Nonprofit accounting beginner’s guide and key financial statements

Nonprofit accounting is crucial for any organization that relies on donations and grants to fulfill its mission, not just those without revenue. It goes beyond simple income and expense tracking. Nonprofit accounting ensures your organization uses its financial resources effectively to move your mission forward.

This guide will cover all the essentials of nonprofit accounting, from setting up your books to preparing financial statements. With this knowledge, you'll be able to make data-driven decisions and manage your nonprofit's finances with confidence.

• What is nonprofit accounting?
• Essential elements of nonprofit accounting
• 4 key financial statements for nonprofit accounting
• Streamline your accounting and save time
• Nonprofit accounting FAQ

What is nonprofit accounting?

Nonprofit accounting is the practice of tracking and accounting for funds received or disbursed by a nonprofit organization. It includes recording nonprofit growth in revenues and expenditures, tracking expenses, preparing financial statements and analysis reports, budgeting, and ensuring compliance with relevant laws and regulations. 

This type of accounting is similar to corporate accounting in many respects, but there are also rules, regulations, and reporting requirements specific to nonprofit organizations. It ensures that all resources go to supporting the organization’s mission.

Nonprofit accounting vs. for-profit accounting

Nonprofit accounting tracks and reports the costs of activities associated with an organization’s mission and goals, such as donations and program expenses. It also focuses on the sources of funds that support an organization’s activities, such as grants and contributions. 

On the other hand, for-profit accounting involves tracking and reporting revenues from and expenses of producing goods or providing services for a fee. For-profit accounting also focuses on revenue sources and production costs, such as materials and labor.

Essential elements of nonprofit accounting

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

Nonprofit accounting procedures typically involve preparing detailed financial statements that provide an overview of the organization’s financial health, as well as disclosure of any related party transactions and other information to ensure readers can make informed judgments about the organization’s operations.

Picking an accounting method

The first step to accounting for nonprofits is choosing whether your organization should use cash-basis or accrual-basis accounting. When deciding between the two,  you should consider your nonprofit’s financial and reporting needs and what it’s better equipped for. 

• Cash basis accounting: Records income and expenses when cash is received or paid out. 
• Accrual basis accounting: Records income and expenses according to when the transaction occurs, regardless of when the cash is received or paid out. 
• Fund accounting: A type of accrual accounting method that specifically caters to nonprofit accounting needs.

The cash-basis method is usually simpler to maintain than the accrual-basis method and may be adequate for smaller nonprofits. However, the accrual-basis method may be necessary if the organization plans to seek funding from larger donors. 

Nonprofits, in particular, follow a specific type of accrual accounting called “fund accounting,” which tracks expenses and income in separate funds or accounts representing specific revenue sources like donations or grants. It also helps nonprofits measure their financial performance against their charitable goals.

Maintaining GAAP compliance

Complying with the generally accepted accounting principles (GAAP) will ensure that your nonprofit reports financial information accurately, transparently, and consistently. 

GAAP compliance establishes guidelines for financial reporting so the public can better understand and compare the financial health of different organizations. As a result, it ensures that donors, investors, and other stakeholders can trust their donations or investments are going toward a financially sustainable organization.

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

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 to cover operational expenses such as salaries, rent, utilities, office supplies, and other overhead costs.
• Program costs: Allocate funds to cover necessary program-related expenses such as staff training, program delivery 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 if a surprise expense arises. This could be especially helpful for organizations operating a large emergency or disaster relief program.
• Fundraising: Plan fundraising events and campaigns to bring in the necessary resources for your organization. You’ll want to make sure donations exceed the cost of hosting such events or campaigns.

By considering these factors, you can ensure that your nonprofit organization has the necessary resources to reach its objectives and is in line with GAAP standards.

Taking care of overhead

Taking care of overhead before seeking out donors for a nonprofit demonstrates financial responsibility and a commitment to efficiency—important decision-making factors for potential donors.

Here's how to successfully handle overhead:

1. Review existing policies: Start by reviewing existing policies and procedures to ensure that there is no existing guidance addressing the issue of handling overhead expenses in your nonprofit business.

2. Define overhead expenses: Clearly define what constitutes overhead expenses and how you will account for them in your nonprofit's budget.

3. Track expenses: Keep complete records and track them regularly. This will help you identify potential overspending and make adjustments as needed.

4. Make a budget: Make sure to include an appropriate allowance for overhead expenses in each year's budget and any other necessary expenses.

5. Monitor expenses: Monitor overhead expenses closely to ensure that spending does not exceed the allotted budget for the year. If necessary, adjust the budget to ensure that spending remains within the allotted amount.

6. Utilize resources: Utilize available resources and grants from public and private sources as much as possible to reduce overhead costs.

7. Seek approval: All overhead expenditures should require approval from a board member or other authorized party before charging them to the nonprofit's account.

8. Audit statements: Periodically audit financial statements to ensure all expenses are properly recorded and that spending is within budget guidelines.

Donors will be more likely to give if they feel confident that you will use their money wisely. This includes investing in necessary overhead expenses such as technology, personnel, and other operational costs.

Delegating duties

Delegating accounting tasks in nonprofit organizations ensures the organization is mindful of its financial commitments and adheres to legal and tax requirements.

Bookkeeping tasks include:

• Keeping accurate records of all financial transactions
• Recording expenses, such as payroll and charitable donations, accurately and on time
• Reconciling bank accounts and other financial records
• Maintaining and updating a system of accounting records and procedures
• Generating reports on financial activity and submitting them to the nonprofit’s board of directors
• Tracking accounts payable and receivable

Accounting tasks include:

• Analyzing operational performance, comparing actual results against budgets, and preparing financial statements for review by management and the board of directors
• Forecasting expenses, revenues, cash flows, and other items by creating models and financial reports to gain insights into the current financial performance of the organization
• Identifying areas to implement cost savings or improved processes 
• Working with the audit committee to ensure the accuracy of financial statements and compliance with government regulations and GAAP compliance
• Assisting in budget preparation and reviewing budget performance reports regularly

Proper accounting and financial management are necessary for nonprofit organizations to stay viable and remain accountable to the public, donors, funders, and other stakeholders. The delegation also helps alleviate leadership of day-to-day accounting tasks and allows them to focus on other organizational objectives. 

Additionally, delegating these tasks allows for more accurate tracking of budget investments, which assists with planning and forecasting into the future by improving operational efficiency, reducing costs, and increasing profits.

Paying employees

Properly paying employees can help boost morale and motivation within the organization, leading to greater job satisfaction, improved productivity, and better quality services from the nonprofit.

Here are the six steps to effectively paying your employees:

1. Ensure proper classification of employees: All employees must be classified correctly, such as whether they are paid as independent contractors or employees. This ensures they receive the full benefits they’re entitled to and that they properly report their taxes.

2. Set clear pay rates: Establish pay rates for each job and state them in the employee handbook. This will avoid confusion when it’s time to pay employees, ensuring they receive accurate and consistent pay.

3. Follow fair labor standards: Nonprofit organizations must follow applicable federal and state labor laws, which include minimum wage standards, overtime rules, and compliance with other compensation regulations.

4. Calculate and report taxes: Follow all laws related to the taxation of wages and benefits. This includes accurately calculating federal and state taxes, FICA (Social Security and Medicare) withholding, and applicable unemployment compensation taxes.

5. Properly document payments: Produce documentation of all employee payments, such as timesheets, payroll records, check stubs, and other payment information, to ensure GAAP compliance. Records should be kept for seven years in case of an audit by a governmental agency or tax authority.

6. Maintain proper accounting practices: Nonprofits must maintain proper accounting practices regarding employee payments as part of their GAAP compliance obligations. This includes regularly reconciling bank accounts, maintaining detailed records of payments, and ensuring proper bookkeeping practices.

Tackling taxes

Nonprofits must abide by the laws concerning taxes, filing deadlines, and any other applicable regulations that pertain to their special tax status. Failure to comply with these requirements can result in loss of tax-exempt status, significant penalties, and fines. 

All nonprofit executives should be aware of Internal Revenue Code 557, which outlines the requirements for maintaining tax-exempt status, such as filing necessary forms and providing public disclosure of certain financial information. 

It also outlines the reporting, filing, and notification requirements related to a nonprofit's activities. In addition, this code discusses the circumstances in which a nonprofit organization will be liable for taxes, penalties, and other charges.

4 key financial statements for nonprofit accounting

Nonprofits use financial statements to provide transparency and accountability so nonprofit stakeholders, donors, and government agencies can evaluate the organization’s financial health. This is especially important since board members have a fiduciary duty—requiring them to be transparent about finances.

Keep in mind that financial reporting should be accurate and consistent and reflect 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 ensure nonprofits manage charitable resources responsibly, ethically, and according to applicable laws.

1. Balance sheet

Also known as the Statement of Financial Position, a balance sheet is an important document that nonprofits use to track their assets, liabilities, and net assets. When building out your balance sheet, you’ll use this formula:

Net assets = Assets - Liabilities 

The point of this statement is to help determine whether or not the organization meets its goals or has enough funds to support its programs. You’ll be able to provide a snapshot of the organization's financial health so that stakeholders can assess its performance and decide its future direction. 

To accurately fill out your balance sheet, follow these steps:

1. Begin by entering the company’s assets: These include cash, accounts receivable (invoices due to the nonprofit), inventory, prepaid expenses, equipment, investments, and any other assets that the organization holds.
2. Enter the organization’s liabilities: These include accounts payable (monies owed to creditors or vendors), notes payable, deferred income, and any other liabilities the nonprofit has incurred.
3. Calculate the organization’s equity: This is the difference between the assets and liabilities of the nonprofit, and you can calculate it by subtracting the liabilities from the assets. Equity represents the net worth of the nonprofit.
4. Ensure all totals are accurate: It is important to double-check that all assets and liabilities are accurate and the equity figures are correct.
5. Make sure totals on both sides are balanced: Once you make all entries on both sides of the balance sheet, ensure that total assets match total liabilities. If these do not match, it may indicate a calculation error and must be corrected accordingly.

2. Statement of cash flows

A statement of cash flows is a financial statement that provides information about a nonprofit organization's cash receipts and payments. It helps to illustrate how cash flows in an organization and cash balance changes over time.

The statement of cash flows includes three basic activity types: 

• Operating activities: Cash inflows from operations (donations, grants, etc.) and cash outflows from operations (employee salaries, supplies, administrative costs) 
• Investing activities: Cash inflows from investments (income from investments) and cash outflows from investments (purchasing investments)
• Financing activities: Cash inflows from financing sources (loan payments) and cash outflows from financing sources (loan repayments)

To correctly fill out a statement of cash flows as a nonprofit organization, you’ll need to provide data on the cash received or expended during the period in question, including the following items:

• Cash from operations: This figure represents the total cash generated from donations, grants, and other revenue-generating activities. This can include sales from merchandise, ticket sales, and fundraising events.
• Cash from investments: This figure represents the total cash generated from investments like stocks, bonds, and securities.
• Cash from financing activities: This figure represents the total cash generated from loans, donor contributions, and other financing sources.
• Net cash flow: Calculate this figure by subtracting the total cash outflows (including payments made on loans) from the total cash inflows during the period in question. It is an important measure of overall financial performance.

You may also need to provide other information, like unrealized gains or losses on investments and noncash transactions, such as depreciation or amortization expenses. As with any financial statement, ensure that all figures are accurate and up to date before submission.

3. Statement of functional expenses

A statement of functional expenses for nonprofit organizations is a financial report that itemizes expenses according to their purpose. This report provides information on where resources have been committed and allocated within an organization. 

Typical categories include program services, management and general, fundraising, and other sources of income. You can use the statement to assess the usage of funds, track performance, and make decisions about future operations.

Follow these steps to fill out your statement of functional expenses:

1. Enter your organization's total expenses for the accounting period.

1. Divide your total expenses into two categories: administrative and program costs. Administrative costs refer to expenses such as salaries and rent, while program costs are the costs associated with delivering your core services, such as materials, activities, and staff.
2. Enter the administrative expenses and their corresponding amounts. This might include office or organizational supplies, office rent and utilities, payroll, insurance, and other operating costs.
3. Enter the program-related expenses and amounts, such as staff salaries, professional fees, material costs related to delivering services and activities, etc.
4. Calculate the total amount of income from all sources, including donations, grants, investments, and any other income sources earned during the accounting period.
5. Enter the total income next to the "total expenses" line near the top of the statement.
6. Calculate your organization's total net income by subtracting total expenses from total income. You should display this amount on your statement as well.

4. Income statement

An income statement for nonprofits is a financial statement that shows the sources and uses of funds over a set period. It typically details all revenue, such as contributions, grants, salaries, administrative costs, and program costs. 

The net income on an income statement for nonprofits is what remains after subtracting total expenses from total revenues.

Here’s how to fill out your nonprofit income statement:

1. Revenue: Begin by listing all sources of income for the nonprofit, including grants, donations, membership dues, and earned income. Include any other noncash income you may have received, such as in-kind donations or donated services.
2. Expenses: List all expenses associated with running the nonprofit, such as payroll, office supplies, and rent. Include operating expenses such as administrative fees, travel expenses, and other costs. Also, include any overhead costs such as overhead or depreciation on assets.
3. Net operating income: Calculate the net operating income by subtracting the total expenses from the total revenue. This will give you a final figure that indicates whether the nonprofit is making a profit or loss.
4. Other revenues and expenses: In this section, list any other types of special revenues or expenses that do not fit into either the revenue or expense category. This could include items like capital gains/losses, gains/losses from investments, or taxes paid/refunded.
5. Total income: Add up all the revenue sources, including income from other sources, to determine the total income for the nonprofit.
6. Total expenses: Add up all expenses incurred to operate the nonprofit, including expenses from other sources, to calculate total expenses for the nonprofit.
7. Net income: Calculate the overall net income by subtracting total expenses from total revenue to determine the overall.

Streamline your accounting and save time

Strong nonprofit accounting practices are the foundation for efficient financial management. By leveraging online accounting solutions, you can streamline tasks like bookkeeping and reporting, freeing up valuable time and resources for your staff and volunteers to focus on your mission-critical activities.

Seamlessly organize financial statements and donor data with nonprofit accounting software. This online accounting solution provides a user-friendly dashboard and reporting tools that give you real-time insights into your organization's financial health—enabling you to make data-driven decisions and optimize your fundraising and grant-seeking goals.