Nonprofit Accounting Guide: What You Need to Know
Stay Out of Hot Water With Excellent Accounting Procedures
A nonprofit organization’s accounting responsibilities are different from for-profit businesses. Accounting can be tricky for a nonprofit, and even more so if you can’t afford to hire a professional accountant to manage your finances. This guide runs through the basics of accounting for nonprofits so you can do your best with available resources.
Know Your Financial Terms
Before jumping into accounting, it’s helpful to know some basic accounting terms that you’ll come across. Keep in mind, these terms may take on a slightly different meaning when applied to nonprofits rather than for-profit businesses. Once you’re familiar with these basic terms, you can better understand your nonprofit’s accounting needs, and begin to prioritize your activities.
- Assets: Things your nonprofit owns, like cash, patents, or office equipment
- Liabilities: Things your nonprofit owes, like loans or payables
- Types of Revenue: All money coming into your nonprofit, such as donations, grants, membership dues, investments, tickets, program fees, or service fees
- Net assets: Assets minus liabilities. Net assets can be classified in one of two ways: those with donor restrictions, and without donor restrictions
These donor restrictions can be further broken down into three categories:
- Unrestricted: Use these funds for any purpose, even for daily operations. For example, donations to your annual fund are unrestricted meaning that the donors leave it up to the organization to decide how they are spent.
- Temporarily Restricted: These funds can only be spent on a specific program or at a certain point in time. Examples include money donated during a crisis or emergency where the donors want the money spent on that event.
- Permanently Restricted: These funds may never be spent by the nonprofit but can earn interest from being invested. For instance, an organization can not use the corpus of endowment funds, although the interest those funds earn may be used.
Prepare Your Organization’s Financial Statements
As a nonprofit, transparency in operations is critical. One way to strengthen this transparency is to prepare your financial statements properly. According to the Generally Accepted Accounting Principles (US GAAP), nonprofits should make the following statements for reporting:
Statement of Financial Position
Similar to a for-profit corporation’s balance sheet, a Statement of Financial Position breaks down assets, liabilities, and net assets. It’s an overall snapshot of the health of your nonprofit.
Statement of Activities
A nonprofit’s primary purpose is to provide services or programs that meet specific needs. A Statement of Activities reports revenue and expenses with donor restrictions and without.
Statement of Functional Expenses
The Statement of Functional Expenses reports expenses by their function and type in a spreadsheet format.
For example, expenses would be broken down by function, such as programs, fundraising, or administrative. They’d also be broken down by the nature or type of expenses, such as salaries, supplies, or marketing.
Statement of Cash Flows
Similar to a for-profit corporation’s Statement of Cash Flows, this document reports how much cash and cash equivalents are entering and leaving the organization over a specific period. Your cash flow can be either positive or negative, depending on whether inflows are higher than outflows (positive) or if inflows are less than outflows (negative). Cash flows fluctuate and do not reflect profit or loss over the long term.
This statement is divided up into three sections: investing, financing, and operating.
- The investing section of the statement reports amounts spent on long-term assets, such as investments or equipment.
- The financing section reports amounts received from borrowings or repayments.
- The operating section of the report outlines what is not included in the investing or financing sections.
Notes to Financial Statements
It’s important to include any additional disclosures regarding restrictions, liquidity, and other notes in this section. Common disclosures for nonprofits include a summary of accounting policies, information about investments, status of assets and depreciation, status of outstanding loans or leases, as well as the status of long term pledges from donors.
Of course, to compile these statements, your nonprofit will need to track income, expenses, and activity. Accurate tracking requires attention to detail, as well as choosing accounting software appropriate for the size and complexity of the organization.
Track Funding Coming In and Expenses Going Out
To put together accurate financial statements, it’s essential to track all funds that come and go from your organization, best done by using an organized system (outlined below). Moreover, because the tax code may change, you’ll need to know what you’re tracking and why. It’s important to keep income and expenses separate, but you should also speak to a tax expert to ensure you’re recording everything you need to safeguard your tax-exempt status.
There are two different tracking methods nonprofits can use: cash basis accounting or accrual basis accounting.
Cash Basis Accounting
With cash basis accounting, you record revenue when physical cash is received, not when a transaction takes place. You record expenses when cash is paid. Using this system in a nonprofit, for example, means you’d record the payment when you receive a member or donor’s payment.
Cash basis can only be used if you have no more than $5 million in annual income per year, according to the IRS, making it a popular system for smaller nonprofits.
Accrual Basis Accounting
With accrual basis accounting, you record revenue or expenses when transactions take place. For example, you’d record the transaction when you send an invoice for dues or a pledged donation. Not when you receive the physical payment.
Nonprofit accounting isn’t just limited to donations and expenses, however. Don’t forget about the other activities you should be tracking as well, such as investments and savings. A variety of nonprofit accounting software is available to make tracking easier, and many of them are easy to implement and affordable to boot.
File a Form 990
According to the IRS, there are 29 types of nonprofit organizations that are exempt from federal taxes and many state taxes. The most common type of nonprofit organization is a 501(c)(3), which is either a public charity or a private foundation.
Even though nonprofits are exempt from federal taxes, they must still file an annual information document known as a Form 990. Form 990 is a public document that lets the IRS and the public examine a nonprofit’s mission, finances, and operations for the prior year. Depending on your nonprofit organization's assets or gross receipts, you’ll file Form 990, 990-PF, 990-EZ, or 990-N. Some churches and faith-based organizations may be exempt from this requirement if they have not formally filed for 501(c)(3) status.
Remember that being exempt from federal income taxes doesn’t mean you can skip filing a business tax return. You may also need to pay property tax or sales tax. In some states, navigating tax codes and responsibilities can be tricky, but joining your state’s association of nonprofits can help you find information on local and state regulations.
Make Room for Professional Accounting in Your Budget
While this guide is meant to offer you an introduction to nonprofit accounting, it by no means replaces professional expertise. Many nonprofits assign accounting tasks to an untrained staff member or volunteer–a big mistake. Inexperienced bookkeeping can often lead to unintentional fraud and costly mistakes. Therefore, a professional with experience and training in nonprofit accounting is essential to your organization.
A CPA can also guide board members and staff through the accounts, ensuring everyone is informed and up to date. Knowledgeable staff and board members can lead to a more stable and organized nonprofit. Plus, you may be able to find a volunteer who also doubles as a willing and experienced CPA or accounting professional.
This article is just for informational purposes. It is not intended to be legal advice. Check other sources, such as the IRS, and consult with legal counsel or an accountant.