Five Costly Red Flags Hiding in Your Financial Statements
As an executive leader in a member-based association, you likely have a good understanding of financial management. But even the most experienced executives can miss key details that could lead to bigger problems down the road.
At Enkel, we work with associations across Canada, and we regularly see issues in financial statements that, if left unaddressed, can spell trouble.
In this post, we’ll show you how to spot five common problems we see in member-based associations’ financial statements and show you how to fix them before they cause lasting issues in your organization.
1. Records Don’t Follow Generally Accepted Accounting Principles (GAAP)
Associations are not-for-profit organizations, which means their bookkeeping should align with the Accounting Standards for Not-for-Profit Organizations (ASNPO) set out in the Generally Accepted Accounting Principles of Canada.
However, we frequently see member-based associations not adhering to these accounting standards.
In the long run, this oversight can create compliance issues, misunderstandings with your Board, and unnecessary complications and unexpected surprises when year-end comes around and it is time to send the books to your CPA.
How to Spot This Red Flag:
Associations often have complex invoicing systems tied to membership fees, making it difficult to stick to ASNPO.
To spot this in your financial statements, look into:
- How budgets are created
- How bookkeeping records are maintained
- How end-of-year audited financial statements are presented.
And compare them to the ASNPO. You can also simply reach out to your bookkeeper or CPA and ask: “Is my bookkeeping compliant with ASNPO?”
How to Fix It:
This problem usually arises with bookkeepers who don’t fully understand the nuances of Accounting Standards for Not-for-Profit Organizations (ASNPO).
The simplest fix is to switch to a bookkeeping provider that understands nonprofit accounting standards; they can help unravel any mess and ensure your books are ASNPO compliant.
2. Misunderstanding Revenue Recognition
Revenue recognition can be tricky for member-based associations, especially with diverse income streams like membership fees, event income, and sponsorships. The problem arises when revenue is recorded based on when cash is received rather than when it’s earned, leading to inaccurate financial reporting.
How to Spot This Red Flag:
You might notice discrepancies during year-end audits, where auditors question how revenue, such as membership dues or event income, has been recorded. For example, revenue might have been recorded when cash is received, but it should have been recognized over the membership or event period.
Common signs include:
- Revenue is recorded immediately upon receipt, regardless of when it was earned.
- Revenue that is “lumpy” — typically member-based revenue would be “even” throughout the year, adjusted for member churn and new members acquired.
- Auditor remarks or adjustments during year-end audit or review.
How to Fix It:
This issue often happens when bookkeepers aren’t familiar with revenue recognition principles, especially for nonprofits. The solution is to ensure your bookkeeping aligns with the Matching Principle, which states that revenue should be recognized in the period it is earned, and Deferred Revenue, which applies to funds received in advance.
Typically, associations will derive revenue from membership dues, events, and professional development courses. In these cases, revenue would be recognized at the time or over the period of time to which the revenue relates.
As an example, if the association has a December year-end and receives its membership dues in December, for the next year, it would typically reflect the membership dues as deferred or prepaid membership dues, recognizing the revenue on these membership dues the following year.
Although it is rare for associations, if an association receives non-reciprocal funding such as government grants or donations this is known as contribution revenue. If an association receives contributions, this can lead to a number of different revenue reporting options for the Association.
Working with a bookkeeping partner that understands nonprofit revenue recognition ensures your income is properly recorded across the relevant periods.
For more information on this topic, check out our guides:
3. Running a Deficit
Many associations aim to break even each year, but when expenses exceed revenue, deficits can become a recurring issue that threatens your organization’s long-term financial health.
The problem with a deficit is that it might not be obvious at first glance. Deficits can appear slowly over time, draining capital reserves and creating cash flow challenges.
How to Spot This Red Flag:
Some telltale signs that you’re running a deficit can include:
- Regularly dipping into savings or capital reserves to cover operating costs.
- No clear budgetary plan for upcoming expenses.
- Expenses consistently outpacing revenue across multiple months.
How to Fix It:
This is where a Fractional Controllership and CFO service can help you get a clearer financial picture. By reviewing your financials, forecasting future revenue streams, and identifying areas to cut back or increase revenue, a CFO can help develop a plan to bring your budget back into balance.
If you’re not sure whether your association is running a deficit, consult with a CFO to evaluate your financial health and develop a sustainable financial plan.
4. Declining Cash Balance
Cash flow is the lifeblood of any member-based association. And while it can fluctuate throughout the year, a consistently declining cash balance is a major red flag that needs immediate attention.
How to Spot This Red Flag:
You may notice that even when revenue comes in, your cash balance remains low or keeps dipping dangerously close to zero.
Signs to look for:
- Low cash reserves that make it difficult to cover monthly expenses.
- Seasonal fluctuations in cash flow, but no plan to address low-cash periods.
- Difficulty meeting operational costs or payroll due to lack of funds.
How to Fix It:
One rule of thumb is to maintain at least three months’ worth of operating expenses in cash reserves. If your cash balance is consistently declining, you’ll need to either cut costs or find additional revenue sources during low-cash periods.
Offering professional development courses, conferences, or sponsorships during slower periods can also help smooth out cash flow during periods where cash flow typically dips.
Working with a CFO or financial consultant can help you assess your cash flow, get your organization back on track, and develop a strategy to maintain healthy reserves year ‘round.
“Offering professional development courses, conferences, or sponsorships during slower periods can also help smooth out cash flow during periods where cash flow typically dips.”
— Omar Visram, Head of Growth, Enkel
5. Unnecessary Complexity
One common issue among associations is an overly complex Chart of Accounts, which can make financial statements difficult to interpret and manage. While it’s tempting to create detailed categories for every expense, this often leads to confusion and inefficiency.
How to Spot This Red Flag:
An overly complex Chart of Accounts might cause you to struggle with categorizing expenses consistently, leading to unclear or bloated financial statements.
Tell-tale signs that your Chart of Accounts needs to be simplified include:
- Difficulty finding where specific expenses should be categorized.
- Confusion or hesitation when deciding how to record similar transactions.
- Financial statements that are hard to interpret because of too many overly granular categories.
How to Fix It:
Simplify your Chart of Accounts by grouping similar expenses together. For example, there’s no need to split out every subscription service or tool into separate categories. A streamlined system makes it easier to track and report financial data accurately.
If your financials feel overwhelming, asking your bookkeeper to audit and simplify your Chart of Accounts can help give you and your team a clearer financial picture.
Need Help Fixing These Red Flags?
Don’t let these issues go unnoticed in your financial statements. Whether it’s revenue recognition issues, running a deficit, or overly complex bookkeeping, these problems can create long-term challenges for your association. The good news is, with the right support, they can all be fixed.
If any of these problems sound familiar, it might be time to reach out to Enkel. Our team specializes in providing bookkeeping, financial operations support, and fractional CFO services tailored to the unique needs of your association.
You can also join us at the upcoming webinar, Mastering Financial Oversight: Essential Skills for Association Executives on October 15. Learn how to avoid common financial pitfalls and build confidence in your association’s future.
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