Reporting
The primary driving force behind a nonprofit is usually its mission. But every organization needs to manage its accounting to stay ahead.
Of course, accounting for nonprofits differs significantly from accounting for other organizations. Nonprofits generate and expend revenue through grants and donations rather than sales. Furthermore, nonprofits use their revenue to cover operations costs and pay for various programs.
These differences might create the impression that nonprofits don’t need to focus on accounting as much as for-profit organizations, but that’s not true. Nonprofits can benefit greatly from understanding how they perform financially. And to do that, they require a particular approach to accounting.
This article will explain what nonprofit accounting is and why it matters as much as it does.
In terms of accounting, nonprofit organizations have a stronger focus on accountability than profit. This is because they need to stay accountable for their donations from contributors. This dynamic also creates a unique form of financial management.
The grants that nonprofits receive from various organizations don’t function like loans. The recipient directs the received sum toward a program rather than repaying it. The money is used only for the immediate program costs, while all other expenses aren’t covered. The accompanying costs can include insurance or utilities, which can reach a considerable amount. This is one of the reasons why nonprofits need to keep track of their finances.
A nonprofit organization has to inform its stakeholders of the details of financial management. Since the donors can restrict their grants, the nonprofit must ensure that they direct the received funds toward the agreed-upon goal.
Nonprofits use fund accounting to manage this relatively complex situation. This type of accounting separates the nonprofit’s money into three groups: restricted, temporarily restricted, and unrestricted funds.
First, there are restricted funds that the organization needs to spend on strictly defined projects. Temporarily restricted funds are intended for particular projects but have a time limit. The nonprofit will transfer these funds into the unrestricted group after the designated period ends. Unrestricted funds function annually, and the nonprofit is free to spend it on any organizational aspect it deems a priority.
Essentially, a nonprofit uses fund accounting to track where money is assigned and how the organization uses it. No aspect focuses on profits since a nonprofit doesn’t generate any.
A nonprofit can set up separate accounts for different funds, each with a balance sheet and designated budget. This approach ensures proper control over the money that goes through the organization.
Fund accounting is not only beneficial for nonprofit organizations but also for city management, governments, churches, charities, universities, and hospitals.
Nonprofits also have a specific constraint that refers to the distribution of funds. While for-profits are free to distribute extra funds among their organization leaders, nonprofits aren’t allowed to do the same. Instead, if a nonprofit ends up with extra money, those funds won’t be considered net earnings. The organization will have to reinvest them in a different project on its mission.
As you can see, the accounting methods used for nonprofits are quite specific. Not surprisingly, the accounting reports for these organizations are particular as well.
Every financial statement should contain revenue, expense, and balance information. A nonprofit needs to provide this information for every fund the organization manages.
Professional accountants use particular guidelines to produce detailed and valuable reports for nonprofits. These guidelines are the Generally Accepted Accounting Principles (GAAP), which accountants adhere to across all sectors. These principles prescribe the essential documents and information for comprehensive accounting reports.
A nonprofit creates its budget according to the information provided by the development team. It also takes into account the organization’s spending habits.
The nonprofit uses the budget for expense prediction and resource allocation. The document contains details about the expected yearly revenue and costs, but the greatest emphasis is on the revenue. You can calculate a nonprofit’s revenue with historical data and the cutoff or the discount method.
In the case of the cutoff method, you multiply every stream of revenue by the nonprofit’s chance of getting a grant. For example, if the organization had a 50% chance of receiving the funds, you would multiply the revenue by 0.5.
On the other hand, the discount method considers the total revenue that the organization might receive. You multiply the total revenue by the probability index. For example, suppose a nonprofit expected $100,000 in grants with a 50% chance of getting the funds. You would multiply the expected revenue by 0.5, which would be $50,000.
If a nonprofit is looking for a more straightforward method, you can always list your expenses by category. The categories will vary from one organization to the other but usually include administrative costs, insurance, advertisements, and expenses for the programs.
In for-profit organizations, the statement of financial position is a balance sheet that shows the net equity of business owners and shareholders. Of course, since nonprofits don’t function as regular private businesses, the statement of financial position is a bit different.
The statement of financial position shows the nonprofit’s financial health. The document lists assets and liabilities and shows the net asset state of the organization. Calculating net assets is relatively uncomplicated. It’s the result you get when you subtract the value of liabilities from the value of assets.
The statement of financial position is vital for understanding where the organization stands financially. It can serve as an excellent point of orientation and influence the nonprofit’s direction. Of course, if the net assets are in positive values, that will indicate good financial health, and negative net assets will mean the opposite.
The statement of activities shows revenues and expenses divided into categories according to sources and individual costs. Nonprofits can track specific expenses and compare them to the revenue received from different sources.
The statement of functional expense provides the clearest overview of expenses. This document focuses on costs alone by showing them in separate categories and assigning each a function. These functions are program, administrative, and fundraising expenses.
The statement of functional expense is useful because it gives the organization a complete image of all costs. It also separates the expenses similar to Form 990, which all nonprofits must submit annually.
Form 990 represents a vital part of nonprofit accounting. All nonprofit organizations must submit this tax form to gain a tax-exemption status. The form is required for nonprofits to comply with IRS regulations, making it instrumental for the organization.
Form 990 records the yearly financial situation, including all revenue and expenses. The IRS uses the document to determine the legitimacy of the nonprofit.
The statement of cash flow is a breakdown of financial, investing, and operating activities. This document allows the organization to monitor the use of its funding from various revenue streams.
Accounting reports can provide a clear overview of all financial dealings. Understanding how this reporting works can help organizations manage their funds and create the most effective budget possible.
While proper budgeting and reporting might seem complex, following certain best practices can make those processes more manageable.
Some practices allow nonprofits to approach their accounting more effectively and make optional decisions about their financials. First, it’s best not to focus too much on overhead expenses. These are the expenses of administration, marketing, and other internal costs of the organization. In other words, they are everything that a nonprofit pays for outside of its programs.
Until recently, donors decided whether they’d invest in a nonprofit by looking primarily at overhead expenses. Naturally, this caused organizations to become overly focused on those expenses.
However, overhead expenses are unavoidable in nonprofit organizations, and donors have started to understand that aspect of the nonprofit sector. An organization’s community impact is a better way to determine if it’s worth investing in. Of course, nonprofits must also change their attitude toward overhead expenses and their role in budgeting.
A nonprofit’s budget should be addressed and checked frequently and regularly. Instead of annual reports, you should revisit the budget monthly. This way, the reports can be compared, and the budget evaluated against the expenses and revenue the organization has reached.
Regular budget checks can increase the organization’s capability to adapt. Nonprofits can encounter many unpredictable situations like discontinued projects or sudden funding changes. When those changes occur, a budget review can help the organization shift its strategy and distribution of funds.
Reliable internal control is another regular practice that can help nonprofits make their accounting more effective. Internal control prevents possible fraud and allows the organization to detect errors. Smaller nonprofits can implement an internal control system if they follow particular guidelines.
For instance, organization members can share tasks related to finances and set up security policies, specifically for data protection. The organization can also have a concise inventory of all fixed assets like computers, phones, and other means that allow the nonprofit to function.
When it comes to tools for this task, nonprofits should use specialized accounting software. This way, all financial information can be recorded and stored reliably.
Setting up proper accounting for your nonprofit can help your organization achieve its goals. Regular reporting can provide a clear picture of financial affairs and help form successful strategies.
Although it might seem a distant priority, these accounting reports will help your organization move forward. If you want to see how powerful financial reporting can help you progress your mission, don’t hesitate to sign up for a Swyft Books free trial.