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Nonprofit Accounting 101: 3 Best Practices to Follow

When you think about the term “accounting,” what comes to mind? You might picture an accountant crunching numbers and inputting data into the ledgers of a for-profit company. However, what you might not consider at first is that accounting is also critical for nonprofits.

While most businesses leverage accounting practices to earn a profit, nonprofits focus on the accountability side of accounting. Demonstrating that your organization is using funding and managing finances effectively helps you stay accountable to stakeholders and engage more donors in your mission.

If your nonprofit is just starting to develop an accounting system, here are three best practices to follow:

1. Create an Annual Operating Budget

2. Compile Financial Statements

3. File Tax Returns Correctly and on Time

Let’s get started with an overview of a key accounting resource: your nonprofit’s budget.

1. Create an Annual Operating Budget

Your nonprofit’s operating budget serves as the backbone of your organization’s financial activities. It’s not only essential for effective accounting, but also to guide your fundraising, programming, and project management activities.

Budgets have two main components: projected revenue and expenses. Most nonprofits further categorize their revenue by source, so they know how much they plan to bring in from individual donations, corporate philanthropy initiatives, grants, and other income types. Expenses are usually broken down into program costs and overhead, which refers to your administrative and fundraising expenses combined.

While you’ll create your operating budget from scratch once a year, it’s important to review it regularly—once a month is recommended. That way, you can ensure your spending and fundraising remain on track throughout the year.

2. Compile Financial Statements

In addition to your budget, financial statements are some of the most important documents for your organization’s accounting system. Each type of statement provides different insights into your nonprofit’s use of funds by organizing financial data in different ways.

Jitasa’s guide to nonprofit financial management explains the three main types of statements as follows:

– Statement of activities. This document is similar to a for-profit company’s income statement. It outlines your organization’s revenue, expenses, and net assets for the previous year, which you can use to help create next year’s budget.

– Statement of financial position. Also known as a balance sheet, this statement breaks down your assets and liabilities to provide a snapshot of your organization’s financial health.

– Statement of cash flows. This statement shows how money moves in and out of your organization, providing an overview of your spending and fundraising habits.

Some nonprofits add a fourth statement to their accounting practices: the statement of functional expenses. Its main purpose is to organize costs in a way that makes it easier to fill out your annual tax return.

3. File Tax Returns Correctly and on Time

Although registered 501(c)(3) organizations are exempt from paying most taxes, that doesn’t mean they can sit back and relax during tax season. Instead, the IRS requires nonprofits to file Form 990 each year to maintain financial transparency—and their tax-exempt status.

There are four types of the Form 990, and the version your organization files will depend on its annual gross receipts. Your options are:

– Form 990-N, used by small nonprofits with less than $50,000 in gross receipts.

– Form 990-EZ, for organizations whose gross receipts total between $50,000 and $200,000.

– Form 990 (full version), for the largest organizations who have more than $200,000 in gross receipts.

– Form 990-PF, which all private foundations have to file regardless of gross receipts.

No matter which of these form types your organization completes, the filing deadline is the 15th day of the fifth month after the end of your fiscal year. For most nonprofits, whose fiscal year follows the calendar year, the deadline is May 15. Late submissions can incur fines, so make sure to file your Form 990 on time.

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As you implement these best practices, you should be aware of two valuable resources. The first is the Generally Accepted Accounting Principles (GAAP), which serve as the foundation for all accounting activities. Additionally, there are professional accountants who work specifically with nonprofits, and calling on their expertise can help you apply the GAAP standards to your organization’s unique needs.

ABOUT THE AUTHOR:

Jon Osterburg

Jon Osterburg has spent the last nine years helping more than 100 nonprofits around the world with their finances as a leader at Jitasa, an accounting firm that offers bookkeeping and accounting services to not for profit organizations.