Many accounting classes start with the “lemonade stand” model of business management. You want to sell lemonade, so you work through the process of buying supplies and selling products. However, running a business becomes more complicated when you leave the private sector to start a nonprofit. Instead of selling lemonade, you’re now trying to collect funds so others can have lemonade. Or you’re selling lemonade to donate funds. Nonprofits have their own accounting challenges and requirements, with specific documentation and legal guidelines for what they can accept and what they can do with their money. However, despite their complexity, the basic principles of accounting shine through. Nonprofits with clear records and organized financial categories have better odds of succeeding and bringing positive influence to whatever cause they support. Learn more about nonprofit bookkeeping and its accounting process to better position your charity to apply for grants, win over big-money donors, and drive change. Identify Cash Flow Sources As your nonprofit grows, you may have multiple cash flow sources. Each source of income requires different levels of effort and spending. However, you’re responsible for tracking every dollar your nonprofit receives—and accounting for what you do with it. A few common examples of income sources for nonprofits include: Cash donations from benefactors and supporters Local, state, and federal grants Legacy gifts from donors who passed away Fundraising partnerships from local businesses Ticket sales to events and your donor-facing locations For example, an art museum or animal rehabilitation group can sell tickets to the general public. The art museum might also sell tickets for fundraising galas and summer camp activities for kids. Meanwhile, the animal rehabilitation center can fundraise through events like goat yoga, with the proceeds supporting the food and medication needed for their animals. Not every nonprofit has a donor-facing experience, however. Many homeless shelters and child advocacy groups rely instead on grants and donations from benefactors and businesses. While every nonprofit is different, most charities rely on individual donations to stay open. It’s estimated that up to 70% of income for nonprofits comes from individual giving. Whenever you propose a new fundraising opportunity or activity, consider which category the development efforts fall under. This may determine how you can spend the money and the target ROI expected for your efforts. Quantify In-Kind Donations Beyond money, there’s a whole different kind of donation that nonprofit organizations need to track and build into their budgets. In-kind donations refer to gifts that aren’t monetary but have a monetary value. A few examples of in-kind donations include: A local restaurant donating a $100 gift card for part of a charity auction A marketing agency offering its services pro bono on a monthly retainer basis Local high school students collecting soup cans or coats from their peers to donate A few retired volunteers spending a couple of hours each week filing paperwork and performing other administrative tasks Each of these in-kind donations is specific and has value, but how can you track them in your accounting systems—and why do you need to? There are 2 main reasons why you need to track your in-kind donations. First, you’re required to for tax reporting purposes. In some cases, businesses and individuals can claim charitable donations on their taxes to receive deductions. The in-kind donation that a business provides might be part of its core values, but the company also wants a tax break. Next, you need to identify the sources of income and value to your business. For example, if a volunteer helps with administrative tasks for an average of 15 hours per week, they provide real monetary value to your business. If they suddenly stopped volunteering, how much would it cost to hire a temporary worker or part-time employee for those 15 hours of work? An administrative assistant earning $15 per hour for 15 hours per week over a year (50 weeks) earns $11,250. Just because that volunteer doesn’t give you cash doesn’t mean they aren’t one of your largest donors. Any person who donates time to your organization provides value and income. By tracking volunteer hours and activities (whether they offer highly skilled IT support or low-skilled help), you can estimate the cost savings to your organization. Once you quantify your in-kind donations, set up a system to accept and process them. You’ll need to report on your in-kind support and volunteer hours at the end of each year, both in your annual report and in your budgeting meetings. Each donor also needs to receive a thank you letter that explicitly details what they gave and its monetary value. This record is used for their tax purposes. Choose Between Cash- vs. Accrual-Based Accounting As you develop the financial policies and procedures of your nonprofit, you need to consider whether you will use cash- vs. accrual-based accounting. Every business has to choose between these 2 accounting models—and keep in mind that it isn’t easy to switch from one to the other. Cash-based accounting means that you only record income when you receive it and expenses when you pay for them. For example, you would record a donation from a benefactor once their check hits your account. The main benefit of cash-based accounting is that you always know what kind of money you have. There is less risk of overspending because you aren’t focused on future income that may or may not come. However, this format can make it hard to forecast upcoming expenses and future donations. With accrual-based accounting, you record any income or expenses when they’re earned, not received. For example, if you call a plumber to fix your organization’s toilet, you will record the cost of the repair when the plumber completes the job—even if you don’t pay the invoice for another few weeks. Accrual-based accounting is viewed as more comprehensive than cash-based models. Nonprofits can understand more clearly the money they currently owe and will soon receive. So which model is best? In the nonprofit sector, most organizations use accrual-based systems. Yes, this process is more complex and time-consuming, but the system is believed to be more accurate and comprehensive. In fact, some nonprofit types are legally required to use accrual-based reporting—for example, if you receive grants or have paid staff. This promotes financial transparency to organizational partners. If you have a cash-based accounting system, you will need to create a disclaimer in your financial reports and year-end statements illustrating this and potentially explaining why. Track the ROI of Your Fundraising Efforts Nonprofit accounting doesn’t just provide transparency to donors and governing bodies—it also shines a spotlight on the efforts the organization works toward. Over the past few years, there have been increased calls for nonprofits to serve as good stewards of the money they receive. Charity Navigator ranks nonprofits based on their transparency and their financial stewardship. If an organization mishandles money (e.g., through overinflated executive pay, overspending, and donation mismanagement), then donors are discouraged from contributing. Every nonprofit has its own operating costs and financial challenges. However, the team at Charity Watch estimates that a responsible expense ratio is 35% or less. For every $100 you bring into your organization, it is reasonable to spend $35 to solicit the donation. Other nonprofits shoot for a 25% expense ratio or a 4:1 ROI. Through your accounting processes, you should be able to track how much it costs each year to bring in donations to your organization. These expenses range from hiring a full-time donor coordinator to hosting fundraising events and galas each season. Additionally, you should be able to track what percent of your total donations actually support your nonprofit’s mission—which reflects your stewardship and respect for donors. These analyses can be performed on both a macro and micro level. While maintaining a high ROI for your fundraising efforts is important for your charity’s reputation, you may decide to prioritize some development efforts over others if they bring in higher donation amounts or cost less to implement. (If you come from the private sector, this is similar to adjusting your products to promote items with a higher gross margin.) Know Your Financial Documents If you’re transitioning from the private sector to the nonprofit world, you may need to translate the financial reporting sheets that charities use. Instead of profit and loss (P&L) statements and balance sheets, nonprofits use other similar documents to report on their finances: Statement of Financial Position (SOP): This document is the equivalent of a balance sheet. The assets are listed from most to least liquid—what could be spent the fastest—while the liabilities are listed in order of obligation. This document provides a high-level overview of the company’s finances and priorities. Statement of Activities: This is the equivalent of an income statement. It explores how your income changes over a period of time and how your expenses impact it. Statement of Functional Expenses: This breaks down the expenses associated with your nonprofit. Keeping a record of your functional expenses can help you to report on your ROI and set fundraising goals. Statement of Cash Flows: This document translates equally from the private sector. It evaluates where your cash is coming from and how much you have. It also reviews where it’s spent. This document is also used to report on your nonprofit’s health. While responsible nonprofit managers will pull these documents quarterly or monthly, they need to be drafted at least once per year when compiling your organization’s annual report. You may need to submit your report to local governing bodies, and your organization can use the report to attract other donors and apply for grants. Develop a Clear Operations Budget Accounting serves 2 major purposes in business: looking back on past performance and planning for future income. While your nonprofit may use financial documents to report on the past quarter, you can also use this visibility to create fundraising goals and budget for future expenses. For example, a nonprofit can review its operational expenses to predict how much it costs to run annually. The organization can then use this information to make cuts or take on new projects depending on whether they have a cash deficit or surplus. On top of tracking operating expenses (OPEX), nonprofits often set goals to help the community and make an impact. These efforts come with their own version of cost of goods sold (COGS). For example, if a nonprofit offers a mobile shower, shave, and haircut service to homeless individuals, the COGS required to offer that service might include towels, soap, the cost of hiring barbers, and care package items to give to those in need. A nonprofit that has a goal to offer 3,000 showers over the course of the year will have to budget for those items. The challenge for nonprofits: the funds for these operating expenses aren’t always guaranteed. Development teams will review the operational goals for the year and set fundraising goals to bring in more money so the organization can expand its efforts. While both the fundraising team and operations department might be on the same page during the year, both parties should meet quarterly to review their current finances to see if operations can get scaled up—or if they need to be pulled back. This is how a nonprofit balances its budget. Set Up a Reporting System The world of finance and accounting can be stressful, especially for those who worry about recording every receipt and tracking numbers accurately—and there is some truth to this concern. If you let your sales receipts and donations pile up without recording them, then your accounting process will become beleaguered. You even risk creating inaccurate documents and making decisions based on outdated information because your books aren’t organized. The easiest way to prevent this backlog of unrecorded transactions is to set up a system where you can record income and expenses quickly. Invest in software tools that let you categorize costs and even auto-categorize repeating charges. Train your team members to reconcile their expenses immediately and report any new donations. By spending a few minutes each day reviewing your transactions, you can keep up with your finances and prevent the dreaded backlog. Prepare to File Taxes and Submit Annual Reports All of your financial documents and accounting processes will help your nonprofit at the end of the year. Nonprofits still need to file taxes, even if they are tax-exempt (tax-exempt doesn’t mean you can skip filing, just that you won’t have to pay taxes). One of the most important tax documents for a nonprofit is Form 990. This form covers the nonprofit’s mission, programs, and finances. There are multiple types of Form 990, with fields that vary based on your organization’s size and operations. For example: Nonprofits with less than $50,000 in gross receipts can fill out Form 990-N, an e-Postcard. Nonprofits with more than $50,000 in gross receipts can fill out Form 990 or 990-EZ. Private foundations fill out form 990-PF. Some organizations are exempt from filling out Form 990. These include faith-based groups, government cooperatives, and subsidiaries of other nonprofits. Along with your taxes, your organization may need to submit an annual report to the state or federal government. These reports are typically made public each year by nonprofits and live on their websites for potential donors to access. Use Your Nonprofit Accounting System as a Marketing Tool Nonprofits are constantly fighting to win over new donors and prove they deserve support. As your accounting system falls into place, promote it within your development materials to show donors that you care about the money they give. Highlight your target ROI and the steps you are taking to improve it. Share your impact goals for the year and the operating budget you need to hit them. Explain what your general fund does and why funding expenses like toilet paper and rent are important. Showcase your stewardship and transparency to prove you respect their donations. You can’t talk about these aspects of your organization without clear proof. This proof comes in the form of financial documents and statistics highlighting your accounting efforts. You work so hard to serve your community and handle their money responsibly—it’s time you started bragging about it. Create Processes to Manage Your Nonprofit Accounts While nonprofit accounting may seem overwhelming at first, there are systems and software tools to help. At Lendio, we offer free bookkeeping services to small business owners, including nonprofits. You can take traditional financial statements and retool them to provide SOPs and annual reports to donors. Our bookkeepers are also happy to help your organization find additional tools to improve your nonprofit management and record in-kind donations or volunteer hours. Once you have a system in place, you can move forward with improving the value of your nonprofit and taking a leadership role in your community. Your efforts can make a significant difference in the causes that your mission supports.