What Is Net Assets in Nonprofit Accounting?

Net assets is what is left when you subtract what the organization owes from
what it owns. It is the nonprofit equivalent of equity, and it is the number on
which almost every judgement about your financial health is actually based.

The word that causes the trouble is restricted. Most people assume it means
money the board has decided to set aside. It does not. A restriction is
something a donor imposes, and only a donor can impose one. That single
distinction explains most of the confusion on this subject, and it is where the
real risk sits, because an organization that misreports it is telling funders
something untrue about how much money it can actually spend.

The two classes, and where they come from

Since the accounting standard changed, there are two classes of net assets
rather than three. Form 990 uses them directly. On the balance sheet at Part X,
line 27 is net assets without donor restrictions and line 28 is net assets with
donor restrictions.

If you have seen the older three-way split of unrestricted, temporarily
restricted and permanently restricted, that is the system these two classes
replaced. Endowment funds that would once have sat in permanently restricted now
sit inside with donor restrictions, and the detail about timing and purpose moved
into the notes. Older templates and older bookkeepers still use the three-way
language, which is worth knowing when you inherit a chart of accounts.

Board-designated money is not restricted

This is the mistake worth spending a paragraph on because it is the one that
gets organizations into trouble with funders.

If your board votes to set aside $50,000 as an operating reserve, that money
is board-designated. It is still net assets without donor restrictions, because
the board can vote again next month and undesignate it. A restriction that the
organization can lift by its own decision is not a restriction in accounting
terms. It belongs on line 27, usually disclosed in the notes as
board-designated, and never on line 28.

Reporting a reserve as donor-restricted makes your unrestricted position look
worse than it is, which sounds conservative and is actually a misstatement. It
also tends to be found in an audit, which is not the moment you want to be
explaining your own balance sheet.

What a restriction has to be to count

A restriction has to come from the donor and it has to be documented at the
time of the gift. A grant agreement specifying a programme does it. A campaign
appeal that said the money was for the building fund does it, because the donor
gave in response to that stated purpose. A verbal preference mentioned after the
cheque cleared generally does not.

Restrictions come in three shapes. Purpose restrictions limit what the money
can be spent on. Time restrictions limit when, which is what a pledge payable
over three years creates. Perpetual restrictions require the principal to be
held permanently and only the return spent, which is what an endowment is.

Release from restriction, and why the timing surprises people

When you satisfy a restriction by spending the money on what it was for, the
amount moves from with donor restrictions to without donor restrictions. On the
statement of activities this appears as a release, shown as a positive number in
one column and a negative in the other.

The effect that catches people out is that a large restricted grant received
in one year and spent in the next makes year one look like a surplus and year two
look like a deficit, when nothing unusual happened in either. If you present a
board with the bottom line and no explanation of the release, you will be
answering the wrong question for twenty minutes.

Net assets is not cash

The single most useful thing to understand here is that healthy net assets and
an empty bank account are entirely compatible.

Net assets includes everything you own, and that can be a building, a vehicle,
equipment, or money someone has promised but not yet sent. An organization with a
paid-off building carries substantial net assets and can still be unable to make
payroll on Friday. This is why a board that only looks at net assets is not
governing the thing that will actually close the organization.

The number to read alongside it is months of cash on hand, and the place to
plan it is the
budget, not the balance sheet.

The liquidity disclosure, and why your auditor asks for it

The accounting standard setters reached the same conclusion this page just did, and did something about it. Since the standard that collapsed the three net asset classes into two, every nonprofit presenting audited financial statements under US GAAP has had to disclose, in the notes, how much of what it holds is actually available to spend in the coming year.

The requirement has two halves. The quantitative half is a number: financial assets available to meet cash needs for general expenditure within one year of the statement of financial position date. Financial assets means cash, receivables, investments and similar instruments, so the building and the vehicles are excluded by definition. The qualitative half is a short narrative describing how the organization manages its liquid resources, which in practice means stating what your policy is rather than describing what happened to work last year.

Getting from the balance sheet to that number is subtraction, and the subtractions are the point.

The board designated row is where organizations get this wrong in both directions. Money the board set aside is not restricted and belongs in the available figure, because the board can release it by voting again. But leaving the designation undisclosed misrepresents intent, and treating it as unavailable understates your liquidity to exactly the readers who are trying to assess it. The disclosure covers the purpose of the designation and the amount, so give both.

Two reasons to care about this even if nobody audits you. The first is that the calculation is the honest version of the question every board asks badly, which is whether we can pay for things. A balance sheet showing strong net assets and a liquidity note showing eleven weeks of available financial assets tells a board something the bottom line will not. The second is that funders and auditors read the note before the numbers above it, and an organization that can produce the figure without a scramble is signalling something about how it is run.

If you have never calculated it, do it once against last year’s closing balances. It takes an hour, and it is the fastest way to find out whether your chart of accounts can separate the two classes cleanly, which is usually where the answer turns out to be no.

Where to find it on your own statements

Net assets appears on the statement of financial position, which is the
nonprofit name for the balance sheet, as the bottom section. It appears again on
the statement of activities as the change in net assets for the year, and the two
have to reconcile: opening net assets plus the change equals closing net assets.
If they do not reconcile, something is wrong in the bookkeeping and no amount of
narrative will fix it.

Blank versions of both statements, with the lines a small organization
actually uses, are in
nonprofit
financial statements. If the classes are not coming out cleanly, the cause is
almost always the
chart of
accounts rather than the accountant.

The same two lines can be read across the whole sector at once. We ran them for 259,062 organizations and the result is not what the standard advice implies: the median holds five months of cash, and organizations under $100k hold far more than the largest institutions do. What nonprofits actually hold in reserve has the distribution by budget size.

What the split looks like across the sector

The classes above are the accounting. This is what organizations actually report, from the Form 990 returns of 256,539 charities.

Most small organizations have no restricted net assets at all, which is worth knowing if you have been told every nonprofit needs to track two classes. Below $1m, three quarters do not hold any. The obligation to present both classes exists regardless; having a balance in both is a consequence of how you are funded, not a standard to meet.

Across the whole sector the aggregate is $2.64 trillion without donor restrictions against $1.10 trillion with, so 29.3% of nonprofit net assets carry a donor restriction. The median organization is nowhere near that, because the restricted trillion is concentrated in a few thousand universities, hospitals and foundations.

15,990 organizations, 6.2% of the file, report negative net assets without donor restrictions. The share rises with size rather than falling, from 4.5% under $250,000 to 8.8% above $25m.

That figure is the accumulated total of every year the organization spent more than it received, so it is the balance sheet equivalent of a run of deficits. It does not mean insolvency: an organization can carry negative unrestricted net assets and pay its bills on time for years, particularly if it holds property whose book value has been depreciated below what it is worth, or if it has deferred revenue it will earn out.

It does mean there is no cushion left in the spendable half of the balance sheet. The useful reading is alongside the income statement, because a negative balance with a current year surplus is a recovery and the same balance with a current year deficit is not. 41% of organizations ran a deficit in the year measured here.

Reading someone else’s net assets

Any organization’s Form 990 is public, and Part X gives you both lines. That
makes it possible to answer questions about a potential partner, a competitor for
a grant, or a prospective employer that nobody will answer directly.

Two ratios are worth the minute they take. Net assets without donor
restrictions divided by annual expenses gives you roughly how long the
organization could operate on its own reserves. And the proportion of total net
assets that carries donor restrictions tells you how much of an apparently large
balance sheet is actually spendable. A headline figure in the millions that is
almost entirely restricted describes an organization with less freedom than its
size suggests.

Filings are searchable at
ProPublica’s
Nonprofit Explorer, and
Form 990 explains
which version an organization files and why that changes what you can see.

Is the restricted money actually there?

This is the question the two class presentation invites and the balance sheet does not answer directly. If an organization reports $400,000 of net assets with donor restrictions, is $400,000 sitting somewhere, or has it been spent on payroll with the intention of replacing it?

We tested it, and the first attempt produced a misleading answer worth showing. Comparing restricted net assets against cash and savings flags 37.5% of organizations, and the rate rises at both ends of the size range, 45.0% at the smallest and 46.6% at the largest. A measure that peaks at both extremes is usually an artifact, and this one is: an endowment is held in investments, not in a bank account, so the test flags every university by construction.

Repeating it against cash, savings and investments together gives a cleaner figure.

On the broad measure, 16.1% of organizations holding donor restricted net assets, 13,970 of them, hold less in cash and investments combined than the restricted balance. The gradient flattens out, which is what a real effect looks like rather than an artifact.

Be careful what you conclude from it. Restricted funds do not legally have to be segregated or held in cash, and an organization can hold a restricted pledge receivable or a restricted building, neither of which is liquid and neither of which is wrong. But for roughly one organization in six the restricted money is not there in any liquid form, and the obligation to spend it as promised rests on income the organization has not received yet.

If that is your organization, the position is recoverable and is worth naming in front of the board rather than in a footnote. The liquidity disclosure described above is where an auditor will make you say it, and reading it next to months of cash on hand is how a reader finds it in somebody else’s accounts.

Endowments, and the one that goes underwater

An endowment is the clearest case of a perpetual restriction: the donor gives
on the condition that the principal is held permanently and only the investment
return is spent. It sits in net assets with donor restrictions and it stays there.

Two things about endowments surprise organizations that receive their first
one. The first is that you cannot spend the principal to cover a bad year, even
if the alternative is cutting the programme the endowment was meant to fund.
That is what permanent means, and undoing it generally requires the donor, a
court, or your state attorney general depending on the size and the wording.

The second is the underwater endowment. If the fund’s market value falls below
the original gift amount, which happens in any serious market decline, the
organization has to disclose that in the notes to its statements. It is a
disclosure rather than a failing, and boards who have not been warned about it in
advance tend to treat it as a crisis when the auditor raises it.

A quasi-endowment or board-designated endowment is a different animal entirely
and gets confused with the real thing constantly. It is money the board has
chosen to invest and treat like an endowment, and because the board made that
choice it can unmake it. That money belongs in net assets without donor
restrictions, on line 27, however endowment-like the board’s intentions are.

The release timing problem above is also the most common reason a year looks worse than it was. Testing that across the whole sector shows it produces volatility rather than more deficits: organizations funded mostly by contributions actually run deficits less often than fee funded ones, but they swing far wider in both directions. The numbers are in how many nonprofits run a deficit.

Debt is the most common route into negative net assets at small sizes. Under $250,000, 19.0% of organizations that borrow report negative net assets without donor restrictions, against 2.3% of those that owe nothing. Part of that is a mortgaged building depreciating faster than the loan is repaid, which is an accounting effect rather than a failure, and part is founders lending to keep an organization afloat. How many nonprofits carry debt separates the two.

What goes wrong most often

Treating a board reserve as restricted, which understates what you can spend.
Leaving a restriction on the books after the money has been spent on its purpose,
which overstates it. Recording a multi-year pledge entirely in year one without
the time restriction, which flatters the first year and starves the rest. And
running the two classes through a single account in the bookkeeping, then trying
to separate them at year end from memory, which is the version that turns into an
audit finding.

None of these are exotic. All of them are cheaper to prevent in the chart of
accounts than to unwind in an
audit.

Questions people ask

What is the difference between net assets and equity?

They are the same arithmetic: assets minus liabilities. Nonprofits use net assets because there are no owners holding equity, and because the balance has to be split by donor restriction in a way that business equity does not.

Are board-designated funds restricted?

No. Only a donor can restrict. A board designation can be reversed by the same board that made it, so the money stays in net assets without donor restrictions and is usually disclosed as board-designated in the notes.

What happened to temporarily and permanently restricted net assets?

The three-class system was replaced by two classes. What was temporarily and permanently restricted is now reported together as net assets with donor restrictions, with the detail about timing, purpose and perpetuity moved into the notes.

Can net assets be negative?

Yes. It means liabilities exceed assets, which usually indicates accumulated deficits or significant debt. It is a serious signal rather than an accounting quirk, and it is visible to anyone reading your Form 990.

Where are net assets on Form 990?

Part X, the balance sheet. Line 27 is net assets without donor restrictions and line 28 is net assets with donor restrictions. The total also appears on the summary page at the front of the form.

Does a restricted gift have to be in writing?

In practice yes, and the writing can be the donor's or yours. A grant agreement, a signed pledge form, or an appeal that stated the purpose the donor responded to will all support a restriction. A recollection of a conversation will not.

How much in net assets should a nonprofit hold?

There is no required figure. The common planning target is three to six months of operating expenses held without donor restrictions, but the right answer depends on how predictable your income is. An organization on one government contract needs more cushion than one with ten thousand small donors.

Why did our net assets grow when we felt broke all year?

Most often a restricted grant arrived that you cannot spend yet, or a pledge was recorded that has not been paid. Both increase net assets without putting anything in the bank, which is why cash on hand is the number to watch alongside it.

This is reference information, not legal or tax advice. Rules vary by state and change over time. For a decision that carries real consequences, check the current text at irs.gov or your state registry, and talk to a nonprofit attorney or CPA.