Welcome to the world of nonprofit accounting! This guide covers basic definitions, best practices, and advanced examples, as well as outsourcing and software options. Before we dive in, it’s important to know the differences between nonprofit organizations and for-profit businesses.
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Nonprofit vs. For-Profit
Nonprofit and for-profit businesses vary in the overall purpose of their existence. A nonprofit’s mission focuses on activities that benefit society, instead of trying to maximize profit. Nonprofits have a public ownership, which means nobody owns shares of the company or interests in its property. Extra income can’t be distributed to the nonprofit leadership. Rather, it has to be recycled back into the nonprofit’s mission and activities.
Aside from these fundamental differences, there are several other characteristics worth mentioning. For-profits pay taxes based on their net income, and nonprofit organizations are exempt from paying income tax. Since a nonprofit wants to make the world a better place by investing time, resources, and funds into the community, the government credits nonprofits with certain benefits. Nonprofits don’t need to pay income tax, but they do need to pay state and property taxes.
Another difference between nonprofits and for-profits are its financial statements. A for-profit puts together an income statement each quarter, which assesses a company’s financial performance. On the flip side, nonprofit organizations write up a statement of activities that includes revenues, expenses, and net assets, which it gives to its donors and board of directors. The other resource a nonprofit depends on is a quarterly balance sheet listing the owner’s equity. Since nonprofit organizations don’t necessarily operate with an owner or owners, they’ll produce a document showing the organization’s liabilities and assets, known as a statement of financial position. To reiterate, financial statements for a for-profit are meant to show whether the business is making a profit, and financial statements for a nonprofit are meant to keep the organization accountable and to show how they might be pursuing their mission.
What Is Nonprofit Accounting?
A key difference between accounting for for-profit versus nonprofit organizations is the concept of fund accounting. Fund accounting focuses on accountability and stewardship rather than profitability. For-profit entities have a general ledger, which is a single self-balancing account, and nonprofits have a number of general ledgers. These general ledgers also go by the term funds. Funds allow organizations to separate resources into various accounts to identify where those resources came from and how they are used. Since nonprofit organizations receive benefits from being tax-exempt, they must keep detailed records while bookkeeping.
What will funds look like though? They can include:
- Unrestricted funds
- Funds with donor restrictions
- Designated funds
When deciding what a fund might be, ask yourself, “Should I know how much money I’ve set aside for _____ ?” This question helps you identify areas you’re spending money on, which will become your funds. Some programs will mask funds as classes or categories. However, these methods will make it difficult to find out how much money you’ve set aside at a given time, despite allowing you to track how much money you’ve received and spent in a class.
Best Practices for Nonprofit Accounting
Below is a list of best practices while managing your books, which will help protect your organization’s financial data. It is recommended you read up on the IRS’s latest rules and regulations to supplement these best practices.
1. Don’t Assign Every Financial Duty to One Person
This is a simple and effective way for protecting against fraud. By assigning financial responsibilities to multiple people, it creates a layer of accountability among employees. If you notice someone regularly completing tasks assigned to another employee, and you see any discrepancies in the numbers, look into it.
2. Implement a Code of Ethics
Fraud is, unfortunately, a fact of life that nonprofits are not immune to. Creating internal policies and controls will significantly improve your fraud protection. Start by implementing a code of ethics, which will also show your donors, board of directors, and employees the values of your organization.
3. Create an Annual Budget
Budgets are essential to all nonprofits, big and small. Create a realistic operating budget at the start of each year, and if it needs corrections later on, don’t worry. Your organization’s budget is free to evolve further into the year you get, so don’t feel like you have to remain rigid with your initial plan. Also, make sure your budget is approved by your board of directors when it’s written up. It’s important for your board to be aware of upcoming plans and initiatives, and they may need to approve increases to the budget.
4. Understand GAAP and IRS Requirements
GAAP stands for Generally Accepted Accounting Principles (GAAP), and they are guidelines that all accounting professionals must follow. They cover both for-profit and nonprofit tax rules. It’s imperative financial professionals understand the current GAAP rules and any changes that happen throughout the years.
5. Create a Multi-Year Plan
Do you know where your nonprofit will be over the next several years? Creating a financial plan that spans multiple years ensures strategic growth. If you want to raise X amount of money within the next five years, it might mean more hiring or creating a marketing plan. Planning ahead of time means garnering early support from your board of directors.
6. Remember: Your Board Is Not Your Organization
Your board is critical to your nonprofit’s success, which is why your board needs to be totally independent of your organization. A board of directors guides a nonprofit’s success with the decisions they make, and sometimes those decisions can be hard ones. That’s why it’s important no one on your board (or their family member) is employed by the organization. This can create a conflict of interest.
7. Manage Your Fundraising Expectations
Directors often get caught up daydreaming about all the money they’ll raise while they’re planning their fundraising strategy. It’s important you keep yourself grounded during this stage. Realize there are many other nonprofits out there, all vying for the attention of donors, and all of them believe their mission is important.
Create realistic fundraising plans by using past data to set your goals. If this next year involves using new tools or techniques, consider lowering your goal until you’ve tried and tested these new strategies. And remember there’s nothing wrong with adjusting your plan when things go wrong, or even when they go right. Don’t feel shackled by past commitments.
Specialized Services for Nonprofit Accounting
Should You Hire Someone New or Outsource?
Nonprofits often operate under tight budgets, which means they usually employ few staff members. What results is an employee who is expected to fulfill multiple roles to run the nonprofit. As a result, tasks like bookkeeping might get pushed aside while dealing with numerous responsibilities.
More and more nonprofits are outsourcing bookkeeping these days. Letting someone else handle bookkeeping, payroll, and other responsibilities can often allow people to focus on the nonprofit’s mission. It lets them focus on attracting donors, building engagement, fundraising, etc.
If your organization has grown to the point where you need to hire someone to manage the books, even if they are part time, it may be worth outsourcing instead. Avoiding new hires will cut down on administrative costs, reduce the budget dedicated to nonprofit accounting software and training, and save you money in various other places.
Professional bookkeepers can help a nonprofit determine an organization’s annual expenses. Because outsourced services are paid at standard intervals, it can allow nonprofits to budget around consistent expenses. Nonprofits that outsource often experience a reduction in costs compared to staffing a bookkeeper. These cost savings can allow the organization to hire staff in other departments or improve the current staff salaries, which in turn reduces turnover and its associated costs.
Professional Bookkeepers Can Help With Tax Returns Too!
When it comes to filing with the IRS each year, nonprofits can often have some of the most complicated returns out there. This is due to the rules around reporting revenue and expenses for 501(c)(3) organizations. Revenue can come from services the organization provides, admission fees via theaters, art exhibits, museums, etc., fundraising or donations, and other areas.
Any money that enters the nonprofit needs to reflect on the organization’s tax forms in some way. For example, some donors give money every month, and others donate once or give in-kind donations. A nonprofit will need to provide receipts so donors can write off these donations. Outsourced bookkeeping can help an organization handle these tasks, while offering advice on changing tax requirements and codes.
Moving to an outsourced bookkeeping and accounting solution can help nonprofits focus on their mission. The move will offer expertise from tax professionals, and it will reduce expenses and increase revenue.
Accounting software for your nonprofit needs to accurately handle your bookkeeping, contributions from donors, grants, investments, and fundraising events, and produce reports that make submitting forms like your Form 990 easier. You also need to be able to manage administrative work like incoming and outgoing payments, budgets, and reports. Since your nonprofit isn’t working toward maximizing profit, you need accounting software designed to handle fund accounting. Extra benefits in the platform you choose can include donation tools, handling grants, and presenting your data concisely to donors or board members.
Because there are specialized software platforms out there for large and small organizations, and everything in between, it’s important you find one best suited to your needs. For example, a small or mid-sized nonprofit might not need complicated financial tracking, but it might benefit from all-in-one management software. This can simplify your inbound cash flow by accepting donations, event ticket payments, store purchases, and subscriptions, all from a central membership platform, saving you time when it comes to keeping on top of your accounts.
Glossary: Common Nonprofit Accounting Terms
Net assets: These are divided into two major classifications: net assets without donor restrictions and net assets with donor restrictions. Unrestricted net assets are donations to nonprofits that can be used for whatever that nonprofit deems fit in pursuit of their mission. On the other hand, donors can donate funds for a specific program or purpose, and these are called restricted net assets. Restricted assets used to be divided into temporarily restricted and permanently restricted, but that has since been changed.
Financial statements: These are documents that nonprofits issue. These include the balance sheet, also known as the statement of financial position, the statement of activities, which is similar to a for-profit business’s income statement, the statement of cash flows, and the statement of functional expenses.
Statement of financial position: Also known as the balance sheet, this illustrates an accounting equation (Assets = Liability + Equity), and shows a snapshot of your organization’s financial health. It also shows you the current balance of each of your funds if you have been doing true fund accounting.
Statement of activities: Also known as the income statement, this is represented by the equation “Income – Expense = Net Income (Increase in Net Assets).” When viewing this financial statement, it will quickly show whether your nonprofit is making more than it’s spending.