Nonprofit accounting beginner’s guide and key financial statements

Nonprofit accounting isn’t just about balancing the books—it’s critical to the success of your organization's mission. Whether you rely on grants, donations, or earned income, the way you manage your funds directly impacts the effectiveness of your programs and services. 

Proper accounting practices ensure transparency, accountability, and the responsible use of resources—all of which are critical for gaining the trust of donors, funders, and stakeholders.

In this post, we’ll cover everything you need to know about nonprofit accounting, including how to set up your financial system, track expenses and revenue, maintain compliance with regulations, and prepare financial statements.

What is nonprofit accounting?

Nonprofit accounting vs. for-profit accounting

Nonprofit accounting best practices

4 key financial statements for nonprofit accounting

Streamline your accounting and save time

What is nonprofit accounting?

Nonprofit accounting is the process of tracking how a nonprofit organization receives and spends money. It involves budgeting, recording revenue and expenses, preparing financial statements, and ensuring compliance with laws and regulations.

A key aspect of nonprofit accounting is fund accounting, which categorizes resources based on their intended use. This ensures funds are spent according to their designated purpose and helps maintain transparency and accountability. 

Having your non-profit accounting running smoothly means more time spent towards your company’s mission and goals.

Nonprofit accounting vs. for-profit accounting

Understanding the differences between nonprofit and for-profit accounting is crucial to grasping their unique financial needs and reporting requirements. While both types track income and expenses, their focus and objectives differ significantly.

Nonprofit accounting

Nonprofit accounting focuses on tracking and reporting the costs of activities that support an organization’s mission and goals. 

Key aspects include:

• Grants and contributions: Monitoring funds received from donors, government grants, and other sources
• Program expenses: Recording costs directly related to running the organization's programs
• Fund accounting: Ensuring that funds are used for their intended purposes to help maintain transparency and accountability

The main goal is to make sure that all resources go toward maximizing the organization’s impact.

For-profit accounting

For-profit accounting, on the other hand, logs and reports the financial activities of a business driven by profit. 

Key aspects include:

• Revenue: Tracking revenue from the sale of goods or services
• Production costs: Recording expenses related to manufacturing goods or providing services, such as materials, labor, and overhead
• Profit focus: Aiming to maximize profit by managing income and expenses efficiently

Essentially, nonprofit accounting prioritizes transparency and the fulfillment of the organization’s mission over generating profit.

Nonprofit accounting best practices

Knowing the ins and outs of nonprofit accounting will help ensure accuracy, transparency, proper oversight, compliance, and financial accountability.

Nonprofit accounting typically involves preparing detailed financial statements that show how the organization is doing financially. These statements also disclose any related party transactions and other important information to help others understand the organization's operations.

Picking an accounting method

One of the first steps in nonprofit accounting is deciding how your organization will record financial activity: using cash-basis or accrual-basis accounting. The right method depends on your nonprofit’s size, funding sources, and reporting needs.

Accounting methods explained:

• Cash-basis accounting: This method records income and expenses only when cash is received or spent
• Best for: Small nonprofits with limited transactions or no major reporting requirements
• Accrual-basis accounting: This type logs income and expenses when the transaction occurs, even if the money hasn’t moved yet.
• Best for: Growing organizations that need to track receivables and payables or meet grant reporting standards
• Fund accounting: This is a specialized form of accrual accounting used by nonprofits. It tracks financial activity across different funds, such as grants, contributions, or restricted donations, so you can show how money is used based on donor intent
• Best for: Nonprofits, schools, churches, and other organizations that need to manage restricted funds, comply with donor restrictions, or demonstrate accountability for specific programs or grants. It is especially useful for entities with complex funding sources or legal requirements to track how money is allocated and spent.

Which method should you choose?

Cash-basis accounting

• Choose cash-basis accounting if your nonprofit is small, has simple finances, and doesn’t need to report to major funders.

Accrual-basis accounting

• Choose accrual-basis (and fund) accounting if your nonprofit receives grants and contributions with restrictions, reports to government agencies or foundations, or wants a more accurate financial picture.

Maintaining GAAP compliance

Complying with generally accepted accounting principles (GAAP) ensures your nonprofit’s financial reporting stays accurate, transparent, and consistent across reporting periods.

GAAP compliance provides a standardized framework for how nonprofits record and report financial activity. This makes it easier for donors, board members, and government agencies to understand and assess your financial health.

By following GAAP, you:

• Promote financial transparency and accountability.
• Build trust among stakeholders that grants and contributions are being used responsibly.
• Improve your chances of qualifying for funding, audits, and regulatory reviews.

Most importantly, you should adhere to proper disclosure procedures in all financial statements as outlined in the GAAP guidelines. This includes providing accurate information on all related financial transactions, such as donations and expenses.

Strengthening internal controls and auditing

Strong internal controls are essential for maintaining financial integrity and protecting your nonprofit’s assets. They help prevent fraud, ensure compliance, and build trust with donors and regulators.

Here’s how to establish effective internal controls:

• Segregate duties: Divide financial responsibilities among different staff members to prevent errors or misuse.
• Implement approval workflows: Require multiple layers of approval for major transactions and expenses.
• Conduct regular audits: Perform internal audits annually and schedule independent audits as needed.
• Use secure financial systems: Adopt accounting software with role-based access and audit trails to track changes.
• Review policies regularly: Keep your financial policies and procedures updated to align with changing regulations and best practices.

Budgeting

Budgeting for a nonprofit business should require the same care and attention to detail as any other organization. However, you should consider a few unique factors when budgeting for a nonprofit: 

• Operating revenue: Identify all income sources and consider any potential delays in payment. Include federal grants, donations, and membership fees in your budget projections.
• Expenses: Allocate funds for operational expenses like salaries, rent, utilities, office supplies, and other overhead costs.
• Program costs: Set aside funds for program-related expenses, such as staff training, materials and resources, and other costs associated with running the organization’s programs.
• Contingency: Establish a reserve fund to cover unexpected expenses or shortfalls so you don’t have to dip into program funds. This is especially important for organizations operating a large emergency or disaster relief program.
• Fundraising: Plan fundraising events and campaigns to bring in money for your organization. Make sure donations exceed the cost of hosting these events or campaigns.

By considering these factors, you can ensure your nonprofit organization has the necessary resources to reach its objectives while staying aligned with GAAP standards. 

You’ll also want to budget for tax-related obligations to maintain your tax-exempt status. Internal Revenue Code 557 outlines key reporting, filing, and public disclosure requirements. Failure to comply can result in penalties or loss of exemption, so review your tax returns carefully and make sure you're meeting all legal obligations.

Delegating duties

Delegating accounting tasks is also key. By assigning responsibilities based on skill and experience, you reduce the risk of errors and fraud, improve efficiency, and maintain compliance with legal and financial standards. It also frees leadership to focus on strategy while ensuring accountability to donors, funders, and the public.

Taking care of overhead

Efficiently managing overhead shows donors your nonprofit is financially responsible and focused on long-term sustainability. Here’s how to stay on top of it:

1. Review current policies

Check your nonprofit’s existing policies to see if overhead management is already addressed.

2. Define overhead expenses

Clearly outline what qualifies as overhead, such as rent, utilities, administrative salaries, and accounting software, and how these costs will be tracked.

3. Track all expenses

Maintain accurate records and review them regularly to spot overspending or inefficiencies.

4. Budget for overhead

Include overhead costs in your annual budget. Don’t underestimate them—they’re essential to your operations.

5. Monitor and adjust

Compare actual overhead spending to your budget throughout the year. Adjust as needed to stay within limits.

6. Use available funding sources

Apply for public or private grants that help cover administrative costs to ease your nonprofit’s burden.

7. Require approvals

All overhead spending should be approved by a board member or authorized individual before being charged to the organization.

8. Audit regularly

Conduct periodic audits to ensure transparency and confirm that expenses align with budget guidelines.

Donors will be more likely to give if they feel confident that you’ll use their money wisely. This includes investing in essential overhead costs like technology, personnel, and other operational needs.

Managing donor funds with transparency and accountability

Donor trust is a cornerstone of nonprofit success. Proper donor management ensures that contributions are used as intended and that your organization meets all legal and ethical responsibilities.

Best practices for donor fund management:

• Track restricted vs. unrestricted funds: Use fund accounting to clearly report how each donation is allocated and spent.
• Acknowledge donations: Send timely, personalized thank-you notes for tax purposes and to maintain goodwill.
• Report back to donors: Share financial reports and impact updates to illustrate how their contributions made a difference.
• Avoid commingling funds: Keep separate records and bank accounts for restricted funds when appropriate.
• Ensure data privacy: Protect donor information in compliance with data protection laws and ethical standards.

Diversifying nonprofit revenue streams

Relying too heavily on a single income source can leave your nonprofit vulnerable. Diversifying your revenue streams strengthens stability and helps sustain your mission over the long term.

Here are common income streams for nonprofits:

• Individual donations: Develop donor campaigns and recurring gift programs.
• Grants: Apply for funding from government agencies, corporations, or foundations that align with your mission.
• Fundraising events: Host events or galas to raise money and attract new supporters.
• Earned income: Consider selling goods or services related to your mission, such as educational materials or consulting.
• Memberships and sponsorships: Offer perks in exchange for ongoing support from individuals or businesses.
• Investments: Use reserve funds strategically, in accordance with board-approved investment policies.

Paying employees

Proper employee compensation boosts morale, productivity, and performance. Follow these six steps to manage employee payments effectively while staying compliant with regulations:

1. Classify employees correctly

Ensure employees are properly classified: either as independent contractors or employees. This affects benefits and tax reporting.

2. Set clear pay rates

Define pay rates for each position and communicate them in the employee handbook. This ensures transparency and consistency in compensation.

3. Adhere to labor laws

Always follow federal and state labor laws, including minimum wage requirements, overtime rules, and other compensation regulations.

4. Calculate and report taxes accurately

Correctly calculate taxes—such as federal and state income tax, FICA (Social Security and Medicare), and unemployment taxes—while ensuring timely and accurate reporting to tax authorities.

5. Document payments properly

Keep detailed records of employee payments, including timesheets, payroll records, and check stubs. Retain them for at least seven years for potential audits.

6. Maintain accounting best practices

Follow proper accounting procedures for employee payments, including regular bank reconciliations, accurate record-keeping, and adherence to GAAP standards.

4 key financial statements for nonprofit accounting

Nonprofits use financial statements to ensure transparency and accountability, allowing stakeholders, donors, and government agencies to evaluate the organization’s financial health. This is especially important because board members have a fiduciary duty to be transparent about financial matters.

It’s critical that financial reporting is accurate, consistent, and reflects the true nature of the organization's operations. 

Additionally, you’ll need financial statements to obtain and maintain funding, grants, and other forms of support. Accurate financial statements also help nonprofits manage charitable resources responsibly, ethically, and in accordance with applicable laws.

1. Balance sheet

Also known as the statement of financial position, the balance sheet gives a snapshot of a nonprofit’s financial health. It lists what the organization owns (assets), what it owes (liabilities), and the difference between the two (net assets).

Balance sheet formula:

Net assets = Assets - Liabilities

This statement helps stakeholders assess whether the organization can meet its goals and fund its programs. It’s a key tool for tracking financial stability and making strategic decisions.

How to create your balance sheet:

1. List your assets

Include everything the nonprofit owns, such as:

• Cash
• Accounts receivable (invoices owed)
• Inventory
• Prepaid expenses
• Equipment
• Investment
• Other assets

2. List your liabilities

Capture everything the nonprofit owes, including:

• Accounts payable (bills to vendors)
• Notes payable
• Deferred income
• Other outstanding debts

3. Calculate your net assets

Subtract total liabilities from total assets to find the organization’s net assets. This represents the nonprofit’s net worth.

4. Double-check your numbers

Review all entries for accuracy. Every asset and liability must be precisely recorded.

5. Make sure it balances

Your total assets should always equal the sum of liabilities and net assets. If they don’t, recheck your calculations—there may be an error.

2. Statement of cash flows

The statement of cash flows shows how cash moves in and out of a nonprofit over a specific period, tracking where cash comes from, how it’s used, and how the cash balance changes. It offers a clear view of liquidity and operational sustainability.

3 cash flow categories:

• Operating activities: Cash inflows from donations, grants, program income, and other day-to-day operations. Cash outflows for expenses like salaries, supplies, and administrative costs.
• Investing activities: Cash inflows from interest, dividends, or selling investments. Cash outflows from purchasing assets.
• Financing activities: Cash inflows from loans, large donor contributions, or restricted funds. Cash outflows for loan repayments or other financing costs.

How to complete a nonprofit cash flow statement: 

• Cash from operations: Include all income from core activities—donations, grants, ticket sales, fundraising events, and merchandise.
• Cash from investments: Track income from financial investments (such as stocks or bonds) and asset sales.
• Cash from financing activities: Record proceeds from loans, restricted contributions, or capital campaigns.
• Net cash flow: Subtract total cash outflows from total inflows to determine your net cash flow for the period. This number reflects your organization’s short-term financial health.

Additional details to include:

• Unrealized gains or losses on investments
• Noncash transactions, like depreciation or amortization

As with all financial statements, double-check for accuracy and ensure all figures are current before submission.

3. Statement of functional expenses

The statement of functional expenses breaks down a nonprofit’s spending by function (why the money was spent) and nature (what it was spent on). This report gives a detailed view of how resources are allocated, helping stakeholders evaluate how effectively the organization uses its funds.

Common expense categories:

• Program services: Costs directly tied to the nonprofit’s mission and services
• Management and general: Administrative expenses like office rent, salaries, and insurance
• Fundraising: Expenses related to donor outreach, campaigns, and events

This statement helps you track spending patterns, ensure compliance, and make informed budgeting decisions.

How to complete a statement of functional expenses:

1. Start with total expenses. List all expenses for the accounting period.

2. Categorize expenses by function. Split total expenses into:

• Administrative: Office rent, utilities, payroll, insurance, etc.
• Program-related: Costs directly associated with delivering services (e.g., staff salaries, supplies, contractor fees)
• Fundraising: Expenses for campaigns, events, and donor communications

3. Assign amounts to each category. Enter specific expenses under their appropriate functional categories.

4. Include total income. Record all income received during the same period, including:

• Donations
• Grants
• Investments
• Other revenue sources

5. Calculate net income. Subtract total expenses from total income to determine your net income (or net loss) for the period. Display this figure clearly on the statement.

4. Income statement

Also called a statement of activities, the nonprofit income statement shows how money comes in and goes out over a specific period. It outlines revenue sources and expenses, helping you understand whether the organization is operating at a surplus or deficit.

Unlike for-profit businesses that focus on profit, nonprofits track net income, which represents what’s left after covering expenses. This figure indicates whether the organization can sustainably support its mission moving forward.

What to include in a nonprofit income statement:

1. Revenue

List all income sources, such as:

• Grants and contributions
• Membership dues
• Program service fees
• Earned income (e.g., ticket or product sales)
• In-kind donations or donated services

2. Expenses

Break down your costs by category, including:

• Salaries and benefits
• Office supplies and rent
• Administrative and overhead costs
• Program delivery expenses
• Depreciation or amortization

3. Net operating income

Subtract total expenses from total revenue to calculate your net operating income. This figure shows whether your nonprofit is running at a gain or loss for the period.

4. Other revenue streams and expenses

Include items outside regular operations, such as:

• Investment gains or losses
• One-time grants
• Tax refunds or payments

5. Total income and expenses

Add up all revenue and expenses, including operating and non-operating items.

6. Net income

Finally, subtract total expenses from total income to determine your net income: the amount available for future programs, reserves, or reinvestment in your mission.

Streamline your accounting and save time 

Strong nonprofit accounting practices are the foundation for efficient financial management. By leveraging online accounting solutions, you can simplify tasks like bookkeeping and reporting, allowing your staff and volunteers to dedicate more time to mission-critical activities.

With nonprofit accounting software, you can seamlessly organize financial statements and donor data. An online accounting solution like QuickBooks provides a user-friendly dashboard and reporting tools that give you real-time insights into your organization's financial health. This valuable knowledge enables you to make data-driven decisions and optimize your fundraising and grant-seeking efforts.