enough information to be able tell the purpose of the expenses, as well as their descriptive character. For example, looking at a report that shows that the land trust spent x dollars in salaries for the year tells us the character of the expenses (that is, salaries) but doesn’t tell us the purpose (that is, were the salaries spent for working on acquisitions, stewardship, outreach, fundraising or for administrative functions?). We can get some information about the purpose of expenses through a functional presentation on the statement of activities or through a separate statement of functional expenses. The functional presentation will distinguish expenses for program, administrative and fundraising purposes and, if the organization has several different programs, distinguish the costs associated with each.

With functional expense data you can consider whether the land trust seems to be spending its resources in accordance with its mission and the priorities you established in your strategic plan. If you have prepared your budget in the functional format, distinguishing the purpose (fundraising, management, acquisition, outreach and so forth) for which you will expend funds, you will want to see financial reports that compare the actual expenses for each of these functions to budgeted expenses for each function. 

You may want to ask to have some supplemental information included on your financial reports to help you monitor key indicators of both program and financial performance. For example, you may ask to see the information about the progress of various acquisition projects as they move through the pipeline from initial exploration to technical evaluation to price negotiation to fundraising and, finally, to closing. Alternatively, you may want to monitor the number of donors or the percentage of members who renew their membership. Or you may want to track the number of easements monitored in comparison to your goals for the year or in comparison to prior years.

The concept of combining some key financial information with some other key program or fundraising indicators is frequently referred to as a dashboard. To develop a useful dashboard, you will have to identify the variables that make the most difference in your financial outcomes. For many land trusts, these will include the number of donors, donor retention rate and average gift size as key indicators for fundraising and number of easements monitored or acquisition deals initiated and closed as indicators of program success. To be effective, dashboard designers must carefully pick the information to be included to avoid distracting readers with too many variables.

7.       Should we rely on the accuracy of our internal financial reports? While most readers of financial statements will have to rely on someone with greater accounting knowledge to evaluate the quality of the accounting provided by the organization, there is one simple test to spot obvious problems with your land trust’s accounting.

To do the test, you must have the financial statements for two consecutive periods (January and February, for example). Take the total net assets from the first of the two periods and add the net income (change in net assets) reported for the second period. The answer should be the same number as shown for the total net assets at the end of the second of the two periods. If it’s not, seek help from someone knowledgeable about accounting because your books may not be in balance.

Key Balance Sheet Information for Review

The most effective review of the items described below will require that the balance sheet be presented in comparative format with the balances of all accounts at the end of the prior month being presented in comparison to the balances in those accounts at the end of the current month.

• Cash. Determine whether the cash-on-hand balance has increased or decreased compared to the prior month. Ask for a translation of both cash balances into a days of cash estimate to facilitate determining whether the cash balance is adequate to meet the land trust’s needs. Ask for an identification of the minimum cash balance required to meet the need for cash in a typical month. If the cash balance or the days of cash on hand have declined significantly, inquire why this is happening and when the land trust will reverse the trend. Ask to review the cash flow projection to be sure it is consistent with what you are told.

• Contracts receivable. Compare the current contracts receivable balance to that of the prior month. If the contracts receivable balance has gone up significantly, ask for a schedule of the specific contracts included in the receivables balance and request that the balances at both dates be presented in the aged format, which shows what portion of the receivable is 30 days from current, 60 days, 90 days and more than 90 days. Be aware that in many cases, funder delays in paying land trust reimbursement requests are related to problems with the invoices that have been submitted. Ask if the funder has requested revised invoices or provided any other feedback on the cause of the delay in making payment.

• Accounts payable. Notice whether accounts payable have increased in comparison to the prior month. If so, ask for a schedule that displays the largest amounts payable by vendor. Ask that the schedule show whether each payment is overdue and, if so, by how many days (30, 60, 90 and more than 90 days). Investigate why the land trust is not paying its bills on time. Pay particular attention to any outstanding payable amounts to health insurance providers or retirement plans. Be aware that there may be legal consequences for failure to pay these bills on time.

• Payroll taxes payable. While it is unusual today to see land trusts fail to pay payroll taxes on time, including the portion withheld from the employee’s paycheck and the portion that is the employers’ share, it does still happen. This is an extremely serious situation because payroll tax authorities can impose harsh penalties, and board members may, in certain circumstances, be held personally responsible for unpaid amounts. Ask for a certification that no payroll tax payments are overdue.

• Net assets without donor restrictions. Compare the net assets without donor restrictions at the end of the prior month to those at the end of the current month. Notice whether the balance increased or decreased. An increase in net assets without donor restrictions means that the land trust had unrestricted income greater than expenses during the month. A decrease in this category of assets means that the land trust had expenses greater than income in that month. Compare the change in net assets without donor restrictions calculated from the balance sheet numbers with that reported on the income statement (statement of activities). The two numbers should be identical. If not, it may indicate an error in the preparation of the statements. Ask for an explanation of any differences. If your land trust has experienced an overall loss from the year-to-date activity – year-to-date income has fallen short of year-to-date expenses – ask for a year-end projection that shows a plan for managing the finances to avoid a year-end loss.

How Will the Board Recognize Whether Action is Needed to Protect the Land Trust’s Financial Health?

If your financial reports show a series of losses or if you are aware that the land trust lacks cash when needed to meet payroll and pay bills on time or if you are concerned that you may not be tracking donor restrictions properly, you may want to take your review a bit further, including the following steps:

• Review the revenue line items that have fallen short of the planned level shown in the budget. Consider if the land trust can realistically make up the shortfall in the remaining portions of the year. Avoid wishful thinking! Base your evaluation on specific plans with specific estimates.

• If part of your funding is dependent upon the number of trees planted or acres inspected or on the number of people participating in a program, check the numbers in these areas carefully. If you are not achieving your targets, figure out why.

• Review all significant expense items that are significantly greater than the projected level. Determine whether your annual budget estimate will still prove correct (for example, you have just expended amounts in this category at a more rapid rate than planned, but the annual estimate is correct). Don’t waste time worrying amount small expense items like office supplies because, in most cases, the only way to have a significant impact on total expenses is by reducing personnel or professional service expenses.

• Based on your analysis, consider whether you will need to pursue additional strategies to generate the revenue you need or whether you should make reductions in your spending level.

• Review all financial reports you are preparing for funders that have provided restricted grants with great care. Be sure they are based on the numbers in your general ledger and those numbers are correct.

• Be sure you are familiar with the requirements of your agreements with restricted funders. Do you have to obtain their permission to move amounts from one line item to another? If so, your analysis of the reports should focus on identifying any requests for changes you will need to submit to the funder.

• Are any of your grants or contracts “use it or lose it” agreements where your land trust won’t receive funds unless you expend them on specified items? In a “use it or lose it” contract, reducing costs so that you underspend the contract is not helpful to your organization. Instead, if it appears that you are underspending, consider what additional resources the project needs or whether you can make a case to include more of your overall operating costs into the contract budget. Once you have developed a strategy, then you will have to seek approval from the funder.

• Write down your major assumptions regarding the financial statements. Compare these assumptions to your next month’s financial statements. This will provide rapid feedback about how realistic you are being.

• Consider preparing a year-end projection of revenues and expenses. Create the projection by starting with your year-to-date revenue and expenses in each line item and then estimating what additional income will be generated and what expenses will be incurred during the remaining months in the fiscal year. Combine the actual year-to-date information in each line item with your best estimate of what will happen in the remaining months of the fiscal year to create the total year-end projection.

Remember, the longer you wait to make revisions in your plan, the more dramatic the revisions may need to be because you will have less time to benefit from their effect.

Practice 6C1 will help a land trust board decide whether to engage a CPA to provide an audit, review or compilation. It also covers the purpose and value of each of those different types of engagement. 

Once the board has made the audit/review/compilation decision and selected the CPA, your land trust will engage and communicate regularly with the CPA during the engagement. The next step will be making sure your board truly benefits from the CPA’s work. Some land trust boards establish an audit committee to take the lead in selecting the CPA and handling communications during the audit. Other land trusts assign these responsibilities to the finance or executive committee. Regardless of who takes the lead, the full board should be aware of the engagement process, receive the audit/review/compilation report and have the opportunity to meet with the CPA at the conclusion of the engagement to discuss the results.

You should expect the CPA to explain the report, to answer your questions about both the reported financial information and the notes to the financial statements and to talk frankly about any difficulties they may have encountered as they prepared the report. You should organize your meeting with the CPA in two parts. The first part should include both board members and your executive director and the staff member or contractor who does the bookkeeping work for your land trust. The CPA’s main presentation of the report should occur during this portion of the meeting. Ask both the CPA and your staff to discuss any problems encountered during the engagement or any suggestions for improving the land trust’s systems.

The second portion of the meeting should include only the CPA and the board and finance/audit committee members. In this discussion, board members should be free to ask the CPA for their observations about both the performance of the staff or accounting contractor and the usefulness of land trust’s financial management systems. The CPA may alert you to important limitations in your system or in the expertise of your staff. The discussion will provide an opportunity for board members to deepen their understanding of the challenges your organization faces in handling the complex accounting required by land trusts. You could also seek feedback from the CPA about possible strategies to improve your systems. In order to ensure open communication with your CPA, the board will want to make it clear that they understand that they are ultimately responsible for making all financial management decisions for the land trust and, consequently, they are not asking the CPA to step out of their independent role to make management decisions for the organization.

The American Institute of CPAs (AICPA) has an excellent toolkit for not-for-profit audit committees. Portions of the toolkit may be helpful to all board members in building understanding of the audit process and the types of assurance an audit does and does not provide. You may purchase the toolkit from AICPA, or your CPA may be able to provide the board with a free copy of the resource.

If the land trust decides to have a review or compilation rather than an audit, you will still want to give board members the opportunity to meet with the CPA who performed the engagement. In setting up this meeting, you will want to acknowledge to the CPA that you understand that the engagement was not an audit and that, consequently, the CPA has not issued an opinion on whether the financial statements present the land trust’s financial conditions and activities fairly. Once the board understands the nature of the CPA’s work, you can ask the CPA to explain the information in the report, including the financial statements and the notes to the statements. You can also ask whether they encountered any difficulties in completing the engagement or if they have observations about how your systems could be improved. As in discussions with an auditor, you will want to acknowledge that the board understands its responsibility for all financial management decisions.

Beyond the discussion with the auditor, board members will want to talk with each other about the questions that the audit or review report has raised for them. As a starting point, board members should reflect on the extent to which the financial results presented in the reviewed or audited financial statements are significantly different from the information in the internal financial statements. Some useful points of comparison between the audited or reviewed statements and the internal statements include:

• Total net assets (reported on the statement of financial position). Is there a material difference between the total net assets reported on the audited statements and the internal statements? Because total net assets represent the equity of the land trust, it’s an extremely important number. If there is a significant variance, either higher or lower, between the audited and internal statements, it means the board has been making decisions without a clear understanding of the land trust’s financial strength. A significant difference is also a strong indication of problems in the accounting system or a need for additional training and support for the person handling the internal accounting.

• Contributions. If there are significant differences between your internal statements and the audited or reviewed statements in the total amount of new contributions with and without donor restrictions, your board has been making decisions without a complete picture of your income. Significant differences may indicate that the accounting system has not been set up to properly track the receipt of contributions with donor restrictions. Another possible cause is failure to properly record the receipt of grants that were transferred directly into the closing process for purchase of land or easements (that is, they never passed through the land trust’s bank accounts). Such grants are income and should be reflected in the internal financial statements. Still another potential source of difference between the audited and internal statements could be failure to correctly record multi-year grants and pledges in the internal statements. Resolution of all of these underlying problems may require assistance in redesigning the underlying accounting system and providing additional training and support to the accountant preparing the internal statements.

• Cash and investments. These accounts, listed in the statement of financial position, should be reconciled to bank and investment statements every month. Significant differences between the amounts reported on the internal statements and in the audited statements should raise questions about whether the reconciliations have been prepared properly. These reconciliations are an essential internal control. If there has been a breakdown in this area, board members will need to ask the executive director or treasurer to investigate and do whatever necessary to make improvements. 

• Schedules of net assets with and without donor restrictions. The audit or review report will include detailed listings of the ending balances for net assets with and without donor restrictions, as well as for each type of board-designated net asset (for example, board-designated stewardship funds). The board should first ask staff to provide a detailed comparison between the balances reported in the audit and the balances that are recorded in your internal systems. Your board may want to request that a schedule of the balances of each type of net assets with donor restrictions and each type of board-designated net assets without donor restrictions be included with every set of internal financial statements. You may find it helpful to review Practice 5B3 to help board members understand the importance of demonstrating your accountability for board-designated funds and assets with donor restrictions through careful tracking of the different components of your net assets.

These are examples of potentially misleading information that could be provided to the board through the internal financial statements. The board should work with the executive director or treasurer to determine the best way to resolve the underlying problems in the internal systems that generated misleading information. One particularly important control is found in independent review of the bank and investment account reconciliations. Someone other than the person who makes deposits and prepares checks or the person who authorizes transfers and withdrawals from bank and investment accounts should review monthly reconciliations of every cash and investment account. This is critical protection for both the land trust and the person doing the actual accounting functions. If there is no board member who is willing or able to perform the independent reconciliation function, the board may need to consider hiring an independent accountant (not the auditor) to do monthly reconciliations. The cost of such a service is generally low and the positive impact on controls quite high.

Beyond the numbers on the financial statements, board members will also want to consider the auditor’s comments about the strengths and limitations of the land trust’s financial systems. Auditor comments about weak internal controls should be given particular attention. Internal controls protect your organization from both error and fraud. See Practice 6D1 for more on internal controls. 

While it is difficult to establish strong controls in a small organization, it is not impossible. Key internal controls include:

• Board monitoring of the executive director’s performance (for staffed land trusts) 

• Compliance with established policies and procedures by all staff and volunteers

• Careful board review of the financial reports to identify unexpected items

Adopting and monitoring the implementation of a sound investment policy is one of the most crucial responsibilities of land trust boards. State nonprofit statutes and IRS rules for charities require that boards protect the assets of the corporation from loss or misuse. Those same statutes require that board members exercise the duty of care, meaning that they devote the same level of care and attention to the affairs of the nonprofit corporation as they would to the management of their personal assets and finances. Failure to direct and monitor the investment of the nonprofit’s assets is evidence of failure to observe the duty of care.

A land trust’s investment policy should establish the level of risk the board believes it is prudent for the organization to take in investing its resources. Most nonprofit boards are comfortable with investment policies that call for investing their reserves in a mix of publicly traded stocks and more secure government and corporate bonds. The investment policy must give clear guidance regarding the level of risk the organization is prepared to take in its approach to investment.

Investment policies typically express the level of risk the organization is prepared to take through specifying the allocation of funds into differing types of investment strategies. In general, a greater level of risk may be tolerable for funds invested for a longer term. This strategy reflects the reality that much of the risk involved in investing has to do with timing. In general, prices for both stocks and bonds fluctuate over time. Investors who have an immediate need for cash may be forced to sell when the price they can obtain is unreasonably low, while investors who do not have immediate need for cash are able to wait to sell their investments when the market price is favorable.

The time horizon is not the only factor that a land trust must consider when establishing its investment policy. The policy must also reflect the organization’s intentions regarding the level of return it seeks to achieve through investment. Land trusts are, by definition, committed to protecting land in perpetuity. Consequently, an investment policy must balance the desire to grow the balances of various reserve funds to meet stewardship and other needs over time with the recognition that the funds themselves must be preserved to ensure that the land trust will continue to be able to provide stewardship. 

An investment policy should also reflect any restrictions or limitations a donor may have placed on the investment of funds or other assets. Hopefully, the land trust has a clear gift acceptance policy that limits the extent to which the organization will accept gifts with donor restrictions on investments.

Most land trusts recognize that they can take little or no risk with funds needed to meet current operating needs or to execute acquisitions in the short term. For example, board policy will almost certainly require that all funds used for ongoing operations be placed in FDIC (Federal Deposit Insurance Corporation) insured accounts. Current federal rules limit FDIC coverage to a maximum of $250,000 on deposit at any one financial institution. The board should clarify whether the land trust will limit its deposit at any one institution to the level of FDIC insurance coverage. Including this limitation the investment policy may mean the land trust will need to place funds in multiple banks to ensure that no account exceeds the FDIC coverage limits. The Certificate of Deposit Registry Service (CDARS) is an acceptable alternative to this approach. It allows a land trust to keep its funds in one institution, while ensuring that all of its funds will be covered by FDIC. CDARS is a network of financial institutions that work together to maintain FDIC coverage for larger deposits.

A land trust’s investment policy should specify the level of risk and type of investment vehicle used for investing stewardship, operating and other reserves. In most cases, a land trust will want to avoid using these reserves except in specified situations, and its investment goals will be to generate a reasonable rate of return without subjecting the funds to undue risk. The goals for these reserves will be less long term than those for investment of donor-restricted endowment funds or board-designated quasi-endowment funds.

A good starting point for developing an investment policy for endowment funds is to review the most recent audit report. The audit should clearly describe the portion of net assets that meet the legal definition of the term endowment. Look in the Notes to the Financial Statements section to see how these funds are described, including the purposes for which they are intended and any donor imposed restrictions on how they may be invested. Look to see if your land trust also reports any board-designated quasi-endowments as a component of its net assets without donor restriction and review the notes section to determine whether previous boards have placed any limitations on how these funds may be invested or used.

If the land trust has either a donor-restricted endowment or a board-designated quasi-endowment, you will want to become familiar with your state’s version of the Uniform Prudent Management of Institutional Funds Act (UPMIFA). All states except Pennsylvania have adopted some version of the UPMIFA provisions, developed by the American Bar Association. UPMIFA laws spell out the responsibility of governing boards for managing endowment funds and describe the criteria that may be used to evaluate whether the policies guiding endowment fund management are reasonable. UPMIFA laws also describe the legal steps that must be taken if boards wish to use the corpus or body of a donor-restricted endowment fund.

Once the land trust has reviewed the state’s UPMIFA law, it will need to decide whether to establish a separate endowment policy or whether to simply include provisions guiding the management of the endowment in the general investment policy. The policies regarding endowment management should include guidance on the withdrawals (payouts) the land trust can make from the endowment. For most boards, the overall goal of endowment policies will be to at least maintain the underlying the value of the endowment so that it is worth as much in today’s dollars as it was when the donor made the gift (of course, it would be much better if the value actually increased!). Remember, inflation, as well as growth of the land trust’s activities, will require more support in the future than at present. The larger the corpus, the more income it can generate. 

Boards managing endowments must also determine their policy for withdrawing all or portions of the earnings to support current activities or purposes. Most boards follow guidelines established by large endowment fund managers to determine the percentage of the fair market value of the endowment that may be withdrawn and utilized to support the organization’s work. This percentage is referred to as the payout rate. Some endowment policies establish the payout rate but include a provision that if the funds are not needed for current activities, they will continue to be invested in ways that are consistent with the investment of the endowment corpus. While certain accounting entries must be posted to reflect this decision, the funds can remain in endowment investment accounts if the policy permits.

Management of endowment funds is obviously a complex and serious matter. Potential endowment donors are often interested in both the investment policies that guide the investment of their gifts and also in the organization’s recent investment returns.  

Many land trusts are relatively small organizations, despite the very large impact they have on conservation. As small organizations, they lack staff with financial expertise to provide high level support to board committees performing investment management functions or to feel fully confident in evaluating the performance of compensated investment managers. Consequently, many land trust boards consider establishing an endowment with a well-managed community foundation. 

Community foundations are nonprofit charitable organizations formed to encourage philanthropy in specific geographic areas. They are characterized by a structure that includes the creation and tracking of multiple restricted funds dedicated to specific purposes. Many community foundations have policies that permit them to establish endowment funds to benefit a specific charity, such as a land trust. Once such a fund is established, it becomes the responsibility of the board of the community foundation to manage the fund effectively and to authorize the award of grants to the named beneficiary organization. For example, if the community foundation holds a $1 million endowment for your land trust and has a policy that permits a payout rate of 4.5 percent per year, the community foundation will be able to award a grant of $45,000 to the land trust each year. In fact, the actual amount available to the land trust would very likely increase each year as the market value of the endowment grows.

Of course, making the decision to place your endowment at a community foundation rather than retain it within your organization requires careful thought. On the positive side, community foundations often have very extensive holdings and consequently can afford to hire extremely competent investment managers and obtain a very positive rate of return. They also often benefit from having board members and investment committee members who have substantial expertise in investment management and, consequently, are well prepared to evaluate the performance of compensated investment managers. They often have high credibility with potential donors who may already give to the community foundation.

On the other hand, the funds placed in a community foundation endowment belong to the community foundation and are subject to policies set by the board of the foundation. While community foundations generally have provisions for unusual situations in which an organization needs to access a portion of its corpus, the authority to approve such a transfer rests with the board of the community foundation, not the land trust board. Under very limited circumstances, the foundation may permit the land trust to withdraw the funds.

If your land trust has an endowment or is seriously considering building one, you will want to evaluate whether the community foundation option makes sense for your organization. If it does, you will need to take board action to work with the foundation. If you decide that you will manage your own endowment, you will need to determine whether it will work best to prepare a separate endowment policy, in addition to the investment policy, or to combine both purposes into one policy document.

The investment policy should also specify the land trust’s approach to managing investments. Will the board rely on a volunteer investment committee to implement its investment policy and make specific investment decisions? Or will it select and compensate a competent investment manager to make routine decisions and bring clear choices to the board or to an investment committee? The policy should also clarify the process the land trust will use to select an investment a manager or advisor, including the criteria by which to evaluate their competence and integrity. The policy should also describe the process to evaluate the investment manager’s performance, whether that function is being fulfilled by volunteers or by a paid professional.

Of course, the total return on investment a land trust can achieve will depend not only on the performance of its investments but on the costs the land trust incurs in selecting and managing them. Many nonprofits determine that the use of index funds is the most cost-effective approach to investing. Instead of relying on either compensated advisors or a volunteer committee to select individual stocks and bonds or mutual funds, index funds include a pool of stocks or bonds that, when taken together, will perform at a rate at least equal to average for that type of investment. The pool of stocks or bonds is periodically adjusted by the index fund managers to ensure this “midpoint” performance. In fact, in recent years some of the nonprofits with the largest endowments have determined that the use of index funds yields better net results than the selection of individual stocks, bonds or non-indexed mutual funds, even for organizations able to employ the most sophisticated investment advisers. If a land trust decides to utilize index funds, its policy should clarify the process for selecting specific funds and require consideration of fees and other expenses and overall net return.

Socially Responsible Investment Policies

One other key decision to consider as you develop your land trust’s investment policy is the extent to which the policy will require the use of socially responsible criteria for selecting investments. Increasingly, land trusts are recognizing the impact of climate change on their ability to achieve their missions. Some land trust boards have decided that they do not wish to invest land trust funds in entities contributing significantly to environmental degradation and climate change.

In fact, many nonprofit boards have decided that they will embody their missions and values in their investment policies and, consequently, many mutual funds and index fund managers now offer investment pools that have been screened according to social responsible investing criteria.

As you discuss the issue of requiring that investment decisions consider socially responsible factors, you may find it helpful to invite board or investment committee members from other nonprofits that have decided to require socially responsible investment practices to talk with your board about their experiences. There is an increasing body of evidence that socially responsible investment criteria may produce higher financial returns, as well as allowing organizations to make choices that are consistent with their mission.

Investment Policy Review

An investment policy should require periodic review of the policy by the investment committee and full board to be certain that the policy is still meeting your needs. Ask the investment committee and any individuals responsible for managing the investments to maintain notes on any issues and problems that arise for which the current policies do not seem to provide clear and appropriate direction. Their notes can provide a great starting point for the policy review.