Nonprofit organizations play a crucial role in addressing societal needs by championing causes that matter most to the communities they operate within. If you work within the nonprofit space, you know firsthand how important mission-driven work can be, and how important it is to maximize the impact and reach of that work by making every dollar count. That means paying special attention to the accounting practices at the heart of nonprofits' operations, knowing they can be leveraged to enhance organizational efficiency and ultimately amplify the impact you can make for the community you serve.
Nonprofit Accounting: A Different Kind of Bottom Line
Unlike a for-profit business, which aims to generate profits and maximize shareholder value, nonprofits must serve the public interest while fulfilling a specific charitable goal or set of social objectives. It's not that there's no bottom line for nonprofits, it's that there are multiple bottom lines to measure your impact by.
Of course, you're hoping to have a positive impact financially, spending fund resources wisely while fundraising successfully. The people and relationships that keep the whole thing running are another "bottom line", while the efficacy of the mission itself is yet another. Nonprofit professionals can feel like they're always trying to transform qualitative goals into quantifiable results — all while staying abreast of changing policies and compliance directives.
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If there's a specialized software for that, we (and practically every nonprofit bookkeeper) would love to see it! While we're waiting for that to launch, we can at least make managing multiple bottom lines more realistic with this post: a not-for-profit accounting guide you can actually use.
4 Key Differences Between For-Profit & Nonprofit Accounting
The distinction in purpose between profit-generating companies and their nonprofit counterparts impacts how financial transactions are recorded, reported and analyzed. To understand why accounting is important for nonprofit organizations and start implementing best practices for getting the job done right, you need to know key ways it diverges from the accounting for profit companies:
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Funding source(s): For-profit organizations primarily generate revenue from the sale of goods or services, whereas nonprofits rely on a combination of funding sources, including donations, grants, fundraising events, and program fees
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Profit prioritization: For-profit entities focus on measuring profitability through metrics such as net income, gross profit, and earnings per share. By contrast, nonprofits aim to achieve a surplus of revenues over expenses, which is reinvested in furthering their mission rather than distributed to owners or shareholders.
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Fund accounting: Nonprofit organizations use fund accounting, which involves tracking and reporting funds separately for different purposes or programs. This allows nonprofits to be transparent and demonstrate compliance with donor restrictions toward allocation and utility. We'll explore this a little more in-depth below.
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Taxes: Nonprofit organizations typically enjoy tax-exempt status, which grants them certain advantages, such as exemption from income taxes. The tradeoff comes in compliance with associated reporting requirements and restrictions.
Ultimately, there's more overlap than not when it comes to best bookkeeping and accounting practices for both nonprofits and for-profit organizations. You'll follow much of the same GAAP for nonprofits that you would in any business, and sometimes, it will feel just as tedious. That's especially true if your resources allow for a team made up primarily of many volunteers among a few essential staff members, each of whom is likely more interested in your mission than your margins, unless you have dedicated accountants working for you.
What Kind of Accounting Do Nonprofits Use?
Remember when we said that we'd come back to the concept of fund accounting? We're as good as our word. Nonprofits must manage multiple funds dedicated to a specific purpose or program, and nonprofit accountants must carefully allocate and track each fund across different accounts and categories. It's a lot, sure, but it all helps ensure that each fund's resources are utilized appropriately and in accordance with donor restrictions.
Specifically, nonprofit dollars are divided into three main categories:
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Restricted: When a donor gift or won grant or is explicitly earmarked for a specific project, initiative or expenditure, it's considered restricted and cannot be diverted toward anything else
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Temporarily restricted: Money in this fund must be diverted toward a specific activity or project until a specific date
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Unrestricted: Any financial resources that are not earmarked for a specific or time-bound initiative or project are considered restricted and can be used at the nonprofit's discretion
Read More: How to Increase Transparency & Visibility in Accounting Processes
What to Know About the Documents, Financial Statements & Reports Used in Accounting for Nonprofits
We mentioned that much of the GAAP nonprofit accountants use align closely with the GAAP their for-profit counterparts use in day-to-day work. That's true, but there's an additional twist. Think of FASB 117 as the cherry on top of a dotted-"i" sundae, courtesy of the Financial Accounting & Standards Board (FASB). It says:
"[FASB 117] establishes standards for general-purpose external financial statements provided by a not-for-profit organization. It specifies that those statements include a statement of financial position, a statement of activities, and a statement of cash flows …"
In plain speech, nonprofits must include a set of four financial statements in the reports they generate:
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Statement of Cash Flow – On its face, this financial statement seems straightforward enough (total cash received minus total cash spent), but generating it tends to be what nonprofits struggle with most to remain compliant. Using cash accrual accounting, nonprofits must track operating, investing and financing cash flow.
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Statement of Activities – Three financial reports exist within an organization's statement of activities, which allow watchdogs, governing bodies, donors and nonprofits themselves to understand how an organization is faring financially and evaluate performance:
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Income Statement: This financial statement reflects revenue minus expenses for the nonprofit and must be broken down by fund, functional area and net asset class (net assets with and without donor restrictions).
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Statement of Changes to Net Assets: Drilling down into net assets, this statement assesses the effort and effectiveness of the nonprofit to provide their services and must be listed by line item in each asset class category.
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Statement of Financial Position: A nonprofit statement of accounts creates a snapshot of all assets and liabilities and can be used to calculate an organization's net worth or loss.
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Statement of Functional Expense – Since 2017, nonprofits have been required to keep a financial statement that accounts for expenses by function (administrative, fundraising and programming) to track real costs.
An additional document to be aware of as a nonprofit is the IRS 990 form, which nearly every nonprofit must file each year to be eligible for tax-exempt status as a charitable organization or 501(c)(3).
Don't skip it! This informational form serves as something of an annual report that outlines your organization's financial health, it keeps you on the right side of IRS regulatory compliance. After three missed filings, your organization can automatically lose its tax-exempt status. Staying current and meeting the 990 deadline each year not only ensures forward-facing accountability for the public and compliance with IRS regulations, it gives you a chance to take stock of where you can leverage accounting to make an even bigger impact.
It's an excellent opportunity to check in on the health of your:
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Budget and financial planning process
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Internal controls and segregation of duties
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Financial recordkeeping and reporting processes
CFO Weekly Podcast: Episode 27 - For-Profit Skills in a Non-Profit World
Make an Impact When You Outsource: Nonprofit Accounting Specialists & Providers
Nonprofits already have hurdles to clear around fundraising, including managing cash flow strategically enough to ensure there's enough in the coffers to continue to provide the programming the communities they serve rely on to fulfill unmet needs — and that's in a good year.
If you do have access to accounting talent, they're likely already spread pretty thin and with the need for nonprofit offerings showing no sign of slowing down, that can leave important accounting work undone, open it up to mistakes and risk relationships with valuable donors.
So, how can you start making a bigger impact? Simple. You leverage outsourcing to put every dollar to more important initiatives. A reputable and experienced outsourcing provider can bring a lot to mission control:
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Cost savings: Outsourcing accounting functions can usually help nonprofits save up to half of the costs they'd normally budget toward hiring and maintaining an in-house accounting team. Nonprofits can allocate the difference toward core programs and activities, allowing them to expand their impact and reach more beneficiaries.
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Expertise: Outsourced accounting providers typically have specialized expertise in nonprofit accounting. It's their job to stay up to date with the latest regulations, reporting requirements and best practices specific to the nonprofit space. It's like a secret weapon nonprofit entities can deploy to ensure accurate financial reporting, compliance and efficient financial management.
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Scalability & flexibility: Outsourced accounting services offer scalability to accommodate the changing needs of nonprofit organizations. For instance, at Personiv we create virtual accounting solutions that start with teams as small as one — and grow as needed. Flexibility like this allows nonprofits to focus on their mission while ensuring their accounting needs are adequately addressed even if those needs change.
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Nonprofit accounting software: Some providers leverage advanced technology, software and tools that streamline processes to improve efficiency, and nonprofits reap the benefit of faster and more accurate financial reporting, enhanced data analysis, and improved overall financial management.
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Risk mitigation: Outsourced accounting providers can identify potential risks and implement preventive measures to safeguard nonprofit entities' financial assets — reducing the risk of fraud, errors and financial mismanagement to ensure resources are used effectively to maximize impact.
When you're ready to make the most impact as a nonprofit, Personiv can help refocus your attention to the valuable, mission-driven work you do and away from time-consuming accounting tasks that don't drive it.
Read More: Personiv Ranked Among Top 200 Outsourced Accounting Firms
Want to see how much money we can save you while freeing up more time in your day? Check out our pricing structure here and see what drives us as an organization whose commitment to Giving Back aligns with your values.
Then get in touch and tell us how we can help you make a bigger impact.
