A Beginner’s Guide to Nonprofit Accounting

Jul 9

Ever wondered how nonprofits manage their money to keep changing the world without ending up in the red?

It's all about mastering nonprofit accounting — because let’s face it: no mission can be achieved without the money to get there.

But the jargon surrounding nonprofit accounting can sound foreign, especially if you’re coming from a for-profit business. Here are some frequently-used phrases we use to describe some of the elements of nonprofit accounting – and information on how to create and maintain a nonprofit budget.

The "sponsored project" operates under the fiscal sponsor's umbrella. The fiscal sponsor manages the funds and resources for the project, allowing it to receive tax-deductible donations and grants. This arrangement can be beneficial for initiatives that might not have (or want to dedicate) the administrative capacity to navigate the process of obtaining and maintaining their own 501(c)(3) status.

person looking at bank account on cell phone — Fund Accounting for Nonprofits

This is a special way to organize finances so that we know which bucks are meant for what purpose. It’s like having different pots of money, each earmarked for specific projects or donor restrictions. This setup helps nonprofits stay on the straight and narrow, ensuring that they respect donors' wishes and regulatory requirements.

Net Assets

Instead of the for-profit world's “owner’s equity,” nonprofits have what’s called “net assets.” Think of net assets as the financial cushion or the heartbeat of a nonprofit, showing the residual value of the organization’s assets after all liabilities have been subtracted. It’s like looking at what the organization owns versus what it owes, and the balance left over is what's available to support its mission over time.

Net assets are divided into three main categories: unrestricted, temporarily restricted, and permanently restricted. This categorization is super important because it tells you not just how much financial runway a nonprofit has, but also how much of that runway is available for immediate use versus how much is earmarked for specific future purposes or indefinitely tied up by donor restrictions.

Unrestricted net assets offer nonprofits the most flexibility. This portion can be used at the organization's discretion to fund daily operations, launch new programs, or cover unexpected expenses, essentially serving as the organization's financial backbone.

Temporarily restricted net assets are tied to specific donor conditions, such as being used for a particular project or program, or they’re time-bound, becoming available for general use only after certain conditions are met or time elapses.

Permanently restricted net assets are funds that must be maintained intact indefinitely, often endowments, where only the income generated from these assets can be used according to donor restrictions.

Functional Expenses

This categorization is all about transparency and accountability, breaking down expenses by their function rather than just by the type of expense. Think of it as slicing the financial pie into pieces that show not just what was bought or paid for, but why.

There are three main slices in this pie:

Money symbol with rotating arrows around it

Program Services: These are the costs directly related to fulfilling the nonprofit’s mission. Whether it’s delivering meals to the elderly, offering free educational programs, or conducting research on environmental conservation, program services expenses show the direct impact of the nonprofit's work. This is the slice donors love to see the most because it directly correlates with the organization's purpose.

Management and General: Often seen as the less glamorous side of operations, these expenses cover the administrative backbone of the organization, including day-to-day operations, financial management, human resources, and overall organizational governance. It's the infrastructure that keeps the lights on and the engines running smoothly behind the scenes.

Fundraising: This is all about the costs associated with drumming up financial support for the nonprofit. It includes everything from special events and grant writing to marketing and public relations efforts aimed at increasing donations. While sometimes scrutinized for taking resources away from direct program activities, effective fundraising expenses are an investment in the nonprofit’s future sustainability and growth.

Creating and Managing a Nonprofit Budget

Creating and managing a nonprofit budget is a crucial step in ensuring the financial health and sustainability of your organization. It's about more than just numbers; it's a reflection of your nonprofit's goals, priorities, and mission in action. Let's break down how to set up a nonprofit budget, explore the steps involved in the budget process, and delve into the specifics of operating and capital budgets.

How to Set Up a Nonprofit Budget

Setting up a nonprofit budget requires a clear understanding of your organization's financial situation, goals, and mission. It involves collaboration across departments to forecast both revenue and expenses for the upcoming fiscal year. Start by reviewing your past financial performance, consider any upcoming projects or goals that will require funding, and estimate your income and expenditures accordingly.

The 7 Steps in the Budget Process

Review your strategic plan: Align your budget with your nonprofit's strategic goals and objectives for the coming year.
Gather input from different departments: Involve team members from various parts of your organization to get a comprehensive view of needs and anticipated expenses.
Forecast revenue: Estimate how much money your nonprofit will generate from different sources like donations, grants, and fundraising events.
Project expenses: List all expected expenses, categorizing them into fixed costs (like rent and salaries) and variable costs (such as event expenses or program supplies).
Create the budget draft: Combine your revenue and expense forecasts into a draft budget for review.
Review and revise: Share the draft with key stakeholders (e.g., board members, department heads) for feedback and adjust as necessary.
Approval and implementation: Once finalized, the budget should be approved by your board and then used as a financial roadmap for the year.

When to Create a Capital Budget

A capital budget is necessary when your nonprofit plans significant long-term investments in assets like buildings, land, or large equipment. These are usually substantial expenditures that go beyond the scope of annual operating expenses and require separate planning to ensure they align with long-term strategic goals and financial capacity.

What is an Operating Budget for a Nonprofit?

An operating budget for a nonprofit outlines the expected revenue and expenses related to the organization's primary activities over a specific period, usually one fiscal year. It includes day-to-day expenses such as salaries, utilities, and program costs, as well as anticipated income from donations, grants, and fundraising activities. This budget is crucial for managing the organization's finances, ensuring it can cover operational costs while pursuing its mission.

What Should Be Included in a Nonprofit Budget?

A comprehensive nonprofit budget should include:

Revenue projections: Donations, grants, membership fees, event income, and any other sources of revenue.

Fixed expenses: Regular, predictable costs like rent, salaries, insurance, and utilities.

Variable expenses: Costs that can fluctuate, such as program expenses, event costs, and marketing.

Capital expenses: If applicable, costs for significant long-term investments in assets.

Reserves: Funds set aside for unexpected expenses or financial downturns.

In-kind contributions: Estimated value of non-cash donations like goods, services, or time.

Net income/net loss: The expected financial outcome, showing whether the organization anticipates a surplus or deficit.

Managing Your Nonprofit Bank Account

Managing a nonprofit bank account requires a nuanced understanding of how these accounts differ from traditional corporate bank accounts. While both serve the fundamental purpose of managing an organization's finances, there are key distinctions tailored to meet the unique needs and structures of nonprofit organizations.

Difference Between a Regular Corporate Bank Account and a Nonprofit Bank Account

Feature	Nonprofit Bank Account	Corporate Bank Account
Purpose	Designed specifically for managing the finances of a nonprofit organization, emphasizing features that support donation handling, grant management, and tax-exempt status.	Focused on the broader needs of a business, including profit management, investments, and operational liquidity.
Fees	Often lower fees or specially waived charges to support the nonprofit's mission and operations.	Standard fees for account maintenance, transactions, and other services, with potential for volume-based discounts.
Interest Rates	Some banks offer higher interest rates for nonprofit accounts to support their fundraising and revenue-generating activities.	Interest rates are typically standardized based on market conditions and the account balance.
Tax Reporting	Accounts are set up to facilitate the unique tax reporting requirements of nonprofits, including tax-exempt status documentation and charitable donation records.	Focuses on traditional business tax reporting, with features designed to support profit and loss tracking, expense categorization, and investment income.
Services and Support	Specialized services such as assistance with setting up charitable trust accounts, managing endowments, and educational resources on nonprofit financial management.	A broad range of business banking services, including loans, credit lines, payment processing, and financial advice tailored to the for-profit sector.
Access and Permissions	Customizable access controls to accommodate the governance structures of nonprofits, allowing for multiple signatories and role-based access levels.	Typically designed for corporate governance structures, with flexible but differently focused access controls and permissions for account management.

Understanding these differences is crucial for nonprofit leaders to ensure they choose the right banking solutions that align with their organization's financial management needs and mission objectives. Nonprofit bank accounts are not just about holding funds; they're about fostering the financial stewardship that is vital for achieving and advancing nonprofit goals.

Lean on a Fiscal Sponsor to Navigate IRS Form 990

Navigating IRS Form 990, the annual tax form required for nonprofit organizations, can seem like a daunting task. This form is not just a tax requirement; it's a public document that provides a comprehensive overview of a nonprofit's finances, operations, and mission-related achievements. For nonprofits, especially those benefiting from fiscal sponsorship, managing Form 990 doesn't have to be an overwhelming challenge.

Leveraging the fiscal sponsorship benefits offered by organizations like Mission Edge can significantly ease the burden of handling IRS Form 990.