The Finance Hierarchy

Dear Erin,

We hired a bookkeeper! Yay! This has been a goal for a a few months, intended to free me up from operational tasks so that I can direct my energies towards more strategic work and grant writing.

I’ve spent the past few weeks trying to document what all of the finance tasks are so that If I stopped doing it entirely, we wouldn’t miss a beat. Here’s the thing: I’ve been doing this single-handedly for over five years now, and simply passing it over to someone else is not so easy. Especially to someone who brings exactly the skills we need - bookkeeping - but none of the institutional knowledge. Moreover, the process is complicated. To the layman, finance is finance. So, my colleagues don’t understand how much work is left for me (or internal staff), even after the bookkeeper is onboarded and doing her thing.

When your business is small, it all may feel like the same thing: finance is finance. But I assure you, the finance function in your organization has very distinct parts, all working together: Record-keeping, Bookkeeping, Accounting, Payroll, Tax, Audit and Financial Analysis. Yes, I just hired a bookkeeper, but the bookkeeper can’t function if there isn’t adequate record-keeping, which is the responsibility of staff. Accounting and payroll need to be set up separately; sometime the bookkeeper runs payroll, sometimes not. Tax ands Audit are completely different animals, requiring specific skill sets and certifications. Financial Analysis is the part that ostensibly makes sense of it all for business leadership. The fact that I could do all of it myself made our start-up start up that much faster. But now that we are moving from start-up phase to “regular business operations” phase, we’re having to slow down a moment just to unwind some of the commingled functions that got lumped into the “finance bucket” on my watch.

Record Keeping

This is the part that induces eye-rolls across Corporate America. Some poor troll down in the accounting department needs your receipts. In some cases, if you spent your own money on the purchase, you can’t get reimbursed without the receipts. That feels icky, like they don’t trust you. But it’s much more than just trust. You really do need a record of what you spent and why. Aside from corporate policies meant to reign in spending, the bookkeeper can’t do her job without records and way down the line the auditor is going to be very unhappy if you don’t have them.

Not just receipts. Money comes in, money goes out. When it’s just you, with one checking account and maybe a debit card, and not a whole lot of money, knowing where the money came from and went to will not be a big deal. You remember where you got the money and you remember how you spent it. When it’s time to jump to the next level, bookkeeping, you can just go off memory.

This system works well exactly up until the minute another person gets involved. As soon as someone else is receiving funds, writing grants, making deposits, spending money or doing the bookkeeping for you, you need adequate records. Let me be honest: we don’t have a great record keeping system in my organization, mostly because my memory and knowledge of almost everything that goes on in the company makes it easy for me to code a transaction as promotion or office supplies or whatever because I really do know what it is. But I’m one week into onboarding a bookkeeper and can tell you that relying on one employee’s memory is exactly the opposite of a good system.

Here’s an example: Hannah makes the deposits and saves a copy of the checks. Ok, great. You would think that’s enough. Yeah, no. Because a check can be a rent payment, a grant, an individual supporter’s donation or revenue from a event-goer’s ticket purchase. When I “close the books” at the end of the month, meaning I do all the bookkeeping and accounting, I can look the scanned image of the deposit and see who wrote the check and I just know what it is because of my experience in the company. It’s not written down, Hannah didn’t record anything, I didn’t ask her to…I just know. So I take a $6,000 total deposit and I break it into its components, because we’re track corporate vs individual vs tickets separately. This “system” is enough when I “just know.” The system falls apart as soon as I turn over bookkeeping to a new bookkeeper, who couldn’t possibly know unless it’s written down somewhere and therefore cannot possibly break the deposit down into its components.

Same thing with the credit card: there are about 100 different transactions on our monthly credit card, and all of them need to be mapped to whatever line in the financial statements are appropriate. Some are easy: the wi-fi bill that we have on auto-pay is a utility. But the Amazon charge? Even the Canva printing charge: was that for flyers printed for programming, or for thank you notes printed for fundraising? Different.

Not only does the bookkeeper need these records to turn a bunch of transactions into a meaningful financial statement, but, as you’ll see later, sometimes the Auditor demands that you have a record for Every. Single. Transaction.

I’ll say this last thing before I move on to the Bookkeeper: also critical to record keeping is the bank statement. The bookkeeper will need access to the monthly bank statement to ensure that the cash as represented in the financial system you are using matches the cash balance in the bank. You need the month-=end ending balance if your re going to reconcile the bank accounts. I haven’t quite figured out whether that means you should give the bookkeeper access to your bank account or whether you have to remember each month-end to download the statements for the bookkeeper and save them in a shared file. Either way - the bookkeeper cannot do the job without these and I need a system for saving and sharing the information.

Bookkeeping

The bookkeeper’s primary job is to code the transactions into the financial system. The bookkeeper may do other things for you as well. Some run payroll; some prepare checks for signature; some do the invoicing for the organization. But all of them rely on the records that come out of your record-keeping system and make sure each and every one of the transactions backed up by those records is represented accurately in the financial system.

Think of a simple checking account. You write checks, maybe Venmo/Zelle people money, use the ATM, make deposits, perhaps get some interest automatically deposited into your account. If you are watching your money, you’ll record all of that in the check register (old school) or maybe in a spreadsheet or a financial software. Not only do you need the date and the amount, but you want to know the “why.” What was it from or for?

In business, you’ll get a bit more formal, giving separate names to all the categories of “from” or “for” that are meaningful to you. These different categories are referred to as line items or “accounts” giving rise to the single most confusing thing in accounting: an account is a discrete category, not a bank account, even though a bank account could in fact be an account in your accounting system. Ugh. Call me if you want more on that - I’ll need a pen to explain it further. But for the rest of this essay: an account is a discrete line item in your financial system, not a bank account.

Your revenue (money in) accounts might be: Ticket Sales, Donations, Grants, and Royalties. Your expense (money out) accounts might be: Compensation, Independent Contractor Fees, Space Rental, Advertising, and Licensing Fees. Each one is a separate account. You need a clear mapping of what goes into each. At the same time, you’ll have accounts for your cash and investments and accounts for any money you owe, even outstanding credit card balances.

The bookkeeper’s job is to take the records and ensure that every single transaction is put in the right account. Some accounting might be involved to establish the rules or to tell the bookkeeper what additional transactions need to be entered that aren’t so obvious - see next section. The end result should be financial statements that reflect the financial profile of the business.

Typically, bookkeepers must wrap things up each month, a process called “closing the books.” When the bookkeeper closes the books, all transactions have been recorded and the bank statements are reconciled, meaning that your financial statements and your real cash position tie together. These financial statements are the primary reports for analyzing the financial health of your business.

Accounting

A bookkeeper is not an accountant, although the two are closely related. One way to think about it is the accountant is specifically educated in the rules of accounting and can make decisions and establish rules for how things should be reflected in the financial systems. The bookkeeper is trained to follow those rules. In some ways, it might be the same as the difference between an Executive Chef and a Prep Cook. The Executive Chef knows the recipes, can modify them within some established boundaries, sets the menu for the restaurant and directs the Prep Cook as to the specific tasks that need to be completed. Sometimes, a bookkeeper is an accountant or an accountant does the bookkeeping. But I’ve noticed that there is a cottage industry of bookkeepers who are perfectly good at their jobs but are not accountants. These bookkeepers often are highly organized, detail-oriented people who are comfortable with numbers and happy to come in and take care of a list of tasks according to rules they’ve been given.

An accountant will help you set up your chart of accounts, or the list of line items that describe all the transactions that are meaningful to your business AND consistent with what’s called Generally Accepted Accounting Principles, or GAAP. Sticking with the kitchen metaphor, GAAP is the Bible of French Cooking. The rule book. The play book. Here’s how it is done.

An accountant will also set rules for some of the more unusual or complicated transactions, for example, depreciation. You know for sure that your car’s “blue book” value is different than what you paid for it. That difference is called depreciation. It is the decline in the value of an asset over time. An accountant will know the accepted life of an asset and do the calculations. You don’t make that up on your own just by feeling it out. For example, a building is depreciated over 39 years; a desk, 7 years. The desk is assumed to go from full value at the time you paid for it to zero in seven years, even if you think it will last decades.

An accountant will also set up the management accounting entries. Financial accounting is hard and fast - this creates financial reports based set of rules familiar to those outside the organization. Management accounting must operate within the boundaries of financial accounting, but allows for internal allocation methodologies that help you manage the company internally. We talked earlier about how you need to track your nonprofit expenses in the three buckets of programming, fundraising and management costs. How do you assign the Executive Director’s salary to these buckets, when they are involved in all three? This is an example of management accounting that an accountant will help you figure out and then set a rule for bookkeeper to use when recording the transaction.

Accountants at the top of their professions will bear the certification “CPA” or Certified Professional Accountant. This is a big deal - accountants must go through rigorous training and testing to earn the CPA designation. Note that bookkeepers usually are not CPAs and often don’t have any professional certification. This doesn’t mean the bookkeeper isn’t good at her job; it just means that the onus is on you to have the accounting system and rules in place for the bookkeeper to follow. It also means that you need to carefully vet a bookkeeper before hiring them to make sure that they are good.

Payroll

Payroll is a whole different thing, made way more complicated than you think it would be because of taxes and reporting requirements. Again, some bookkeepers do payroll, as do some accountants. Or, you can outsource payroll to a payroll provider like ADP or Gusto. You absolutely do NOT want to risk getting payroll wrong - not only because you are messing with people’s pay, but also because of the mess you can get yourself into if the tax portion is wrong. And then there is the benefits piece, should you be offering health or other employee benefits. Whole new level of financial and managerial accounting.

You know, it’s so complicated I don’t even want to get into it right now. Suffice it to say that payroll, regardless of who does it, must feed into your financial systems. The bookkeeper must code it properly and if there is a management accounting piece, that must be set up by the accountant and followed by the bookkeeper. We use a payroll provider to file the quarterly federal and state payroll tax reports; if your accountant or bookkeeper is responsible for that, they’ll have that on their priority list as well and you’ll want to be 100% sure that it is done correctly.

Tax

Here I’m talking about federal and state business tax year-end filings (not the payroll or unemployment insurance reports that have to be filed regularly with the government. And, if you have to collect and report sales tax to your state’s Department of Revenue, that’s a whole different deal. As a nonprofit, you likely will NOT have to do this, unless you have unrelated business income that is taxable). We have a Tax Accountant who does JUST THIS for us. JUST the year-end tax filings, called the 990 (nonprofit speak; the for-profit tax forms are called something different depending on how your company is set-up). The firm takes our year-end financial reports, created by the bookkeeper according to the rules set up by the accountant, and turns those financial statements into the tax filings.

Only I wish it were so easy. I suppose sometimes it is… but not for our nonprofit. In fairness, the tax reporting I did for my father’s for-profit business was pretty straightforward. I was able to complete the year-end financial statements and send them to the Tax Preparer. A few questions would come back, but not many. That said, I had created the financial statement structure in terms of what I was reporting to mirror what I knew was going to be needed in the tax return. That’s a pro tip we talked about a few weeks ago: set up your financial systems to align with, if not exactly mirror, the tax reporting you know you’re going to have to do every year.

The tax reporting for nonprofits is a bit more complicated than the for-profits, because there is quite a bit of information required that is collected by the government in the name of transparency and ensuring that your organization is meeting the requirements of a charity in service to the public good. You need to be able to describe in narrative form your top three programs as well as report the total revenue and expense associated with each. There are a few other nuances as well, especially related to composition of funding and donors.

Not all accountants are tax accountants, just like not all dancers are ballet dancers. It’s a very specific skill set. To be honest, I’m not even sure if all tax preparers are required to be accountants… Anyway, we use a CPA firm that does nothing else for us but prepare and file our taxes. Internally, there is a finance professional (me) who understands the information required to prepare the taxes and modifies or augments the standard reports coming out of the financial system so that the tax preparer has what they need.

Taxes, I find, are needlessly complex, but complex all the same. If push comes to shove when you are small, perhaps you can do them yourself. When you get to any meaningful size or level of complexity, it’s way better to have an expert do them for you. And that expert is typically NOT your accountant or bookkeeper. Once again, you have to hand off the information to the next expert on the assembly line.

Audit

Ahhh, the audit. An audit is a process conducted by an outside, unaffiliated third party to validate your financial statements. When a nonprofit reaches a certain size, typically determined by revenue, it is required by the state in which it is incorporated to conduct an audit. (The rules vary by state.) This is expensive and time consuming, but required. In Illinois, the revenue level is $300,000. Once you hit that, you need to hire an outside CPA firm to audit your organization’s financials. In California, you don’t need one until you reach $1MM in revenue. Some grantors require that you do an audit or they won’t give you funds. Or, an audit might be required in your by-laws. The audit is a good thing to have, because it gives leadership or funders a level of comfort that the financials of the organizations re what the organization says that they are. But, like most things worth having, it comes at a cost.

Your auditor will be an accountant or an accounting firm supervised by CPAs. They will be trying to ascertain that all of your financials are complied in accordance to GAAP (hence the need for some accounting expertise when setting up the financial and bookkeeping systems), that your taxes are filed (hence the need for a tax preparer), that your payroll records are accurate and consistent with the quarterly payroll reports sent to the government (hence the need for a payroll provider or experienced in-house payroll person), that your transactions are code appropriately (hence the need for a good bookkeeper), and that you have records supporting all of the transactions (hence the need for a record keeping system). Our audit literally takes months to complete, though the time will vary based on the size and complexity of your organization.

There is some debate as to whether the taxes can be filed before the audit or whether the audit should be completed first. We tried it both ways, but found that doing the audit first made more sense. At the end of the day, the auditor typically has final word on how some transactions are recorded. You would think there is no gray area, but sometimes there is. The auditor will create the final “audited financial statements” which must tie to the taxes which must tie to the internal reports. If the auditor wants a change in how something is booked, and the taxes are filed already, you’ll have to go back and file restated tax returns. That’s messy. It’s easier to let the auditor have at it first, make whatever adjusting entries are required in the internal systems so that the internal financial statements tie to the audited financials and send that final version to the tax preparers. Unfortunately, this might mean you have to file for an extension on your taxes, should the audit be a lengthy process.

Some of our sister organizations are able to get their audit completed in a few weeks and then the tax return is filed by the deadline. For whatever reason, our audit takes months so our taxes cannot be filed until seven months after the close of the year. We are trying to get this timeline shortened, but I’m not exactly sure where in the timeline we can speed up the work, to be honest.

Financial Analysis

What does it all mean? That’s where the Financial Analysis comes in, done by Financial Analysts. Here, you do need someone with a good sense of the overall business; someone who can translate the story the numbers are telling to what is going on in the organization. Perhaps it’s a single person with the title of CFO or Chief Financial Officer. Usually the financial analyst has some background in business management or finance and accounting. I suppose you can learn quite a bit of it on the job, but unless you have a strong working vocabulary in the language of finance and accounting, it’s not going to work. For example, if you don’t know what a balance sheet is versus a cash flow statement, you’re going to have a hard time doing this part well.

In an ideal world here at my current job, I’m receiving monthly financial statements from the bookkeeper that I can analyze for patterns, opportunities and concerns. I’ll look at the composition of the financial statements (for example, where is my revenue coming from), key metrics (for example, how many months of operating expense do I have in cash reserves or what is my debt to assets ratio), and comparisons to budget and prior year. I’ll have a good sense of what is coming so that I can forecast financial trends with a reasonable level of certainty.

As a financial analyst, I’ll make some judgements as to the financial health of the organization and where management may need to make some adjustments. This will come in the form of conversations with the Executive Director or Board Treasurer, or perhaps a review with the Finance Committee. The most important part of the financial analysis process is taking sometimes complex financial statements, which typically need education or training to understand, and to turn them into a prescriptive analysis that informs a conversation with leadership. You want 100% of your leadership team to have a clear sense of the organization’s financial health and a voice in what to do about it. You’ve failed if some or all of your team opts out of the “number” discussions, either because they feel like they don’t understand it or because they feel that’s someone else’s job. Your job, as financial analyst, is to tell a clear story and offer prescriptive suggestions. Leadership’s job is to decide what to do based on the information the financial analyst provides.

In addition to making sense of the month, quarterly and annual reports for the rest of the team, financial analysts often prepare the annual budget and project budgets, which are important for grant funding or, in a for-profit, product or department funding.

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My Executive Director often says to me, “I have no idea what you do all day, but I’m sure glad you do it.” Managing this Finance Hierarchy is certainly one of the critical functions that consumes my days. While I am delighted to bring on the bookkeeper to assume part of the workload, I think it is going to surprise the rest of my team how much work still remains. I’m not saying I want to do it! I’m saying someone has to. And the bookkeeper won’t do the tax filings any more than the tax accountant will do the audit. Not. My. Job.

It may remain my job for some time to be the Financial Analyst, or, if our next senior hire has CFO experience, s/he may take that on. That means between now and then my job will be to document and remove myself from all of the various functions outlined above. I do hope that the new person has a decent grasp of the finance function as my end-goal is to extricate myself from the process. And, I believe that when running a business, you can only offload so much of the core functions to outside parties. Hopefully the new person allows us to keep some critical parts of the process within the responsibilities of in-house staff members.

I am excited for the time when Finance is not my job. And I’m thrilled we are taking this first step by hiring a bookkeeper. But that’s all it is. A first step. Next step is explaining to everyone why the bookkeeper isn’t doing the record keeping, accounting, payroll, taxes, audit and financial analysis…

Love, Mom