Bookkeeping and Accounting For Your Nonprofit
Nonprofit organizations are formed to address societal needs. To further their mission, nonprofit organizations rely on volunteers, and on funding sources that could include grants, donations, and revenue from campaign drives.
So you have an idea to start a nonprofit organization. You probably spend most if not all of your time on how your nonprofit’s charitable mission can be furthered. You know you will need equally passionate individuals that could act as volunteers, and you have plans for various fundraising campaigns. I am sure you have filed for a 501c3 IRS tax-exempt designation. After all, that is one of the principal benefits that nonprofit organizations enjoy vis-a-vis their for-profit counterparts. You probably know that nonprofit organizations are required to comply with certain state and federal regulations to maintain their tax-exempt status.
In our experience, most nonprofits underestimate or do not take into account the operational, as well as reporting resources required to comply with federal and state statutes and make informed decisions. In this article, we will be focusing on nonprofit bookkeeping and accounting which are the bedrock of day-to-day operation management and short and longer-term planning.
While nonprofit bookkeeping and nonprofit accounting overlap in their functions, it is important to make a distinction. Bookkeeping is the systematic recording and classification of financial transactions. The principal function of nonprofit bookkeeping is to maintain accurate records of all monetary transactions of a nonprofit. Bookkeeping has three principal steps which are:
- Recording financial transactions
- Categorizing and summarizing all transactions into ledgers
- and preparing a trial balance from all your ledger accounts.
Accurate bookkeeping is the foundation of the success of a nonprofit organization. Financial reporting such as cash flow statements, statement of activities, budgeting, and accounting have at the base bookkeeping. Accountants use trial balances prepared by the bookkeeper to put together financial reports, file information returns, prepare an organization for audits, etc. A nonprofit budgeting committee uses financial statements and reports for budgeting. It all starts with bookkeeping. Inaccurate bookkeeping could have a domino effect on an organization if not spotted and corrected.
The Function of a Nonprofit Bookkeeper
- Data Entry: Bookkeepers must record all transactions with proper classification of funds, expenses, and other transactions.
- Cost Allocation: Generally nonprofit bookkeepers allocate costs by program costs, administrative costs, and the cost of fundraising campaigns.
- Paying Operational Expenses: Bookkeepers are in charge of paying bills and other operational expenses.
- Preparing bank deposits
- Verifying receipts
- In smaller nonprofits without a human resource department, the bookkeeper is usually in charge of processing payroll.
- Preparing invoices
- Making Purchases
- Monitoring overdue accounts.
Let’s examine some areas that can be impacted by bookkeeping.
Nonprofit Bookkeeping & Budgeting
A function of a nonprofit budgeting committee is to put in place a plan on how to further a nonprofit’s goals, approve and allocate budgets for each program. For that to be accomplished, the budgeting committee tasks include:
- An estimate of the costs and associated resources needed for each program.
- Estimate the dates and amounts of revenue that will be generated based on historical data and current economic indicators
- Compare the estimates to make sure there is a positive budget variance
- Finally, come up with a budget to present to the Board of Directors.
The basis of all forecasts and decision-making is keeping accurate books and having proper internal controls in place to make sure restricted and unrestricted funds are properly classified. Erroneous input of data by a nonprofit’s bookkeeper, and mischaracterization of costs and funds will lead to incorrect revenue and costs projections.
Nonprofit Bookkeeping & Financial Reports
The foundation of sound planning starts with accurate bookkeeping. Accountants base their reports on bookkeeping records. Inaccurate bookkeeping could have a domino effect on an organization.
The risks involved in inaccurate financial reporting could easily result in bad operational decisions and damage to reputation that could ultimately doom your nonprofit organization. After all, there are too many nonprofit organizations competing for a small pool of donors. Prospective donors are much more likely to give to nonprofit organizations that are well-run and have the reputation of being good custodians of donations.
Nonprofit Bookkeeping & Statement of Cash Flow
Nonprofit organizations use cash flow reports to make important decisions on how best to allocate resources to further their mission. A nonprofit’s statement of cash flow reports what an organization’s revenues and expenses look like, and most importantly when revenues come in, and when they are spent. Inaccurate cash flow information such as not separating restricted grants into separate cash accounts will result in nonprofit leaders making decisions based on an overestimated cash flow report. The timing of cash inflow and how it should be classified for accurate reporting is challenging.
Cash flow management is always complicated no matter what type of organization is involved. Nonprofit organizations are constantly dealing with cash flow issues. However, being informed through accurate bookkeeping and accounting, being strategic, and being collaborative can ensure that a nonprofit’s bottom line is not derailed by inaccurate information.
Nonprofit Accounting
Accounting is a step up from bookkeeping. The function of accounting is to provide a clear view of financial statements for short and long-term decision-making. If you do not plan, you plan to fail. Nonprofit accounting is the basis of nonprofit plans. It helps nonprofit organizations determine their financial position so that they can allot resources accordingly. Accounting plays a vital role in the success of a nonprofit’s program.
Fund Accounting
Fund accounting is just another way of describing nonprofit accounting. Nonprofits rely on donors to fund their causes. Donations can come from individual donors, donor-advised funds, grants, etc. Individual donors want to make sure that a healthy percentage of their donations is going towards programs rather than expenses. Grantees offer grants with strings attached. Funds from grants must be spent only on specific and agreed-upon programs. To track how funds are spent and on what, nonprofit organizations use fund accounting. Through fund accounting, funds can be categorized or labeled as:
Restricted Funds. These funds must be spent on specific and agreed-upon programs.
- Temporarily Restricted Funds. These funds must be spent only on specific programs for a given period. After that, the funds can be spent with no strings attached.
- Unrestricted Funds. As the name suggests, these funds can be spent with no restrictions.
Non-Distribution Constaint
The purpose of nonprofit organizations is to further a cause and not to enrich its members. If there are unspent funds, nonprofit organizations are required to invest additional funds in their mission. Unlike for-profit companies, nonprofit organizations are not allowed to distribute these funds or net earnings to their members.
Generally Accepted Accounting Principles (GAAP) and Nonprofit Accounting
Generally Accepted Accounting Principles are a common set of rules issued by the Financial Accounting Standards Board (FASB). In other words, commonly accepted ways of recording and reporting accounting information. The goal of GAAP is to ensure that a company’s financial statements are complete, consistent, and comparable. Public companies are required to follow GAAP when their accountants compile their financial statements. This is also a requirement for most nonprofit organizations.
Smaller nonprofits are not required to adhere to GAAP. Nonetheless, it is always advisable to follow these guidelines as your nonprofit organization grows.
Setting a Nonprofit Budget
Nonprofit Short-Term vs Long Term Budgeting
The challenge is to make sure that the forecast matches or is close as possible to the actual income and expenditure. To make sure that this is the case, organizations often create both short and long-term budgets. Short-term budgets usually range from monthly to quarterly, while long-term are annual budgets. Short-term budgets are regularly adjusted to make sure the long-term budget is as accurate as possible to actual amounts.
Steps to take when preparing a budget for your nonprofit organization.
- Understand Your nonprofit mission & Goals. This will help you prepare a budget that aligns with and facilitates them.
- Estimate Your Income for the period covered by your budget. This is usually the most challenging part to get right as you have little control over donations. However, historical data and other external factors could affect the amount donors ultimately give.
- Estimate your expense. Expenses are easier to forecast as your organization maintains a certain level of control. Expenses can be divided into fixed costs that remain constant and variable costs that vary over time.
- Determine Your Budget Surplus or Deficit. After you have accounted for all your nonprofit income and expenses, you can then apply them to your budget. This is where you determine if your projected revenue or income covers your projected expenses.
Statement of Financial Position
A statement of financial position is what for-profit organizations call a balance sheet. As the name indicates, it is a complete picture of your nonprofit’s financial health within a given period. It is your nonprofit’s net assets.
Assets – Liabilities = Net assets.
Nonprofit Assets:
Assets are what your nonprofit has in terms of value and they include: what you have, what is owed to you, what you have deposited with others, and what you have invested in. The list of assets usually includes:
What your organization has in hand
- Cash or liquid assets. Do you have enough cash to cover expenses or do you have too much cash in non-interest-bearing accounts?
- Account Receivables and Pledges. It is important to take into account that accounts receivables and pledges are never a guarantee that the funds will come in.
- Prepaid expenses such as supplies or investments in future fundraising events
- Fixed assets such as equipment, property, and furniture.
- Contra asset or accumulated depreciation. A record of how fixed assets depreciate over time.
- Other valuables such as art, and artifacts.
- Unrestricted funds
- Temporarily restricted funds
- Permanently restricted funds
What is owed to you:
- Grant awarded that have not yet been received
- Revenue earned but not yet collected
- Loans made by your nonprofit
What you have deposited with others:
- Advance rent, security deposits, payroll bonds, etc.
Assets are usually listed in order of declining liquidity or with the most liquid at the top. In this case, cash.
Nonprofit Liabilities:
Nonprofit liabilities are what your organization owes or holds on behalf of others.
What your nonprofit owes
- Accounts payable
- Payroll Liabilities
- Accrued expenses
- Conditional Contributions
- Bank line of credit
- Loans
What your organist holds on behalf of others:
- Deferred revenue or refundable advances
- Conditional contributions, such as matching grants
A nonprofit’s liabilities are often listed in declining order of their maturity. In other words, short-term liabilities are listed before long-term liabilities.
Quiz: Are mortgages considered short or long-term liabilities?
Nonprofit Net Assets
Net assets also referred to as equity, capital, retained earnings, or fund balance, represent the remaining value that is left once liabilities have been subtracted from assets.
Statement of Activities
The Statement of Activities is the nonprofit income statement. The purpose of a nonprofit’s Statement of Activities is to provide details about transactions. It reports revenue, expenses, and a change in net assets or equity over a given period of an organization. It also details how these transactions are being used for the nonprofit’s programs and activities.
A statement of activities can be a strong fundraising tool in that it is used to showcase how well the organization runs, how it is using donations, and what its accomplishments are. It can also be used by organizational leaders to determine what programs are working, and where to direct resources.
As a rule of thumb, the statement of activities must be divided into permanently restricted, unrestricted, and temporarily restricted activities.
Revenue On Statement of Activities
Examples of revenue items in a nonprofit’s statement of activities include donor-restricted donations, net investments, program fees, member dues, and proceeds from fundraising campaigns. Revenues must be reported on a gross basis, while investments can be reported on a net basis. Other revenue can come from the state and federal governments in the form of grants. Other revenue types include:
- Federal & State grants
- Private grants
- Non-cash contributions
Expenses On Statement of Activities
Nonprofit organizations are required to report expenses by functional classification with at least two categories. Nonprofits use two classifications: natural and functional. Natural expenses are those that go into things like rent, supplies, utilities, etc. Functional activities can be divided into program expenses, management, administrative, and fundraising expenses.
Statement of Functional Expenses
Under FASB issued ASU 2016-14, Presentation of Financial Statements for Not-for-Profit Entities, nonprofit organizations are required to present expenses by natural and functional classifications. A nonprofit’s statement of functional expense breaks down its expenditures into several categories based on the function of each expense. Natural expenses as a feature in a nonprofit’s statement of activities can be classified per the functional category. In other words, as follows:
- Program expenses. Represent costs of operations of an organization’s programs or cost that goes into fulfilling an organization’s mission.
- Management & Administrative Expenses. These are supporting expenses associated with running an organization. Common natural expenses in this category include accounting, legal, and filing fees.
- Fundraising activity expenses. These are costs incurred in raising funds for an organization. Natural expenses in this category could include mailers, employees’ time spent fundraising, etc.
Natural expenses that can’t be directly tied to a functional expense (program, management & administrative, and fundraising), should be tied to a functional expense that it is closest to or whatever makes sense to your organization.
Statement of Cash Flow
The statement of cash flow reports the change in cash and cash equivalents of an organization during an accounting period. The statement of cash flows consists of three categories:
- Cash flow from operating activities. The reports of the changes in cash are not included in investing and financing activities.
- Cash flow from investing activities. This reports the amount spent on the purchase of long-term assets
- Cash flow from financing activities. This reports amounts received from borrowing and also any repayments
Stakeholders can use a nonprofit’s statement of cash flow to see how a nonprofit organization is using its funds.
Information Return - Form 990
Except otherwise exempt, nonprofit organizations are required to file an IRS Form 990 every year. The IRS uses Form 990 to gather information about a tax-exempt organization to promote transparency, accountability, and compliance. Non-profit organizations that fail to file the information returns on time without reasonable cause could incur fees and penalties. If the nonprofit fails to file for three successful years, its tax-exempt status will be automatically revoked.
Form 990s are public documents, meaning that it is accessible to stakeholders, journalists, prospective donors, etc. It is therefore vital for nonprofit organizations to take it seriously. File your Form 990 before or on the due date. Use it as a marketing document to showcase how well your organization is being run. It is advisable to designate a certified public accountant to get it done well and right.
Key Differences Between Nonprofit Bookkeeping and Accounting
Simply put, the function of a bookkeeper is to record and organize financial data while accounting is the preparation, interpretation, and presentation of this data to various stakeholders. The following are key differences between bookkeeping and accounting:
NONPROFIT BOOKKEEPING | NONPROFIT ACCOUNTING |
Data input | Reviewing accounts |
Recording transactions | Preparing reports |
Payroll processing | Preparing for an audit |
Allocating expenses | Filing Information return |
Writing checks | Account Reconciliation |
Making deposits |
Why it is a Good Idea to Outsource Your Nonprofit's Bookkeeping & Accounting
The importance of having qualified bookkeepers & accountants can not be overstated. Hiring bookkeepers specialized in nonprofit bookkeeping will aid an organization in various ways, key amongst them is the proper recording and allocation of expenses, donations, transactions, and other financial data.
Certified Public Accountants who are well-trained in nonprofit accounting and employ the best practices in accounting standards will help your organization in several ways that include:
- Accounting for budget variance
- Balancing accounts
- Preparing financial reports
- Make sure you are audit-ready
- Filing your nonprofit’s information return, etc.
Nonprofit bookkeepers and accountants play a big role in keeping your organization in compliance with state and federal regulations and also help in presenting data that will help your organization to operate efficiently.
Should bookkeeping and accounting be done in-house, should it be outsourced, or should your organization use the software? The needs of each organization vary based on the size, qualification of its staff, and costs. However, given the vital role bookkeepers and accountants play, we advise you to play it safe and outsource.
If your organization has someone qualified on staff. Then weigh the cost/ savings benefits accordingly before you use in-house services. Hiring an outside firm like the Foundation Group that works exclusively with nonprofit organizations will save your organization thousands of dollars every year. An important fact to also consider is employee retention. Though qualified, will your in-house bookkeeper be with you for the long haul?