Beauty and the Balance Sheet

The balance sheet may be a “beast of boredom” for many in the world of the nonprofit arts. But I propose that it’s one of the most essential and evocative lenses on our work. The balance sheet (aka, the Statement of Financial Position) sets the scene that shapes our capacity and constraint. And it describes a foundational difference between for-profit and nonprofit endeavor.

The latest episode in the ArtsManaged video series attempts a basic overview of the balance sheet, and outlines the many reasons that it matters for the nonprofit arts.

Transcript

There is a powerful and profound document that sets the scene for the work of your arts organization. It describes the capacities you bring to that work. And it even suggests some of the challenges or constraints you’re going to face along the way. The trick is knowing how to read that document.

Hi, I’m Andrew Taylor. I’m on the faculty of Arts Management at American University in Washington, DC. And this is ArtsManaged, a series of resources about Arts Management: what it is, how it works, how you can get better at it.

Today, we’re talking about what is often a beast of boredom for your board of directors and your executive staff. It’s the balance sheet.

In short, the balance sheet is a snapshot. It’s a picture captured in a moment of time that describes your organization’s financial status. It captures what you own and what you owe. And helps you understand the relationship between those things.

And if you stay to the end, you’ll learn why the balance sheet is a particularly challenging document for a nonprofit arts organization as opposed to a commercial firm.

So let’s build out the balance sheet and see how it can tell the story and set the scene for a successful arts organization that thrives in the world over time.

First, we imagine a box. This box represents everything the organization owns and everything it owes.

The first step is to be really clear about what we represent in this box. This box is not donors. This box is not lenders. This box is an organization, the entity. This entire box is from the perspective of a single business entity, which in this case is your arts organization.

Now further, we can divide this into two parts. On the left side of this box, we put everything we OWN. So once we make a list of all the things we own, all the things of economic value that we use in our organization and control – things like buildings and equipment and technology and financial instruments like cash – we also have to think about, well, how did we come to acquire that stuff? How do we get that money and stuff we needed to make our enterprise whole?

And that’s where the other side comes in. The other side describes all of the people and things we OWE, that is people who were often the sources of the resources that helped us to purchase that building, to help us to purchase that equipment, to give us the cash we needed to do our work in the world.

And there’s two other ways to name these boxes that might make them useful to you.

One is to say this side is our USE of resource. And this side is our SOURCE of resource. So we decided to use money and financial value we had to buy a building, to buy equipment, to buy supplies, to hold in cash so we could pay our staff. But we had to have a source of that money.

And a third way of thinking about these two sides of the box is to think of this side as RIGHTS. So we have the rights to hold and use the things in this box, things of value. Sometimes you don’t technically own them, but we have control of them, therefore we have rights to them. And these are OBLIGATIONS. These are things we are obligated to other people. And so obligations are the people or the institutions or the entities to which we are accountable to which we have an obligation. Either to pay them back, or if we happen to liquidate everything and go out of business, somebody’s going to hold the rights to the things we are selling.

So now if we focus in on the obligations and the things we owe and the sources of our funds, we can imagine two ways funds might get into our enterprise that way. And so let’s divide this into two.

On the top, we might have people who are willing to lend us money: banks or organizations or institutions or corporations or individuals that would lend us money. And we can use that money and pay them back over time for an expected or contracted return.

Or we can get money from investors, from people who are willing to put money directly into the business not as a loan, but as an investment in the organization’s success.

Now in the commercial world, these investors expect back some return on that investment. They’re looking for positive net value increases or earned income from that investment. In the nonprofit world it gets a little tricky. And we’ll dig a little bit more into that in a minute.

So now we can label these boxes a little bit more in ways that you might recognize. So everything we own, the things we have rights to, the ways we’ve decided to use our resources are the ASSETS of the organization. It doesn’t include everything that’s valuable, just the things that are specifically valuable in a way we’d measure in a balance sheet. We’ll get to that in a minute.

These are LIABILITIES. These are basically kinds of loans, liabilities. So these are loans. These are debts. These are amounts of resources that have been lent into the enterprise on the expectation of being paid back, usually with interest.

And then there’s this lower right box, which has different names in different contexts.

In the for-profit world, we’d call this box EQUITY. It represents investment from owners and other investors seeking some net positive value on their investment. In the nonprofit world, there are no owners, as we saw in a previous video, so we call them by their more generic name: NET ASSETS.

So you might have some questions about this lower right box, which would be completely common. Everybody has questions about that lower right box. For one, let’s imagine it from the for-profit business perspective. Let’s say I’m the only owner of this business. I put in all the money that is invested in the enterprise. So how can it be that I owe myself money that is mine?

And the answer that question is from the beginning of this conversation where we suggested this box is from the perspective of the entity, not the owner. The owner has their own balance sheet, as do all the lenders. They are outside of the box or the enterprise. The enterprise is only about its own assets, its own liabilities, and the net assets that it has obligations to outside sources.

So in another video, I said that Arts Management is “the practice of aggregating and animating people money and stuff toward expressive ends.”

Well, you don’t see any people in these boxes. But you do see money and stuff. So let’s dig in about where exactly we see the money and stuff and what the other boxes mean.

So anything of economic value is an asset. So again, this can be a building that we could own or control. This can be equipment that we own or control. This can be supplies that we have, it could be inventory that we’re ready to sell, it could be cash, it could be things like cash. And to acquire or build or accumulate those assets, we needed some source to help us fund that activity.

One of those sources could have been debt. We could have gone to a bank and said, “Can you lend us money? We will pay you back.” It could be friends and family loaning us money on the expectation of return. It could be outside organizations loaning us money. So a loan or other liability is one way for money to flow into the enterprise with a corresponding obligation going back out.

Or in the commercial world, we might also get money through direct investment. So if I’m the owner, I can put money in from my own bank account into the business’ account. I can get other investors to put their money in. And that creates a different kind of obligation, different from loans. So investment is another way for money to flow into the organization with a different kind of obligation reflected back.

So in the commercial world, if I’m an owner or investor, I have the right to expect back some of the value generated by the enterprise. So if we want to calculate in the commercial world what amount of value is available to the investors and owners, we do a little math. We say, “Let’s take all the assets and economic value we have available, let’s subtract all the liabilities or loans that we owe to other people, and whatever’s left is available as a value to the investors or owners.”

Now you can see why it’s called a balance sheet, because it always has to balance. It’s a math problem. All of the assets, minus all of the liabilities you owe to other organizations or people, leave you with the net assets or equity that’s available to the investors or the owners.

So the question has to come in a nonprofit organization or nonprofit arts organization: Who owns the net assets or the equity? And the answer is: nobody owns it. But in fact, the mission of the organization essentially owns the net assets. It holds the equity of the enterprise. Net assets are everything that’s left when you take the full value of the organization minus its current loans and liabilities. And that’s what’s left to actually invest back into the organization’s mission and purpose.

Sure, donors put money into that box. Donors act as investors in many ways. But donors release control of their resources when they contribute to a nonprofit organization. They’re no longer allowed to control either the financial benefit to those resources or any sort of administrative activity of those resources. They’re donating them into the public trust. And anything that remains here in the net assets is intended to be reinvested in the purpose of the enterprise.

Now, when you actually see a balance sheet in a financial statement, it’s not going to be organized this way. Usually, it’s gonna have the assets, and then the liabilities, and then the net assets all in a row, top to bottom.

But it’s really helpful to think of it this way, because then you understand the balance and you understand the dynamics between all the things we own and the different ways we owe the world back for those things.

So why is this such a critical document for a sustainable and vibrant cultural enterprise in the nonprofit world? Well, for one thing, it describes the scene within which you do your work as an arts manager. It describes the terrain and the tidal forces that are pulling you in different directions all at the same time.

But for a nonprofit arts organization, it underscores an even bigger challenge that you’re going to face every day of your professional life. And that’s in the difference between what a for-profit and a nonprofit does.

The dominant focus of a for-profit organization in the balance sheet is net assets. Your entire purpose as a for-profit organization is to maximize net assets, maximize yield and return for your owners and investors. So therefore, you can make adjustments to your assets and your liabilities. You can make choices about maximizing. And what you’re trying to maximize is the net asset box.

But for nonprofit arts organizations, it’s a whole different ballgame.

You certainly care about net assets, because they give you resources to invest and change. You care about liabilities because you don’t want to extend yourself too far on debt. But you care mostly in the balance sheet, as a nonprofit arts organization, on assets. You’ve decided to make creative work into the world. That creative work requires a certain combination of money and stuff – maybe a fancy theater or a gallery space or canvases or complex equipment. It needs resources like money to build out a show before you even sell tickets.

So things that we call assets in the arts in the nonprofit world almost behave like liabilities. They are obligations. I have to hold this theater because I need this theater to make the work. The theater is not generating positive net revenue. The theater is generating costs.

So the game in a nonprofit arts organization is to understand deeply what do you really need in terms of assets of economic value? And how are you going to resource those assets over time through loans, or through net assets including contributed income. Your challenge is not to balance the balance sheet, because it balances by math. Your challenge is around how to aggregate and animate the assets you need, the money and the stuff, to make your work into the world in sustainable ways over time; to pay the people you need to pay with dignity and respect; and to not consume the resources that might be beneficial to some other organization in your community. So to do it thoughtfully, resourcefully. practically.

If you dig into the work a little bit deeper every day, you will come to understand why making beauty into the world is sometimes a beast.