If you have a nonprofit organization, working toward making the world a better place is likely your top priority. However, since nonprofits receive generous tax breaks and must be accountable to their donors, ensuring you properly account for and report your incoming and outgoing money is also of the utmost importance.
Nonprofit accounting provides financial transparency that makes donors feel comfortable and assured that the organization is spending money wisely to further its goals. Additionally, sloppy or inaccurate accounting can lead to problems with the IRS, which include possibly losing nonprofit status, hefty fines, and even criminal charges.
This guide will help nonprofits improve their accounting skills, handle unique accounting challenges, and remain compliant.
What is nonprofit accounting?
Nonprofit accounting differs from small business accounting. It’s a system of financial management, recordkeeping, and reporting for not-for-profit groups. Nonprofits are organizations that:
- Have no owners or ownership interests
- Receive contributions or donations from third parties that don’t expect a return
- Have a purpose other than making a profit
Nonprofit accounting uses specific language and designations to note funded activities and create reports to show donors how their money is being used:
- Programs. The services a nonprofit provides are called programs. Each program generally has its own revenue, expenses, and records.
- Donor restrictions. Some donors restrict their contributions to specific purposes or programs. Nonprofits must account for these restrictions in their financial management. Funds that are not donor-restricted can be used for any program, administrative costs, or other purposes.
- Fundraising. Fundraising denotes activities for raising an organization’s profile or soliciting donations. Fundraising activities can include direct mail campaigns, email newsletters, and charity fundraising events.
- Administration. Funds used for managing a nonprofit are called administration or overhead funds. These funds are necessary to keep the nonprofit operating; they must be noted in all accounting and reported to donors. Donors generally prefer that nonprofits keep their overhead, such as salaries, as low as possible to direct most funds toward programs.
According to Eileen Gwaltney, former director of government contracting services at Wall Einhorn & Chernitzer P.C., one of the biggest accounting mistakes nonprofit organizations can make is the improper allocation of functional expenses. Good nonprofit financial management should ensure that the organization can function and grow. However, if your functional expenses become too large, donors might hesitate to give.
“With donors focused on making the most of their contribution, it is important for nonprofits to allocate costs correctly,” said Gwaltney.
Create a realistic annual business budget for your nonprofit and a three- to five-year plan for strategic initiatives.
What is the difference between nonprofit and for-profit accounting?
Nonprofit and for-profit organizations must produce regular reports detailing their financial activities and use many of the same accounting principles. However, their different goals result in significant differences in these reports, including the following:
- Balance sheet vs. statement of financial position: A for-profit company produces a balance sheet that details its net equity for owners and shareholders. However, a nonprofit doesn’t have shareholders or owners. Instead, it produces a financial position statement outlining its assets and debts.
- Net assets vs. equity: In for-profit accounting, the stockholders’ equity is equal to a company’s assets minus liabilities, sometimes called net assets. A nonprofit does not have equity, so this line item is always referred to as net assets. Net assets are labeled as restricted or unrestricted.
- Income statement vs. statement of activities: Because a company is trying to generate a profit, it produces an income statement showing its revenues, fixed and variable expenses, losses, and gains. A nonprofit doesn’t have a bottom line because it’s driven by a mission instead of the need to make a profit. Instead of an income statement, it produces a statement of activities that outlines the revenues and expenses associated with each program.
- Statement of cash flow: Both nonprofits and for-profits must track and report their cash flow via cash flow statements.
Though the terminology differs, nonprofits and for-profits use the same accounting principles. According to business development strategist Maggie Tallman, many nonprofits would be better off if they followed for-profit practices of sharing data on the relationship between income (donations in this case) and outcomes (their programs and services).
“Real-time insight into program, operational, and financial metrics is imperative in today’s environment,” said Tallman, who has worked closely with nonprofits to streamline their accounting practices and business operations. “Those nonprofit organizations that understand how to manage their data, and the insights and results derived from that data, are the ones that will leapfrog everyone else in donor and constituent engagement and organizational sustainability.”
Communicate internal policies and controls throughout the organization to reduce accounting mistakes and prevent employee accounting fraud.
Do nonprofits need accountants?
Like any organization that handles cash flow and pays taxes, nonprofits should invest in a professional accounting and finance team.
Many nonprofit organizations don’t allocate resources for a professional accountant to manage their finances. Instead, they assign the task to an untrained staff member or volunteer. Tiffany Couch, CEO of forensic accounting firm Acuity Forensics, says this is one of the biggest mistakes not-for-profit organizations make.
Nonprofits run the risk of fraudulent activity if they don’t carefully manage bookkeeping and accounting. Mistakes are often unintentional, arising from a lack of oversight or experience. Volunteers often make up a large part of a nonprofit’s staff and may leave an organization with short notice, which can cause recordkeeping gaps.
Hiring a bookkeeper or other professional ensures that someone with training and experience always pays attention to the accounts and may notice something an untrained employee would miss. For example, many organizations meet the requirements that release temporarily restricted funds but don’t realize it because no one keeps track.
“Too often, temporarily restricted funds are kept out of mind until cash flow needs are tight,” said Adam Holcombe, director of the United States Securities and Exchange Commission reporting and technical accounting at f45 Training. “Maintaining an up-to-date net asset schedule allows for management to have a better idea of what funds are available to better budget their operating needs.”
“Don’t have a mindset of scarcity when it comes to ensuring you have appropriate resources in terms of handling your money,” Couch advised. “There are plenty of CPAs who would be willing to provide a discount or pro bono services.”
Tax accounting for nonprofits
The tax code for nonprofits can be confusing, and tax reforms can affect everything from how you report income to how you manage volunteers. Nonprofits should pay close attention to the following.
1. Handling and reporting income.
Some of a nonprofit’s income can be taxable if not reported or managed correctly. Whenever new tax laws pass, the rules outlining how nonprofits must handle and report income change.
“Under the 2017 Tax Cuts and Jobs Act, a nonprofit can no longer aggregate the profits and losses from various trades and businesses in computing their unrelated business taxable income (UBTI),” warned Julie Treppa, a tax attorney and partner at Farella Braun + Martel LLP. “[Nonprofits must] be sure to segregate income and expenses from each trade or business in which it engages … UBTI [unrelated business income tax] is now computed separately with respect to each trade or business.”
2. Recording and valuing benefits.
Nonprofits must also be careful to record and report the valuation of specific employee benefits, which can count as taxable income if not reported properly. “A nonprofit’s UBTI includes any qualified transportation fringe benefits and on-premises athletic facilities provided to employees,” said Treppa.
However, she added, proper reporting can save you from paying taxes on these benefits: “The organization can avoid the addition of these items as UBTI if it includes the cost of the benefits on its employees’ Form W-2.”
3. Tracking labor and services.
Tax accounting for nonprofits doesn’t just involve expenses and donations. You also need systems to track labor and services. Volunteers, for example, may provide unpaid labor, but that labor still has value that can affect your taxes and overhead.
“The market value of the donated services are reportable on [tax form] 990 as program service revenue and can reduce the percentage of administrative and management costs that is directly paid for by the organization’s cash contributions,” said Tab Burkhalter, CPA and tax attorney for Burkhalter & Associates PC.
To ensure proper tax reporting and guarantee that you get the most value from volunteers, nonprofits must establish a system to track and record their work. Updating these records should be part of regular bookkeeping and accounting operations, and the financial tracking system should be standardized across the organization.
Nonprofits also face unique marketing issues. Nonprofit marketing challenges include an overly broad audience, difficulty fundraising, and a reliance on volunteers.
Do nonprofits follow GAAP?
Generally accepted accounting principles (GAAP) are a set of accounting procedures and standards issued by the Financial Accounting Standards Board (FASB). All public companies in the U.S. must follow GAAP and private companies generally do as well. Nonprofits must also follow GAAP standards, although their rules are sometimes slightly different from the ones for-profit companies follow.
GAAP’s goal is to ensure that companies’ financial statements are consistent across industries, allowing investors and the government to interpret them more easily. GAAP rules for nonprofits are intended to create transparency for donors and grant-makers and help the government monitor whether an organization should retain its tax-exempt status.
In addition to general GAAP principles, specific rules apply only to nonprofits:
- Labeling net assets. Assets in a nonprofit’s statement of financial position should be labeled according to whether they are restricted — either by donors or grant conditions — or unrestricted.
- Describing cash flow. In addition to quantitative information listed on the statement of financial position, nonprofits must provide qualitative information that describes how they manage their liquid resources to meet everyday expenses. In particular, nonprofits must show any limitations or restrictions that impact their cash flow.
- Investments. While nonprofits should be aware of any investment management fees, they don’t have to report these separately. Instead, nonprofits must report investment income net of related external and internal expenses.
- Donations. Your accountant or accounting staff should also monitor donations closely and record them in compliance with GAAP. You must record promises of future donations when you receive the pledge instead of when your nonprofit receives the actual donation.
What is the best accounting software for nonprofits?
No matter who does your books, choosing the right accounting software for your nonprofit is crucial. You’ll need an accounting program to track everything and be prepared when tax season rolls around.
Nonprofits should look for the best accounting software that covers general bookkeeping and accounting, as well as specific not-for-profit needs, including donor management, FASB compliance, and grant management.
Several low-cost or free accounting software programs are designed specifically for nonprofits, including the following:
- Nonprofit Treasurer: Nonprofit Treasurer is free online accounting software for charities and nonprofits. It supports multiple users and includes features for taking online payments and donations, tracking expenses, attributing income, and reporting or budgeting based on your organization’s fiscal year.
- Financial Edge NXT: Financial Edge NXT is Blackbaud’s accounting software for nonprofits. It has most of the standard features that a nonprofit would need to handle bookkeeping and accounting, such as activity tracking, accounts receivable and accounts payable, bank reconciliation, and FASB-compliant reports. It has the option for a free trial, but long-term use has a variable fee.
- Aplos: Aplos is cloud-based accounting software for nonprofits and religious organizations. The software’s free version contains the basic accounting features most organizations need, such as fundraising management, donation receipts, donor statements, pledge tracking, donor databases, and compliant reporting. You have the option to upgrade to a paid membership for additional features.
- Sage Intacct Cloud Accounting: Sage Intacct Cloud Accounting doesn’t offer dedicated donation tracking or payroll, but it includes most other features nonprofit accounting requires. It offers various budgeting and compliance tools as well as activity tracking and partnership management.
- AccuFund Accounting Suite: AccuFund Accounting Suite has a core nonprofit accounting system that includes AP, general ledger, bank reconciliation, form designer, and report writer features. You can add modules for AR, loan tracking, grant management, payroll, and more to customize your accounting software.
In addition to specific nonprofit accounting solutions, other accounting software applications have functionality for for-profit and nonprofit organizations. These include:
- QuickBooks: QuickBooks is best known as an easy-to-use accounting solution for small businesses. However, Intuit QuickBooks Online also has a robust version for nonprofits, allowing you to easily track donations, grants, and expenditures by program. It also helps nonprofits manage donors and handle traditional accounting needs like payroll, invoicing, and reporting. Read our in-depth QuickBooks Online review to learn more. When your nonprofit grows, you can upgrade to QuickBooks Enterprise Nonprofit, which lets you store thousands of donors, safeguard donor data, and more.
- Oracle NetSuite: Oracle NetSuite can handle both for-profit and nonprofit accounting. Oracle NetSuite provides free or low-cost accounting software to nonprofits through its Social Impact program. Small nonprofits can use a version of the software for their sector at no cost. Organizations that need more functionality, such as grant accounting, FASB reporting, and budgeting, can access these modules at a deeply discounted cost. Read our review of Oracle NetSuite for more information.
- FreshBooks: While FreshBooks doesn’t have dedicated nonprofit software, nonprofits will likely find the application helpful. Like for-profit businesses, nonprofits can use FreshBooks to invoice and create reports. Its integrated secure online payments function helps you easily accept donations. Read our complete review of FreshBooks to learn about additional functionality.
Communication is key for nonprofit accounting
No matter what software you choose, the most important part of nonprofit accounting may be communication. Couch recommends keeping your staff and board members updated on what your accountants do and discover.
“Make sure you have a CPA who will walk you through all of your numbers, ensuring that you understand the profit-and-loss statement, the balance sheet, and your cash flow statement,” she said. “The more knowledgeable you become, the more empowered you become to make financial decisions that will lead to your success.”
This communication between accountants and decision-makers, Couch said, is essential to creating a sustainable nonprofit.
“If you don’t have a CPA assisting you in this understanding, find one who will.”
Hiring a CPA can alleviate burdens like learning ever-changing tax laws, understanding deductions, and staying up to date with filings for nonprofit directors.
Accountability is crucial in nonprofit accounting
The most important part of nonprofit accounting is, well, accountability. Unlike small for-profit companies that answer only to a handful of owners (or one owner), nonprofits have many stakeholders with varying interests:
- Board of directors: Board members and volunteers must trust that the organization uses its incoming donations wisely and efficiently.
- Donors and grant-giving organizations: Donors and grant-giving organizations like foundations must trust that your organization will prudently spend and account for the money they give you.
- Volunteers: Volunteers must trust that they’re sharing their efforts with a worthwhile, responsible organization and that their hard work isn’t in vain.
- Beneficiaries: Nonprofits must ensure rigorous money handling or risk being unable to provide necessary services to the individuals they serve.
Since the stakes are so high, nonprofit accounting should be given the same attention to detail as the organization’s program activities. Best practices include:
- Using a robust nonprofit accounting software system
- Faithfully entering income and expenses into the system in real time
- Having an accounting professional review your accounting files and reports regularly to ensure they are correct and that the organization follows all relevant rules and regulations
By handling your nonprofit’s accounting responsibly, you’ll earn the trust of donors and foundations and more easily accomplish your goals.
Jennifer Dublino contributed to the reporting and writing of this article. Some source interviews were conducted for a previous version of this article.