Proper financial management is crucial to ensuring the sustainability and success of your organization. Tracking and analyzing your financial performance allows you to make informed decisions and provide accurate reports to stakeholders. In this blog post, we’ll cover the basics of nonprofit accounting so you can make informed financial decisions, effectively manage your organization’s resources, and maintain transparency with stakeholders.
What is Nonprofit Fund Accounting?
While business accounting is based on income sources being allocated to expenses, fund accounting allocates income received to funds which are designated for specific events, programs, or purposes.
Nonprofits generate revenue through a variety of sources to support their missions and operations. Some common ways that nonprofits make money include donations, grants, fundraising, membership fees, program service fees, investment income, corporate sponsorships, government contracts, in-kind contributions, and social enterprises.
Fund accounting, informally called nonprofit accounting, is about demonstrating transparency and financial stewardship relating to the income, expenses, assets, and liabilities for all of a nonprofit’s programs. Nonprofits that properly implement fund accounting can demonstrate to grantors and stakeholders that grant funds are being used exclusively for the intended purposes, as well as ensure compliance with grant requirements and exhibit financial accountability.
Types of Funds For Nonprofit Organizations
Nonprofits use different funds to effectively manage and allocate their resources across various programs, projects, and initiatives. This enables transparency by segregating financial resources into distinct categories based on the nonprofit’s needs, legal requirements, or donor stipulations associated with each fund.
As mentioned just now, nonprofit funds are classified as either restricted or unrestricted funds and more detail about the funds is conveyed by various subcategories within each of these two categories.
An overview of restricted funds for nonprofit organizations
Restricted funds for nonprofits refer to financial resources that are designated for specific purposes, projects, or timeframes, as outlined by the donor or grantor. These funds are intended to support particular activities or initiatives, ensuring that the donor’s intentions are respected and that resources are allocated efficiently.
Restricted funds can be temporary, such as those tied to a specific project, or permanent, such as endowments where only the generated income can be spent while the principal remains intact. The use of restricted funds allows donors to contribute to causes or programs that align with their interests and values, while enabling nonprofits to establish dedicated revenue streams for critical initiatives.
Some common subcategories of restricted funds include:
- Permanent endowment funds: Used to account for the principal amount of gifts or grants the organization is required by the donor to maintain in perpetuity or until the purpose of the fund has been achieved.
- Temporary endowment funds: Similar to permanent endowment funds, but after the expiry, the endowment becomes available for unrestricted or purpose-restricted use by the organization.
- Pooled income funds Resources provided by donors where the organization has a beneficial interest but is not the sole beneficiary. Examples include charitable gift annuities or life income funds.
- Custodial funds: Held to account for resources before they are dispersed based on the donor’s instructions. Little or no discretion over the use of these resources.
- Current funds – restricted: This includes current assets subject to restrictions assigned by donors or grantors.
Unrestricted funds and subcategories for a nonprofit
Unrestricted funds for nonprofits refer to financial resources that are not subject to any specific donor-imposed conditions or restrictions. These funds provide nonprofits with the flexibility to allocate resources as needed, supporting general operations, administration, new programs, or unexpected expenses. Unrestricted funds are essential for the financial stability and sustainability of nonprofits, as they allow organizations to adapt to changing circumstances and seize opportunities that align with their mission.
Some common subcategories of unrestricted funds include:
- General fund (aka operating fund): Minimum fund needed for unrestricted resources. Relates to current and noncurrent assets and related liabilities. Can be used at the discretion of the NPO governing board.
- Endowments: Assets which have been assigned to a specific purpose but can still be used at board’s discretion.
- Trading funds: Profits received by the nonprofit while selling goods and services. Used for the purpose of the organization.
- Fixed Assets Fund: Some organizations hold non-current assets and related liabilities in a separate fund from the current assets.
- Current fund – unrestricted: If using Plant fund, this fund is used to account for current assets that can be used at the discretion of the organization’s governing board.
Key financial statements for nonprofits
In FASB 117, the IRS establishes the standards for external financial documents that will be produced by a nonprofit. These guidelines specify which information must be disclosed within your organization’s financial documents so they accurately and clearly describe your organization’s finances to external stakeholders. The three primary financial statements include the statement of activities, the statement of financial position, and the statement of cash flows.
Statement of activities
A statement of activities (also known as an income statement or statement of operations) is a financial statement that shows a summary of the revenues, expenses, and net changes in net assets of a nonprofit organization over a specific period, typically a fiscal year. Revenues are the inflows of economic resources, such as donations, grants, and program fees, while expenses include costs incurred in the process of generating revenues or furthering your organization’s mission, such as salaries, rent, and supplies. The difference between revenues and expenses is your organization’s net change in net assets, which can be either a surplus (when revenues exceed expenses) or a deficit (when expenses exceed revenues).
The statement of activities helps stakeholders understand how your organization is using its resources to further its mission. It is typically prepared at the end of your organization’s fiscal year, but can also be prepared at other times as needed.
Statement of financial position
This financial statement is equivalent to the balance sheet for businesses and shows the financial position of a nonprofit organization at a specific point in time. A statement of financial position provides stakeholders with a snapshot of your organization’s assets, liabilities, and net assets (also known as fund balances).
- Assets are resources that your organization owns or controls that have monetary value, such as cash, investments, and property.
- Liabilities are obligations your organization owes to others, such as loans and accounts payable.
- Net assets represent the difference between your organization’s assets and liabilities and can be further divided into unrestricted, temporarily restricted, and permanently restricted donor categories.
The statement of financial position helps stakeholders understand your organization’s financial position and its ability to meet its financial obligations. It is typically prepared at the end of your organization’s fiscal year, but can also be prepared at other times as needed.
Statement of cash flows
A statement of cash flows shows the sources and uses of cash for a nonprofit organization over a specific period of time, typically a fiscal year. The statement of cash flows is divided into three main sections: operating activities, investing activities, and financing activities.
- Operating activities include cash inflows and outflows related to your organization’s primary operations, such as revenues and expenses.
- Investing activities include cash inflows and outflows related to your organization’s investments in long-term assets, such as property or equipment.
- Financing activities include cash inflows and outflows related to your organization’s financing activities, such as borrowing or repaying loans.
Nonprofit cash flow statements will typically refer to donations, membership fees, program fees, and fundraising proceeds, unlike business cash flow statements that refer to sales, service fees, and investment income.
What duties and responsibilities are involved in nonprofit accounting?
A nonprofit accountant is responsible for a range of tasks related to financial management and reporting. These tasks may include:
- Recording transactions: This involves accurately recording income, expenses, and asset purchases in your organization’s financial records.
- Preparing financial statements: This includes creating balance sheets, income statements, and statements of cash flows.
- Maintaining accurate financial records: This includes ensuring that all financial records are complete, accurate, and up-to-date.
- Following GAAP and industry standards: This includes following generally accepted accounting principles (GAAP) and any relevant industry standards and regulations.
- Managing funding sources: This includes tracking and reporting on different types of funding, such as donations and grants, to ensure compliance with any restrictions or requirements.
- Implementing internal controls: This includes establishing procedures and policies to ensure the integrity of your organization’s financial data. For example, using purchase orders helps you and your vendors stay on the same page regarding the services or products they provide to you.
- Preparing tax returns: Nonprofit organizations are exempt from paying taxes, but they may still need to file tax returns and report certain financial information to regulatory agencies.
- Providing financial reports to stakeholders: This includes preparing financial reports for donors, funders, and regulatory agencies, as required.
- Advising on financial matters: As a nonprofit accountant, you may be called upon to provide guidance and advice on financial matters, including budgeting, forecasting, and resource allocation.
Overall, a nonprofit accountant plays a crucial role in the financial management and reporting of a nonprofit organization. By accurately tracking and analyzing financial data and following proper accounting practices, you can help ensure the sustainability and success of your organization.
Tips For Successful Nonprofit Accounting
- Decide which overhead costs are necessary for growth: Unlike operating costs, overhead costs include expenses related to administration, marketing, and other activities that are essential to your organization’s growth.
- Create an annual operating budget AND a monthly budget: After planning and establishing the annual budget, your board members and finance staff should meet regularly throughout the year to compare your actual revenue and expenses to your monthly and annual projections.
- Establish internal controls: Internal controls help you ensure you’re always compliant with legal and reporting requirements. Having clearly defined systems of operations provides you and your executive team with reasonable certainty that objectives will be reached and deliverables fulfilled in a predictable and compliant manner.
- Perform regular audits: Periodic audits of your nonprofit’s financials provide transparency about your financial solvency. For this reason, many nonprofits include it in their bylaws and some grant funders require audits. In addition, many states require regular audits for nonprofits that either earn above specified revenue thresholds or receive over $750,000 in federal funding.
- Comply with filing requirements: For most nonprofit organizations, this means filing Form 990 annually. However, you need to comply with other requirements based on your state. You can read our guide to internal controls here: 4 Ways To Improve Internal Controls Within Your Company
- Hire or outsource a nonprofit accountant: Usually, a bookkeeper or treasurer handles the finances but you may want to consider hiring an accountant. If you aren’t sure whether to hire or outsource an accountant, read 6 Signs You Need To Hire An Accountant
Do You Need Help With Nonprofit Accounting?
At MBS Accountancy, we specialize in providing accounting, bookkeeping, and tax reporting services to help nonprofits effectively and efficiently manage their financial operations. We tailor our nonprofit accounting services to meet the unique needs of nonprofit organizations, ensuring that our clients receive top-notch service to support their mission-driven activities.