When setting up a nonprofit organization, the main aim is to conduct activities that can be of assistance to certain groups within society. Apart from the purpose, the ownership, structure, recruitment, and finances of a nonprofit organization are undoubtedly different from those of a for-profit organization. However, since nonprofits are not created for making profits, it is possible to assume that accounting is not important as long as you are using the donated funds for the right things. But you couldn’t have been further from the truth.
In reality, accounting for a non-profit organization may be an important factor that will make or mar the progress of such an organization. Without proper accounting, donors may not have enough trust in the organization; hence, donations may stop. Therefore, every nonprofit organization must dedicate some periods to learn about nonprofit accounting.
This detailed guide will show you everything you need to know about accounting for a nonprofit organization.
What does nonprofit accounting entail?
Nonprofit accounting is a unique accounting system that is particularly designed to manage, report and keep a record of the financial activities of nonprofit organizations. This system takes into consideration the peculiarities of nonprofit groups and provides them with accounting services that can take care of their needs. Some of the important peculiarities of nonprofit organizations that affect their finances include reliance on donations or contributions from third parties and lack of ownership interest.
Important terms for nonprofit accounting
Furthermore, there are certain terms that are often used for nonprofit accounting that you should familiarize yourself with. These terms include:
Liabilities – this term refers to the payables, loans and other things that your nonprofit organization owes.
Assets – this term is used for equipment, patents, cash and other items that are owned by your organization.
Net asset – this is the difference between the assets and liabilities.
Revenue type – revenue type refers to the means through which your nonprofit organization gets money that is used for its various activities. Typically, this may include several options such as offline or online donations, tickets, membership fees, program or service fees, and grants.
Programs – these are the services that the organization offers. Before, during and after a program, it is important to keep the record of the expenses and revenues.
Administration funds – these are the funds that are used for salary, procurement of office tools, maintenance and other important activities that are essential for the day-to-day operations of the nonprofit. A nonprofit organization must record and report the administration funds in its financial statements.
Donation restrictions – donation restrictions highlight the types of services or programs that the donors want their donations or contributions to be used for. These donation restrictions can be of three types.
- Permanent restriction – the organization cannot use the fund for anything apart from the investment. Nonetheless, any profits made from the investment can be used for different programs and services.
- Temporary restriction – the organization can only use these donations for certain purposes or at a particular period. For instance, a donor may want a nonprofit organization to use their donations only during an outbreak. Such an organization must adhere to the restrictions.
- Unrestricted – as the name suggests, the donations can be utilized for any program or service and at any time.
It is important to understand that a nonprofit organization must include all these types of donation restrictions in their accounting.
Preparation of financial statements for nonprofit organizations
Generally Accepted Accounting Principles (GAAP) are the standard guidelines that must be duly followed for the preparation of financial statements of any organization. These guidelines also make provisions for nonprofit organizations. The guidelines for nonprofit groups include:
Statement of activities
This statement focuses on highlighting all the services and programs that are provided by a nonprofit group. The statement of activities must indicate the expenses and revenues of an organization during a set time. Besides, donor restrictions should also be reported in this statement.
Statement of financial position
The statement of financial position performs the same function that a balanced sheet does for for-profit organizations. Typically, it contains the details of the assets, liabilities and net assets. This statement succinctly shows the financial standing of the organization; thereby, letting everyone know whether it is healthy or not. Notably if a nonprofit is financially healthy, the net assets will be. However, if it is not, it will indicate a deficit.
Statement of cash flows
This statement records and reports the amount that is coming in and going out of the nonprofit organization within a particular period. This amount may come in the form of cash or cash equivalents that are used for various activities. If the inflow is lower than the outflow, the statement of cash flows will be negative. Nevertheless, if the inflow is more than the outflow, the statement will indicate positive results. Whether negative or positive, periodic fluctuations of the cash flows do not necessarily reflect loss or profit for the organization.
Primarily, the statement of cash flows comes with three basic segments, which are:
- Financing segment – this segment indicates the amount of repayments or borrowings that the organization got at a specific period.
- Investing segment – this reports the amount spent by the organization on equipment, investment and other long-term assets that will be useful in the future.
- Operating segment – this segment of the statement is dedicated to the cash flows that cannot be reported under the financing segment or investing segment.
Statement of functional and natural expenses
This statement simply provides another way of reporting the expenses of the nonprofit group. Expenses can be broken down into either function, such as administrative and services, or nature such as supplies and salaries. The essence of the statement of functional and natural expenses is to help you monitor your activities over a period.
Filing for tax
If you run a nonprofit, you must understand that tax filing is one of the cornerstones of your organization. For nonprofit in the USA, the IRS offers tax exemption to several types of nonprofit groups. In other words, a lot of nonprofit organizations do not have to pay tax to the state and the federal government. In other countries, a similar tax exemption is available for some types of nonprofits. Nevertheless, do not make assumptions; confirm if your nonprofit falls under the types that have been exempted.
Whether your nonprofit is exempted from paying taxes or not, it is still imperative for you to file a Form 990, which is a yearly information document for organizations. With the aid of this document, the IRS and public can have access to the operations, finances and mission of your nonprofit for the previous year. Based on the gross receipts or assets of your group, you may need to file Form 990, 990-N, 990-EZ or 990-PF.
Best practices to ensure high-quality nonprofit accounting
Have a separate bank account for your nonprofit
One of the easiest ways to lose track of your finances is by using a personal bank account for a nonprofit. Create a separate account for the organization and let the bank offer you services that are customized to suit your needs.
Invest in a professional accountant
Although one of your staff members may be able to prepare the basic financial statements for your nonprofit, you should still consider hiring a professional accountant. Without a doubt, there will be a noticeable difference in the financial statements prepared by an untrained individual and the one prepared by a professional.
A miscalculation, unintentional omissions, and other fraudulent activities often characterize financial reports of untrained people. So, investing in a professional accountant will secure the financial statement of your nonprofit. Besides, the accountant may help you to file taxes.
It should be noted that you do not have to hire a professional accountant to work full-time with your team. You can simply outsource your accounting need to an experienced freelance accountant. The cost of hiring an accountant should be reported as parts of administration.
Create and implement a code of ethics
A code of ethics is designed to show what your nonprofit organization stands for and provide guidelines that everyone must follow to make sure the group can achieve its goals. Although this code of ethics may not stop fraudulent activities, it will make it easy for everyone to detect such activities.
Be realistic with your fundraising expectations
As many donors are showing interest in making contributions for your nonprofit organizations, it is easy for you to be carried away and have unrealistic fundraising expectations. Such expectations can make you create budgets your organization may never be able to handle. This will only set you up for disappointment. Therefore, you must learn to manage your fundraising expectations. Use proven records and tools to build fundraising plans and expectations.
Use reliable accounting software
We are in a technologically advanced world, so there are tons of software that can ease nonprofit accounting. Some of the best software available today are Aplos, Nonprofit Treasurer, AccuFund Fund Accounting Suite, Financial Edge NXT, and Sage Intacct Cloud Accounting. These tools can help you keep track of cash flows, record disbursement, and organize all receipts.