A Guide to Nonprofit Accounting

What is nonprofit accounting?

Nonprofit accounting—also referred to as fund accounting—is a unique form of bookkeeping designed specifically for nonprofit organizations. Unlike profit-driven businesses, nonprofits aren’t primarily focused on increasing wealth for shareholders. Instead, they’re driven by a mission to serve a specific societal need, and their accounting practices reflect this difference.

Nonprofit accounting involves tracking donations, grants, and other forms of income, as well as ensuring these funds are used appropriately and efficiently towards the organization’s mission. This form of accounting places a significant emphasis on transparency, accountability, and stewardship, making sure every dollar is accounted for and used responsibly.

Moreover, nonprofit accounting is regulated by a distinct set of legal and financial standards that require detailed reporting and compliance. Understanding these requirements is integral to the management and operation of any successful nonprofit organization.

How is nonprofit accounting different from for-profit accounting?

There are several key differences between nonprofit and for-profit accounting, primarily stemming from the distinct goals and operational structures of these two types of organizations. For-profit businesses aim to generate profits and increase shareholder value, whereas nonprofits exist to serve a specific social purpose and are tasked with demonstrating how they use their funds to further this mission.

In for-profit accounting, the focus is on revenues, expenses, and the resulting profits, with financial statements like the balance sheet and income statement detailing the company’s financial health. On the other hand, nonprofit accounting centers around tracking and reporting on the use of funds, where financial statements such as the statement of financial position and statement of activities provide a transparent view of the organization’s financial situation.

Moreover, nonprofits are held to a high degree of fiscal accountability and stewardship, requiring them to thoroughly document all income and expenditures. They are also subject to specific regulatory and reporting requirements, including filings like the IRS Form 990, which are not applicable to for-profit entities. These differences underscore the importance of understanding and effectively managing nonprofit accounting—it’s not just about keeping the books, but ensuring the organization is taking the right steps towards fulfilling its mission.

How to navigate nonprofit accounting.

Navigating the world of nonprofit accounting can seem like a daunting task, with its unique regulatory guidelines, strict requirements for transparency, and the constant need for fiscal accountability. However, with the right knowledge and tools, it can be effectively managed to uphold your organization’s mission and sustain its operations with confidence and ease.

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 over 80% 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 important nonprofit accounting documents.

Nonprofit accounting requires meticulous maintenance and management of numerous financial documents for transparency and compliance purposes. Here are several key documents that are integral to nonprofit accounting:

1. Nonprofit budget – This vital financial document outlines the organization’s expected income and expenses for a certain period of time, typically a fiscal year. It serves as a roadmap for spending and revenue generation, playing a crucial role in guiding strategic decision-making and ensuring financial sustainability. Some things to remember when creating your budget include identifying your cash flow sources and quantifying in-kind donations.
2. Statement of financial position (SOP) – This document is the nonprofit equivalent of a balance sheet. It provides a snapshot of the organization’s financial condition at a specific point in time, summarizing its assets, liabilities, and net assets. 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.
3. Statement of activities – Analogous to an income statement in for-profit businesses, this document details revenue, expenses, and changes in net assets over a given period. It provides a clear picture of how funds are being sourced and utilized.
4. Statement of cash flows – This is a detailed record of the cash inflows and outflows experienced by the organization during a particular period, illustrating the liquidity and financial viability of the organization.
5. Statement of functional expenses – This statement provides a breakdown of expenses by both nature (what was purchased) and function (why it was purchased). It is unique to nonprofits and helps demonstrate how funds are allocated between program services and supporting activities.
6. IRS Form 990 – This is an annual reporting return that certain federally tax-exempt organizations must file with the IRS. It provides information on the filing organization’s mission, programs, and finances.

Understanding and accurately maintaining these financial documents is crucial in nonprofit accounting, as they provide a comprehensive and transparent record of the organization’s financial activities, ensuring compliance with regulatory requirements and fostering trust with donors, members, and the public.

Develop a clear operations budget.

Accounting serves two 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.

Establishing streamlined processes to manage your nonprofit accounts is essential for efficient and transparent operations. Begin by implementing a system that caters to your unique needs and ensures accurate record keeping. Regularly review your accounts to ensure compliance with regulations and maintain up-to-date records.

Opt for cloud-based accounting software tailored for nonprofits, as they can automate many tasks, improve accuracy, and save time. This includes generating financial reports, tracking donations, managing expenses, and even budgeting.

Develop an internal policy outlining how financial transactions should be handled, including approval processes for expenditures and proper documentation for all transactions. This can play a vital role in preventing misappropriation of funds and ensuring financial integrity.

Training staff and volunteers on the importance of financial management is crucial. Everyone involved should understand their role in maintaining the financial health of the organization. Regular training sessions can keep everyone up-to-date on best practices and changes in financial regulations.

By creating solid processes, you can manage your nonprofit accounts effectively, maintaining the trust of your donors, and ensuring the longevity of your organization.

Nonprofit accounting best practices.

Implementing best practices in nonprofit accounting can enhance your organization’s operational efficiency, financial transparency, and overall accountability. Here are some key strategies to consider:

1. Implement robust internal controls – Internal controls are essential for safeguarding your organization’s assets, ensuring the accuracy of your financial records, and preventing fraud. These can include separation of financial responsibilities to prevent a single person from handling all financial tasks, regular audits, and comprehensive financial policies and procedures.
2. Use nonprofit accounting software – Specialized nonprofit accounting software can simplify complex fund accounting, making it easier to track and report on different sources of income, categorize expenses, and ensure compliance with nonprofit-specific standards and regulations.
3. Regularly review financial reports – Regular reviews of your financial statements can help identify trends, foresee potential issues, and make informed, strategic decisions. This includes closely examining your statement of financial position, statement of activities, statement of cash flows, and statement of functional expenses.
4. Maintain a reserve fund – Having a reserve fund can provide financial stability in times of unexpected expenses or drops in funding. It also demonstrates to donors and stakeholders that your organization is financially responsible and prepared for unforeseen circumstances.
5. Provide transparency – Nonprofits are held to high standards of accountability. Regularly share your financial reports with board members, stakeholders, and the public to maintain trust and demonstrate responsible stewardship of funds.
6. Invest in financial training for non-finance staff – Everyone in your organization should have a basic understanding of your nonprofit’s finances. Providing training can help staff understand the importance of their role in maintaining financial integrity and how their day-to-day actions impact the organization’s overall financial health.
7. Stay current with regulations – As regulations and standards can update, it’s important to regularly check in with the regulatory bodies or consult with an accounting professional to avoid non-compliance.
8. Plan overhead expenses carefully – Nonprofits, like any other organization, will have overhead costs, such as administrative expenses, salaries, utilities, and office supplies. It’s important to budget and monitor these expenses carefully as they play a direct role in your organization’s sustainability and efficiency. A well-planned overhead expense strategy ensures that the maximum amount of funding goes directly to your cause, enhancing trust among your donors and stakeholders.
9. Reference your budget often – Regularly referring back to your budget is key to maintaining financial discipline and ensuring the organization stays on track with its financial goals. This practice encourages proactive adjustments to spending habits and allows for timely reallocation of resources, if necessary, to meet the changing needs and priorities of the organization.

By following these best practices, your nonprofit can maintain strong financial health and continue effectively serving your mission.

Implementing best practices in nonprofit accounting can enhance your organization’s operational efficiency, financial transparency, and overall accountability. Here are some key strategies to consider:

1. Implement robust internal controls – Internal controls are essential for safeguarding your organization’s assets, ensuring the accuracy of your financial records, and preventing fraud. These can include separation of financial responsibilities to prevent a single person from handling all financial tasks, regular audits, and comprehensive financial policies and procedures.
2. Use nonprofit accounting software – Specialized nonprofit accounting software can simplify complex fund accounting, making it easier to track and report on different sources of income, categorize expenses, and ensure compliance with nonprofit-specific standards and regulations.
3. Regularly review financial reports – Regular reviews of your financial statements can help identify trends, foresee potential issues, and make informed, strategic decisions. This includes closely examining your statement of financial position, statement of activities, statement of cash flows, and statement of functional expenses.
4. Maintain a reserve fund – Having a reserve fund can provide financial stability in times of unexpected expenses or drops in funding. It also demonstrates to donors and stakeholders that your organization is financially responsible and prepared for unforeseen circumstances.
5. Provide transparency – Nonprofits are held to high standards of accountability. Regularly share your financial reports with board members, stakeholders, and the public to maintain trust and demonstrate responsible stewardship of funds.
6. Invest in financial training for non-finance staff – Everyone in your organization should have a basic understanding of your nonprofit’s finances. Providing training can help staff understand the importance of their role in maintaining financial integrity and how their day-to-day actions impact the organization’s overall financial health.
7. Stay current with regulations – As regulations and standards can update, it’s important to regularly check in with the regulatory bodies or consult with an accounting professional to avoid non-compliance.
8. Plan overhead expenses carefully – Nonprofits, like any other organization, will have overhead costs, such as administrative expenses, salaries, utilities, and office supplies. It’s important to budget and monitor these expenses carefully as they play a direct role in your organization’s sustainability and efficiency. A well-planned overhead expense strategy ensures that the maximum amount of funding goes directly to your cause, enhancing trust among your donors and stakeholders.
9. Reference your budget often – Regularly referring back to your budget is key to maintaining financial discipline and ensuring the organization stays on track with its financial goals. This practice encourages proactive adjustments to spending habits and allows for timely reallocation of resources, if necessary, to meet the changing needs and priorities of the organization.

By following these best practices, your nonprofit can maintain strong financial health and continue effectively serving your mission.