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Strong nonprofit accounting is a foundational element of how to run a nonprofit. Whether you're in charge of the numbers or not, keeping a pulse on your organization's finances is always a smart idea.
It’s common for leaders to feel intimidated by nonprofit accounting, which has many nuances and regulations. We aim to help you better understand how to introduce compliant and efficient practices that support your organization’s growth with this nonprofit accounting guide.
Your ultimate guide to nonprofit organization accounting will walk you through:
- A deep dive into the nuances of nonprofit accounting
- The differences between for profit and nonprofit accounting
- Guidance around nonprofit accounting statements and reports
- IRS and state compliance requirements and resources
- Accounting best practices for nonprofit financial health
- Frequently asked questions about nonprofit accounting
What is nonprofit accounting?
Nonprofit accounting is the practice of budgeting, allocating, recording, reporting, and making decisions about funds flowing in and out of your organization. While every nonprofit likely has some sort of financial tracking in place, fund accounting offers more structure for keeping things in check.
The Internal Revenue Service (IRS) regulates nonprofit accounting with specific rules and practices for tax-exempt organizations. Following these processes diligently and accurately keeps nonprofits compliant and free from costly fines and penalties.
Clean and organized account procedures ensure every donation is accounted for and goes to the best place to make a significant impact. They also provide accountability to the donors, board members, and community members who make your mission possible.
The rules and specificity around nonprofit organization accounting pay off during tax season when charitable organizations are eligible for generous tax benefits. Managing finances is a year-round effort that simplifies that busy filing season when the time comes to submit reports.
Feeling slightly overwhelmed is normal, but we've got your back. Below, you'll learn more about what's required to stay compliant and the support and outsourcing options that may help.
Methods of nonprofit accounting
The first step to understanding nonprofit accounting is to know where you have options and where specific standards are already in place for all nonprofit organizations. We’ll discuss the requirements for fund accounting later, but let’s discuss the flexibility to make the process your own.
Nonprofit organizations can choose between several accounting methods. The most common are cash and accrual methods, which have benefits depending on their size and scale.
The cash method or fund accounting:
- You record expenses when they occur vs. when you plan them
- You record funding when you receive it vs. when you gain a commitment or promise
- Only one entry per transaction is required, with minimal calculations
- It can feel easier to manage daily
- You can’t track non-monetary income like in-kind donations
- You may lose insight into what's ahead because it focuses only on the current cash flow
- Some states require the accrual method
Cash method example: You may rent tables and chairs in April for your annual fundraising raffle in September. If the payment is due in September upon delivery, you record that expense in September rather than April.
The accrual method (fund accounting) for nonprofit accounting:
- You record expenses when you incur them vs. when you pay
- You record funding when you have a commitment or pledge vs. when you receive it
- It’s helpful to account for aspects like outstanding obligations and pledges
- It requires two entries per transaction
- It can feel more time-consuming if transactions don't go as planned
- Required by Generally Accepted Accounting Principles (GAAP)
Accrual method example: If you rent the same tables and chairs for your annual fundraising raffle in September, you would record the expense in April. Similarly, if you receive a donation commitment from a major donor in February and see the payment come through in March, you'd still record that income in February.
Nonprofit accounting vs. bookkeeping
Accounting and bookkeeping are often used in the same conversation because they are both critical to managing finances. When mapping out your process, it’s helpful to understand how accounting and bookkeeping work together and how they differ.
Bookkeepers organize financial records, while accountants interpret and further analyze that information. Your nonprofit needs both to succeed, so let’s compare them.
Within your nonprofit, you might have an internal role as your bookkeeper and choose to hire a separate accountant. You can also outsource the accounting function to a firm to collaborate with your bookkeeper.
We’ll cover options for hiring an accountant later in this article.
Main differences: How is nonprofit accounting different than for-profit accounting?
Nonprofit organizations have tax-exempt status with the IRS and operate in the best interest of their communities. That comes into play when we examine how nonprofit accounting differs from the best practices a for-profit organization might follow.
While basic accounting principles remain consistent, you can better understand nonprofit accounting by analyzing a few key differences from other businesses.
Accounting system
Nonprofit organizations use a fund accounting system centered on their accountability to donors and stakeholders. For-profit organizations are focused on profitability as the primary measure of success for their board members, customers, and investors.
The fund accounting system considers that not all donations are straightforward. Many restricted funds come with terms set by the donor, usually indicating which project that donation can be used for.
Nonprofits are legally required to accept restricted donations, whereas for-profit organizations have more flexibility in using the traditional accounting system.
Accounting standards
Nonprofit organizations and for-profits commonly operate under the Financial Accounting Standards Board (FASB). These standards are defined under GAAP accounting for nonprofits and have slightly different rules for charitable organizations.
Charitable organizations must record and report financials in a specific way to stay accountable and transparent with stakeholders and donors. Nonprofit organizations are required to provide financial disclosures to help the public see a clear view of operations and growth.
Financial statements
A nonprofit's financial statements focus on expenses and nonprofit donations to nonprofit organizations. The goal is to showcase that funds from restricted and nonrestricted gifts go to the right programs and projects.
Nonprofits are tax-exempt and have different state and federal 501c3 requirements for filing their financial documents than for-profit organizations. Unlike a for-profit organization that needs to maintain a balance sheet, income statement, and other essential documentation, nonprofit accounting has a different set of guiding financial statements that we will cover below.
Key nonprofit accounting statements and reports
Nonprofit accounting under GAAP requires organizations to maintain four critical financial statements. These financial reports should be your top priority to maintain a smooth accounting operation and get everyone on the same page.
Maintaining the following four financial statements will help you stay compliant with any audits, prepare for tax season, and understand organizational health at all times.
The Statement of Financial Position
The Statement of Financial Position acts as a balance sheet in nonprofit accounting. In it, you list all assets (donations) and liabilities (expenses) and arrive at your net assets.
Your statement of financial position cheat sheet:
- Assets may include vehicles, physical office space, furniture, technology, or cash.
- You can also look at liabilities as compensation for employees and bills to maintain operations.
- You can see net assets by subtracting liabilities from assets.
- A positive net assets total reflects a healthy financial position.
- A negative net assets total can show you room for growth and strategic fundraising.
- Net assets showcase your organization's financial health in a nutshell.
The Statement of Activities
A nonprofit's Statement of Activities is like a for-profit income statement in nonprofit accounting. You'll list revenue and expenses accrued over the year and create alignment with any restricted funds.
The outcome is a clear view of how donations are being used to share with an accountant, board members, or other stakeholders. Reviewing the Statement of Activities monthly, quarterly, and annually is standard practice.
Your statement of activities cheat sheet:
- Revenue typically comes from donations, memberships, grants, and sponsorships.
- Expenses typically come from rentals, meals, and other operational or administrative costs.
- You'll want to categorize all revenue and expenses by the fund or program they align to.
- You'll be able to see if your organization is operating in a surplus or deficit.
The Statement of Functional Expenses
The Statement of Functional Expenses examines any funds spent and how. To align with Form 990, you'll categorize expenses as program, administrative, and fundraising during your nonprofit accounting process (more on that in the next section).
Your statement of functional expenses cheat sheet:
- Program expenses include marketing outreach, facility tours, and volunteer efforts.
- Administrative expenses include payroll, bills, rent, and technology.
- Fundraising expenses can include things like transaction fees for donations and the cost of direct mail appeals or signage.
The Statement of Cash Flows
The Statement of Cash Flows focuses on how money comes in and out in nonprofit accounting. Like the Statement of Functional Expenses, you’ll divide cash flow into three main categories: operating, financing, and investing.
This document showcases how fundraising and grants support you and how you use those funds.
Your statement of cash flows cheat sheet:
- Operating activities are considered any cash being used for daily operations.
- Financing activities relate to any debt or equity you're paying off.
- Investing activities might look like money invested on behalf of your nonprofit organization.
Nonprofit 501c3 accounting requirements
IRS Form 990
The IRS requires Form 990 every year for nonprofit accounting. Many charity rating organizations will also look at this form to evaluate your organization's financials.
Form 990 captures information from the four financial statements above, so maintaining accuracy will help you make tax season much smoother. Penalties are in place for organizations with discrepancies in their paperwork or need to file on time, so staying on top of your tax requirements is essential.
The exact Form 990 version you’ll need to submit depends on the amount of gross receipts you receive in a year:
- Small nonprofit organizations making less than $50,000: Form 990-N
- Mid-sized organizations making between $50,001 and $200,000: Form 990-EZ
- Large nonprofit organizations making over $200,000: Typical Form 990
IRS Form 1099
Form 1099 isn't required for all nonprofit organizations, but it will be relevant for any organization hiring temporary contractors, freelance support, or awarding prizes at events like a raffle.
- Form 1099-NEC captures any compensation paid to a non-employee worker exceeding $600 annually. This is a necessary step for workers to file their year-end taxes accurately.
- Form 1099-MISC captures prize and award information exceeding $600, including anyone who won a lottery or raffle hosted within the year you’re filing.
State reporting requirements
Federal nonprofit organization accounting requirements are a great place to start, but your state may have more to consider. Checking in with the state's informational registration and filing rules is always a good idea.
A few areas to be aware of include:
- Form 990 and Form 1099: It's a common requirement to submit these forms on a state and federal level.
- Fundraising statements: Many states want to see fully audited fundraising statements that show cash flow, functional expenses, activities, and financial position.
- GAAP requirements: Some states require nonprofit organizations to use GAAP standards, which will impact how you prepare your forms and documents.
- Registration: In 39 states, your nonprofit organization must register before any legal fundraising activity can occur.
Nonprofit accounting best practices
Hopefully, you’re feeling well-equipped with the logistics of not for profit accounting to explore your financial health. Now, we’ll pivot into ways to get the most value from best practices for implementing compliant and proactive approaches within your team.
Set clear and realistic fundraising goals
Maintaining a clear view of your financial health is excellent, but it's even more valuable when you can use that insight to inform your fundraising strategy. A clear goal can show you how much you need to raise to offset expenses.
When you review your expenses by month, program, and fundraising campaign, you can readjust your fundraising goals accordingly. It's equally important to be realistic about what you can raise in a year and how to do it without hiking up costs.
Setting realistic goals may also mean thinking through:
- The state of the economy and projections ahead
- Donor behavior you've observed, and fundraising activities supporters respond well to
- Reliable income from recurring donations and memberships
- Staff headcount and compensation models
Create and maintain a budget
It's a good idea to start with a budget that you document and make accessible for regular review within your nonprofit. Your budget will list any expenses and revenue you plan to encounter in a year, even if you’re using estimates.
While no one knows exactly what will happen, your budget is your foundation for making critical financial decisions. Create a regular cadence for budget review with key players on your team to ensure it evolves with your organization and priorities.
Quick tips to create your nonprofit budget:
- Be as specific as possible about the activities, fundraisers, and individuals around which you're planning expenses and revenue.
- Use detailed timelines to get a clear view of when fundraising and saving need to increase.
- Leave yourself flexibility among uncertainties with cash reserves.
Create a long-term strategic plan
We've mentioned accounting practices to keep a current pulse on your organization, but it's always good to think long-term, too. Your budget and financial statements will help you plan to scale your mission.
Documenting your long-term strategy will help you see how each year's finances move you closer or farther from your big goals.
It might be helpful to think about:
- Revenue targets for three, five, and ten years from now
- How different focus areas such as recurring donations, peer-to-peer fundraising, crowdfunding, events, major donors, and corporate sponsors align to long-term goals
- Projects you hope to accomplish in the next few years and timelines to establish funding for them proactively
You can always shift your long-term plan, but having that grounding document to keep you on track can bolster your yearly decision-making.
Rely on a solid board of directors
Your board is responsible for financial oversight, so naturally, they’ll play a role in your nonprofit accounting. Hiring members who can advance your mission and set a strong strategic direction for the organization is important.
It's also important to create a degree of separation between your day-to-day operations and your board members. A board member who's personally invested in fundraising activities and supporters may create a conflict of interest.
The board should make financial decisions based on the organization's best interest as a whole and not their personal ties. The more space you can create, the more sound financial advice your board can produce to support long and short-term goal setting.
Implement checks and balances internally
When it comes to the day-to-day operations, a checks-and-balances system will help you remain 100% accurate.
It's important to create processes for your team to follow and take the time to implement them across the organization. Doing so can prevent misalignment, errors, and missing information that could result in fraud or penalties.
A few ways to create internal controls include:
- Create clear roles and responsibilities: Make sure everyone knows who should be handling bookkeeping, who should have visibility and approvals, and who completed the final audit.
- Document everything: Write processes and accounting information down in a single resource that can be referred to over time and help train new employees.
- Consider security: With most processes happening online, prioritize cybersecurity and secure data transfer with safeguards in the event of a hack.
Audit finances regularly
Financial audits can have a bad reputation as something an organization only has to face when something goes wrong. Let's flip that narrative and prioritize regular audits that confirm accuracy.
Every time you run an audit proactively, you can test your internal systems, software, and team readiness to identify holes in the process. That way, you're prepared when required audits happen.
Publishing audit findings is also a great way to build trust and transparency with donors and stakeholders.
Use nonprofit accounting software
Nonprofit accounting software makes everything we've covered so far much easier. Gone are the days of spreadsheets and manual entries.
Specialty tools and tech advancements help you manage your finances. To comply with tax-exempt accounting protocols, it's important to look for software specifically built for nonprofits.
Here are a few key features to look for:
- GAAP compliance
- Ability to produce the four critical financial statements for nonprofits
- Tracking of restricted and unrestricted funding
- Automation to save you time and avoid mistakes from manual entry
Should you hire or outsource for nonprofit accounting?
As you consider the size of your organization and your team's skills, time, and resources, you may decide to outsource the accounting function. Your nonprofit has several options.
Accounting involves close attention to detail and a deep understanding of the organization. Depending on your plans to scale in the coming years, you can decide whether to handle things in-house or work with an accounting firm.
Nonprofit accounting options to consider
- Executives: Many nonprofits give financial responsibilities to their executive directors. This option is great for newer or smaller organizations that can handle simple and time-consuming accounting.
- In-house nonprofit accountants: You can hire a full-time accountant as an employee of your nonprofit. That gives you access to a professional whenever you need them and assurance that they're immersed in your mission and policies.
- Outsource accounting: If you don't have a budget to hire someone full-time or want expertise from a trusted firm, you can always outsource. This option also gives you a third-party view of your finances that might offer more insight for strategic planning.
Nonprofit donor management
From setting your financial goals to ensuring adequate revenue, it all starts with your donors. Just like for profit accounting relies on customer data, donor management is a crucial element of your accounting strategy for this reason.
The more you know about your donors, the better your relationship-building initiatives can be. As you learn from how supporters gave in the past, to which campaigns and amounts, your financial forecasting becomes far more accurate.
It's also important to accurately report donation amounts and view donation activity at a glance for the most precise income statement, statement of financial position, and other financial reporting requirements.
Understanding your donors
Donor management offers you a view into the various donor segments that exist within your community. Here are a few donor groups you can identify to build a fundraising strategy around:
- One-time donors: Individuals who have donated once, directly or through a specific campaign or donation page
- Repeat donors: Individuals who have donated multiple times through the same or a variety of campaigns
- Recurring donors: Individuals who commit to a donation on a regular cadence such as monthly
- Major donors: Individuals who give notably high amounts to move your mission forward
- In-kind donors: Individuals who provide non-monetary contributions like volunteer time, physical goods, or expertise
- Corporate donors: Companies and their employees who partner with your nonprofit to donate
The importance of donor retention
Major donors, corporate sponsors, and recurring donors can all be excellent sources of reliable funding. These gifts create a more significant impact that you can account for in your financial plans, but only if donor retention is top of mind.
A donor retention plan helps nonprofits:
- Build relationships with supporters that keep them coming back to give
- Create advocates that recruit family and friends to support the cause
- Expand the impact that each donor makes in a year through various campaigns
- Establishes loyalty among donor communities, even in uncertainties
Donor retention is all about showing donors gratitude, reaching out regularly with updates, and helping them see the impact they're making.
The value of donor management software
Donor management software can complement your financial strategy by helping you retain donors. Knowing who to contact and when is about having the correct details about your supporters.
Zeffy’s absolutely free donor management solution securely stores and organizes your donor and member data so you can easily engage with the right supporter at the right time.
With Zeffy you can:
- Import your donor contacts and past transactions
- Automatically add new donations or purchases to your contact lists
Filter, segment, and export donor contact lists
- Add notes to donors files to help you remember important details and personalize your outreach
- View emails and past donations to stay engaged
- View contact information and preferences
- Access receipts for all donors and campaigns
FAQs: Accounting for nonprofits
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