What Are Nonprofit Accounting and Best Practices?

Nonprofit accounting includes the process of recording and reporting the different transactions entered by a nonprofit organization. A nonprofit organization is an establishment that has been granted tax-exempt status by the Internal Revenue Service (IRS) because it was formed to provide a public benefit and to further a social cause. Nonprofits must follow and maintain compliance with the appropriate state agency that regulates charitable organizations.

When nonprofit companies accept donations from individuals and businesses, they're expected to make their financial reporting and operating information public to inform donors about how — and how well — their contributions have been used. This is why proper accounting is vital to every nonprofit company.

This guide will discuss the difference between for-profit and nonprofit organizations. We'll also give an overview of nonprofit financial statements.

What Does It Mean to Be Nonprofit?

Nonprofit entities are created to further social causes by providing goods or services or a combination of both to the public. These companies don't have a commercial purpose and, in many cases, get their funding from donations, fundraising events, and government and private grants. Nonprofit organizations include schools, hospitals, registered charitable institutions, churches, and foundations.

The IRS grants nonprofit designation to organizations formed to promote religious, scientific, charitable, educational, literary, public safety, or cruelty-prevention causes or purposes. To receive tax-exempt status, an organization needs to request 501(c)(3) status from the IRS. However, nonprofits pursuing 501(c)(3) status can't be political or spend donations on political campaign activities.

Nonprofit companies generally use volunteer labor but may also need to hire employees. In this regard, nonprofits must pay employment taxes and follow state and federal workplace guidelines just like a commercial business. Nonprofits are also expected to provide fair compensation to employees or individuals for their services. The organization is not to be used to pursue personal gain for its founders, employees, supporters, or associates — all of which should be expressly stated in their organizing documents.

Do Nonprofit Organizations Need Accountants?

Yes, registered nonprofit associations need accountants or accounting software to manage and properly record transactions. Nonprofits have to adhere to tight rules around what they can and can't spend money on, and there are specialized tax rules and accounting practices that they have to follow. Tax-exempt organizations need to file an annual IRS Form 990.

This is the information typically required to file Form 990:

• The organization's mission statement
• Information about the governing body and policies of the organization
• The number of employees and volunteers
• The organization's revenue and expenses
• The organization's statement of position and reconciliation of net assets
• Reports on the compensation paid to current and former directors or trustees
• List of employees who received more than $100,000 in salary
• List of contractors who were paid more than $100,000

Differences Between Nonprofits and For-Profit Businesses

Most businesses are created to earn more money than they spend, and the owners can choose if they want to keep the profits or use it to expand their businesses. At the same time, a nonprofit's purpose is to promote a social cause. Compared to for-profit entities, founders of nonprofits can not keep the organization's profits for themselves.

Nonprofits generally have the same day-to-day operations as any business. They have bank accounts, own assets, receive income from sales or other forms of activity, employ staff, enter into contracts, etc.

However, there are key differences between the two types of businesses:

Purpose

All businesses are created for a purpose. Most companies enter the market to manufacture a product or provide a service to solve consumer problems. The success of such ventures is measured through profits.

However, even though a nonprofit may provide goods and services to generate income, its purpose is to use said income to further or advocate solutions to social issues. Hence, the success of nonprofits is measured by whether they accomplish their mission.

Funding

Owners of regular businesses fund their companies through savings, loans from the bank, government or private grants, and investors. Nonprofits may also be started with the founder's own savings, but they can pursue corporate sponsorships, government and private grants, and donations of time, labor, and money.

Audience

Companies that make products and provide services to generate profits have a targeted audience. For instance, makers of beauty products will primarily market to women. On the other hand, nonprofits must try to reach as wide an audience as possible. A diverse audience for a nonprofit means more ways to get their message out and solicit donations.

Leadership

Whether a for-profit company is a small business or a large corporation, the owner or a select group of people are in charge. These leaders also gain a financial incentive when the company is successful. Most nonprofits are led by board members or a group of people with similar interests and values.

Nonprofit organizations in the United States must follow the Generally Accepted Accounting Principles (GAAP) set out by the Financial Accounting Standards Board (FASB). You can find these standards in Section 958 of the FASB's accounting codification.

What Are the Key Financial Documents for Nonprofits?

The following are key financial documents for nonprofits: the statement of financial position, the statement of activities, the statement of functional expenses, the statement of cash flows, and annual reports. These are not the usual balance sheet or income statement. Even though nonprofits follow GAAP for accounting standards, they're subject to a different set of rules on how to record and report transactions and assets. Find out more about these reports below.

Statement of Financial Position (SOP)

A statement of financial position (SOP) outlines the organization's assets and debts. It's the equivalent of a balance sheet for a nonprofit. Examples of assets are cash, gift cards, accounts receivables from donors, and office equipment. Liabilities may include payables to utilities and grants owed to other organizations.

Since nonprofits don't have owners or stockholders, they report donor contributions instead. Donor contributions can be categorized into unrestricted, temporarily restricted, or permanently restricted. An example of donor restrictions is when donors earmark amounts for specific purposes.

Statement of Activities

This document is the equivalent of an income statement. It shows the increase and decrease in your net assets as the nonprofit takes in donations and pays expenses. Assets are also categorized into unrestricted, temporarily restricted, or permanently restricted.

If your organization accepts goods or services as donations, it's also important that you learn how to value in-kind contributions. This may involve a separate income account in your records for in-kind donations and entering amounts for contributions based on the fair market value.

For instance, if you find a volunteer to facilitate a fundraising event, you'd record what they would typically charge for the same services in your books. If they charge $400, you'll report $400 as an in-kind donation.

Statement of Functional Expenses

The statement of functional expenses breaks down what nonprofits spend on. Examples of categories in this report are program expenses, administrative expenses, and fundraising expenses. Subcategories (e.g., salaries or wages, rent, and utilities) would be under each category.

This report is important because it shows your organization's spending. For example, you'll see if your fundraising events bring in money or if you need to focus your energy on other ways to raise funds.

Statement of Cash Flows

The statement of cash flows shows your organization's sources of cash and how they're increasing or decreasing in a given period. Depending on the number of transactions you process, you may decide to create a cash flow statement every year, quarter, month, or on-demand.

The report includes income from operating, investing, or financing activities. Revenue from operating activities will come from membership dues, donations, or fundraising. Income from investing may consist of earnings from the sale of long-term investments or money market investments, such as bonds.

Annual Report

The annual report contains more than your organization's financial statement. The annual report aims to help attract donors while fostering a culture of transparency and accountability.

Here's what you can include in your report:

• Your mission, what you do, and announcements of future plans
• Accomplishments and success stories
• Financial documents with visual graphics when helpful
• Donor acknowledgments
• Invitation for support

Let Skynova Help You Manage Your Small Business Bookkeeping

The day-to-day operations of a nonprofit are the same as a regular business. You'll hold bank accounts and credit cards, own assets of all kinds, and receive income from many funding sources for which you'll need to set up an accounting system. You'll also have to record transactions in a general ledger, do bank reconciliation, and budgeting.

You don't have to start from scratch, though. Manage your nonprofit bookkeeping with Skynova's accounting software. Track your expenses by uploading your receipts and the software will keep everything organized. The double-entry accounting feature also provides a complete record of financial transactions for you.

Notice to the Reader

The content within this article is meant to be used as general guidelines and may not apply to your specific situation. Always consult with a certified public accountant (CPA) for specific and individual advice on nonprofit accounting.