Nonprofits play a crucial role in addressing societal needs, improving lives, and driving meaningful change in communities around the world. However, behind the scenes of every impactful program and service is the constant challenge of generating and managing money to sustain their mission. Unlike for-profit businesses, nonprofits operate under a unique financial model, where every dollar raised is reinvested into fulfilling their purpose rather than generating profits for shareholders.
While the term “nonprofit” might suggest these organizations don’t need money to operate, the truth is that they require steady funding to fulfill their missions, cover operating expenses, and plan for the future. Understanding how nonprofits make money is essential not only for their leadership teams but also for donors, board members, and stakeholders who support their cause.
From donations and grants to earned revenue and in-kind contributions, nonprofits rely on a variety of income streams to maintain financial stability. Yet, balancing these revenue sources while ensuring compliance, accountability, and transparency is no small feat.
What is a nonprofit organization?
Nonprofit organizations (also called 501(c)(3) organizations, depending on the type of nonprofit) differ fundamentally from for-profit businesses. Instead of distributing profits to shareholders or owners, nonprofits reinvest all surplus funds into their programs, services, and operations. This reinvestment supports their mission and qualifies them for significant benefits, such as tax-exempt status.
Key Characteristics of Nonprofits:
- Their purpose is mission-driven, often focused on community service, education, or advocacy.
- They’re managed by boards of directors or trustees, not individual owners.
- Financial operations focus on accountability and transparency, often using fund accounting to track income and expenses.
Becoming a nonprofit allows organizations to leverage these benefits while focusing on their goals. For many, it’s about making a meaningful difference in the community rather than pursuing profits.
How do nonprofits make money?
Nonprofits make money through a combination of revenue sources that align with their mission and tax-exempt status. Although nonprofits don’t “profit” in the traditional sense, they must generate enough revenue to sustain their operations. Nonprofits rely on diverse revenue sources to fund their operations and fulfill their missions. Here are the primary ways they generate income.
Earned income
Nonprofits often generate revenue by offering goods or services directly related to their mission. Examples include selling merchandise, charging fees for workshops or classes, and renting out event spaces or facilities. For earned income to remain tax-exempt, it must align with the organization’s stated mission. Revenue unrelated to the mission may be subject to taxes (this type of income is known as unrelated business income), so nonprofits must carefully manage these streams to ensure compliance.
Individual contributions
Individual donors are a cornerstone of nonprofit funding, contributing through various channels such as direct monetary gifts, online donations, and in-kind contributions of goods or services. Planned giving, where donors arrange bequests or gifts through their estates, also plays a significant role in long-term financial planning. Nonprofits often focus heavily on building relationships with donors to encourage recurring support and ensure sustainable revenue streams.
Grants
Grants are a critical source of funding for many nonprofits, awarded by government agencies, private foundations, or corporations. These funds are often designated for specific projects or programs and require detailed reporting to meet the grantor’s guidelines. Nonprofits must align their proposals with the grantmaker’s goals and maintain accurate records to ensure compliance, making grants both a valuable and carefully managed revenue source.
Fundraising events
Fundraising events are a popular and engaging way for nonprofits to raise money while fostering community connections. Events such as galas, benefit concerts, auctions, or fun runs not only generate revenue but also raise awareness about the organization’s mission. These events create opportunities for supporters to contribute while enjoying a memorable experience, blending financial impact with mission-driven outreach.
Sponsorships
Corporate sponsorships provide nonprofits with financial or in-kind support in exchange for recognition or branding opportunities. Sponsors often benefit from positive exposure and alignment with the nonprofit’s mission, while the nonprofit gains much-needed resources. These partnerships are mutually beneficial, enhancing the nonprofit’s capacity to achieve its goals.
Investments
Some nonprofits invest their funds to create sustainable income streams. Endowments are a common investment tool, where the principal donation is preserved, and dividends or interest are used to fund operations. This strategy allows nonprofits to build financial security and plan for the long term, ensuring they can continue their work even during economic uncertainty.
What taxes and reporting obligations do nonprofits have?
As an experienced CPA and tax professional, I’d like to outline the key tax responsibilities that a nonprofit must manage to maintain compliance with federal, state, and local regulations. Proper adherence to these responsibilities is critical for preserving a nonprofit’s tax-exempt status and demonstrating financial transparency to stakeholders.
Maintain 501(c)(3) tax-exempt status
Nonprofits registered as 501(c)(3) organizations with the IRS must ensure their operations align with their stated mission and comply with regulations specific to tax-exempt entities. Key responsibilities include:
- Exclusive Mission Focus: Activities must primarily advance the charitable, educational, religious, or scientific purposes outlined in the organization’s charter.
- Prohibition of Private Benefit: No part of the organization’s income or assets may benefit private individuals or shareholders.
- Lobbying and Political Activities: Nonprofits must limit lobbying activities and refrain entirely from participating in political campaigns or endorsing candidates.
Stay on top of annual tax filings
Even though nonprofits are exempt from federal income tax, they are required to file an annual information return to maintain transparency. Nonprofits must file Form 990, 990-EZ, or 990-N (e-Postcard), depending on their gross receipts and assets.
- Nonprofit organizations with gross receipts of $200,000 or assets over $500,000 must file Form 990.
- Smaller nonprofit organizations with gross receipts below $200,000 and assets under $500,000 must file Form 990-EZ.
- Nonprofits with gross receipts of $50,000 or less must file 990-N.
All Forms 990 are publicly available once filed and must accurately reflect the organization’s financial health, governance, and mission-related activities. There are also state-specific tax compliance responsibilities that nonprofits must adhere to or face penalties.
Follow UBIT requirements
Nonprofits are required to pay taxes on income derived from activities unrelated to their primary mission. This is known as Unrelated Business Income Tax (UBIT) and applies when:
- The activity constitutes a trade or business.
- It is regularly carried on.
- It is not substantially related to the organization’s exempt purpose. Nonprofits must report UBIT using Form 990-T and pay applicable taxes on this income.
Organize and maintain donor documentation
Nonprofits must ensure proper documentation and reporting related to donations. For example, written acknowledgments must be provided for donations exceeding $250, including details such as the donor’s name, contribution date, and value. Also, when donors receive goods or services in exchange for their contributions, nonprofits must provide a written disclosure if the value exceeds $75.
Pay payroll and employment tax due
If a nonprofit employs staff, it must fulfill standard employer tax obligations, including:
- Withholding and remitting federal and state income taxes, Social Security, and Medicare taxes for employees.
- Filing employment tax forms such as Forms 941 (quarterly payroll tax returns) and W-2 (annual wage reporting for employees).
- Providing Form 1099-NEC for independent contractors earning $600 or more in a calendar year.
What happens if a nonprofit fails to comply with regulations?
Failing to meet tax responsibilities can have serious repercussions for nonprofits. Noncompliance may lead to the loss of tax-exempt status, requiring the organization to pay taxes on all income. Additionally, nonprofits may face financial penalties for late or inaccurate filings, audits that disrupt operations, and damage to their reputation, which can erode donor trust and jeopardize funding. These consequences not only strain financial resources but also hinder the organization’s ability to fulfill its mission effectively.
What challenges do nonprofits have in their accounting?
Effective bookkeeping is critical for nonprofit organizations to maintain financial accuracy, comply with regulations, and build donor trust. However, nonprofits face unique challenges that complicate their accounting processes. These challenges can impact financial success and hinder their ability to achieve their mission if not addressed properly. Below are a few of the most common challenges we’ve seen nonprofit clients encounter:
- Complex Fund Accounting: Nonprofits often handle multiple funds with donor-imposed restrictions. Mismanaging these funds can lead to financial inaccuracies and noncompliance, jeopardizing donor relationships and legal standing.
- Regulatory Compliance Requirements: Strict regulations, including tax-exempt status maintenance and financial reporting standards, require precise record-keeping and timely filing. Failing to comply can result in penalties, audits, or the loss of tax-exempt status.
- Limited Resources: Many nonprofits operate on tight budgets, preventing investment in advanced accounting software or experienced financial staff. This reliance on outdated methods or underqualified personnel increases the risk of bookkeeping errors.
- Grant Management Complexity: Nonprofits often manage multiple grants, each with unique restrictions and reporting requirements. Poor tracking and reporting can lead to noncompliance, loss of funding, and damage to credibility with grantmakers.
- Weak Internal Controls: Limited staffing can make it difficult to implement proper segregation of duties, leaving organizations vulnerable to fraud, errors, and financial discrepancies.
How can nonprofits ensure accurate accounting and financial reporting?
Managing finances in a nonprofit organization is no small feat. Nonprofits must meet strict compliance requirements, demonstrate transparency to donors and stakeholders, and ensure that every dollar is used efficiently to advance their mission. Here are some of the most common accounting challenges nonprofits face, along with actionable solutions to address them effectively:
Navigate funding restrictions
Restricted funds, such as grants or donations designated for specific purposes, can complicate financial management. Misusing these funds, even unintentionally, can lead to compliance violations, damaged donor trust, and potential legal consequences. The solution for this is to implement a system for tracking restricted vs. unrestricted funds. Use accounting software designed for nonprofits to allocate expenses accurately and ensure compliance with donor and grantor requirements. Regularly review funding agreements to avoid missteps.
Allocate grants properly
Proper grant allocation is essential for compliance and transparency, but the process can be complex. Nonprofits often struggle with allocating shared costs, such as administrative salaries or rent, across multiple programs funded by different grants. To remedy this, it’s best to develop a clear cost allocation policy and use consistent methodologies, such as time tracking or square footage calculations, to distribute shared costs fairly. Provide training for staff to ensure they understand and follow allocation procedures.
Stay on track with the nonprofit’s financial reporting
Donors, grantors, and regulatory agencies require nonprofits to provide detailed and transparent financial reports. Errors or incomplete reporting can lead to compliance issues and erode stakeholder trust. Use accounting software that automates report generation and ensures accuracy. Schedule regular internal reviews of financial statements and consider external audits to verify data. Train staff and board members on understanding key financial metrics and how they impact organizational success.
Account for in-kind donations properly
Nonprofits often receive non-monetary contributions, such as donated goods or services, which must be accurately valued and recorded. Failing to account for these contributions can result in incomplete financial statements and missed opportunities to showcase donor support. Establish a process for valuing in-kind donations based on fair market value. Request documentation from donors that details the nature and value of their contributions. Incorporate these figures into your financial reports to provide a comprehensive view of your organization’s resources.
Manage restricted and unrestricted funds correctly
While restricted funds support specific programs, unrestricted funds are essential for covering operational costs like salaries, utilities, and technology. Striking the right balance between the two can be challenging, especially for smaller nonprofits. Focus on cultivating unrestricted donations by educating donors about their importance to the organization’s overall sustainability. Create a reserve fund to ensure operational stability during periods of funding uncertainty.
Maintain tax-exempt compliance and pay tax due
Nonprofits face a range of compliance requirements, from filing Form 990 with the IRS to adhering to state-level reporting standards. Missing deadlines or providing inaccurate information can result in penalties or jeopardize the organization’s tax-exempt status. Work with an experienced nonprofit accountant or financial advisor to stay up to date on filing requirements and deadlines. Use a compliance checklist to ensure all reports and documents are submitted accurately and on time.
How do nonprofit organizations become financially agile?
Achieving financial stability is essential for nonprofits to sustain their mission and maximize their impact. While managing revenue streams and addressing accounting challenges can be daunting, adopting the right strategies can help organizations thrive. Here are our tips to increase your nonprofit’s financial health and flexibility so you’re able to adapt when unforeseen circumstances happen.
Diversify revenue streams
Relying on a single source of income, such as one major donor or grant, can leave your organization vulnerable if that funding is withdrawn. Instead, aim to build a diverse mix of revenue streams, including individual donations, grants, earned income, and fundraising events. For example, introducing a membership program or offering fee-based services can create new income opportunities while enhancing community engagement.
Build strong donor relationships
Donors are the backbone of many nonprofits, so cultivating strong relationships is critical. Personalized communication—such as thank-you letters, impact reports, or exclusive updates—can help retain existing donors and encourage recurring contributions. Hosting appreciation events or creating donor recognition programs can further strengthen connections and inspire continued support.
Invest in grant writing professionals or grant writing training
Grants can provide significant funding, but competition for them is fierce. A well-written grant proposal that clearly outlines your organization’s mission, impact, and financial needs can make all the difference. Consider hiring a grant writer or training existing staff to craft compelling proposals. Maintaining compliance with grant requirements and submitting detailed reports will also improve your chances of securing future funding.
Use technology to improve efficiency and productivity
Technology can simplify many aspects of nonprofit financial management. Donor management systems help track contributions, identify major donors, and streamline communication. Accounting software designed for nonprofits can automate tasks like expense tracking, fund accounting, and financial reporting, reducing errors and saving time. These tools allow you to focus more on your mission and less on administrative tasks.
Establish and maintain nonprofit operating reserve fund for emergencies
Financial sustainability requires preparation for unexpected challenges. Set aside a portion of unrestricted funds to build a nonprofit operating reserve that can be used during economic downturns or emergencies. A strong reserve fund ensures that your nonprofit can continue operations without disruption, even during periods of reduced funding.
Evaluate your program’s effectiveness on a regular basis
Regularly assess the financial and mission-related impact of your programs. Identify which initiatives are delivering the most value and which may need improvement or reevaluation. Eliminating underperforming programs allows you to reallocate resources to efforts that align more closely with your mission and provide a higher return on investment.
Invest in training for all staff about financial literacy and accounting
Strong financial management starts with a knowledgeable team. Provide training for staff and board members on budgeting, compliance, and financial reporting. Equipping your team with the skills to manage finances effectively will improve decision-making and ensure the long-term health of your organization.
How MBS Accountancy helps nonprofits achieve financial success
Managing finances as a nonprofit can be complex, especially when juggling multiple revenue streams, restricted funds, and compliance requirements. That’s where MBS Accountancy comes in. With deep expertise in nonprofit accounting, we are dedicated to helping organizations like yours navigate the financial landscape, ensuring transparency, compliance, and long-term sustainability.
We provide tailored financial solutions to meet your organization’s unique needs. Whether it’s creating a budget, setting up cost allocation policies, or managing grant compliance, we work closely with you to develop strategies that align with your mission and goals.
At MBS Accountancy, we can also help you manage grant allocations so funds are used correctly and transparently. We help your organization develop clear policies and processes to track restricted and unrestricted funds, so you can maintain compliance and build trust with grantors.
When you partner with MBS Accountancy, you gain a trusted ally committed to your nonprofit’s success. Our expertise in nonprofit financial management ensures that your organization can navigate challenges, remain compliant, and achieve long-term financial sustainability. Ready to strengthen your nonprofit’s financial foundation? Contact our team today to learn how we can help your organization create clarity in your finances and reporting. Let us handle the complexities of nonprofit accounting so you can focus on advancing your mission and making a lasting impact. Visit our website or call us to schedule a consultation!