The IRS recognizes many different types of nonprofit organizations. Within those organizations, though, the 501(c)3 stands apart because of the unique tax benefits it enjoys. In addition to not paying income taxes, individuals and corporations that donate to a 501(c)(3) nonprofit can claim a tax deduction for their donations.
But even within the 501(c)(3) organizations, there are various types of organizations. Two of the most common are Public Charities, like churches, social support organizations and universities, and Private Foundations, like the Bill and Melinda Gates Foundation.
But what is the difference between a private foundation vs. public charity? We’ll dig into that right now.
Private Foundation vs. Public Charity
The IRS defines the two types of nonprofit organizations and sets rules for distinguishing a foundation from a charity. And the difference between them is based entirely on where (and from whom) they get their money.
What is a Private Foundation?
A private foundation is a 501(c)(3) nonprofit that generates much of its support from a small number of sources and investment income. According to the IRS, they “have as their primary activity the making of grants to other charitable organizations and to individuals, rather than the direct operation of charitable programs.”
Private foundations are often referred to as “family foundations” because they tend to be more closely controlled by a single family or a small group of people with aligned interests. It’s common for the board of a private foundation to all be related or to be made up of just a few people.
Some of the largest private foundations distribute annual gifts valued at hundreds of millions or billions of dollars. And their names are probably familiar to you, like The Bill and Melinda Gates Foundation, The Ford Foundation, and The Robert Wood Johnson Foundation.
What is a Public Charity?
Public charities generally receive the largest share of their financial support from the general public, private foundations, or governmental agencies. Rather than depending on a single funding source, like a family or a corporation, they actively raise money to fund their programs. And they have far greater interaction with the general public vs. private foundations.
The board members of public charities are often selected to represent the interest of their broader constituency. So they’re not controlled by one person or family.
A public charity is what you typically think of when you hear the term “nonprofit,” organizations like Goodwill, United Way, Habitat for Humanity, Greenpeace, and your local community organizations.
Which is better: a public charity or a private foundation?
We hear this question a lot, but neither type of charity is “better” than another. They are both equally valid models for operating a nonprofit. But they serve different purposes, and one may be a better fit than another depending on the goals and circumstances of the founder.
Suppose you intend to fund a nonprofit organization yourself and have close control over the operations. In that case, a private foundation is probably the best fit.
That’s why high-net-worth individuals, like Bill Gates, typically prefer the private foundation model when they want to start a nonprofit. However, the downside to this model is that the IRS applies more scrutiny and restrictions to a private foundation.
On the other hand, suppose you’re planning to rely on financial support from a broader base of individual donors and private grants or to rely on government grants. In this case, you’ll typically adopt the public charity model. Choosing a public charity enables you to operate with fewer restrictions from the IRS. And you’ll avoid paying taxes on any investment income as well.
Should I start a charity or a foundation?
When your organization applies for tax-exempt status with the IRS, you will indicate whether you are applying to be a private foundation vs. public charity.
However, each year, a public charity is required to complete Schedule A (an addendum to its 990 or 990-EZ) to verify that it still qualifies as a public charity. Schedule A contains several ‘tests’ and if your organization fails them, your status will be automatically converted to a private foundation.
PRO TIP: Churches, schools, and hospitals are automatically assumed to be public charities and are exempt from the Schedule A tests.
As a part of Schedule A, you will have to compute yourpublic support percentageto validate that you are not simply self-funding your charity. The public support percentage is calculated a bit differently depending on various factors. But the goal is to approximate the proportion of support your organization receives from the general public.
To maintain its “charity” status, your nonprofit must maintain a public support percentage of 33⅓% or greater during at least one of its last two years. That means that a least one-third of your revenue must come from the “general public,” which excludes large private gifts and investment returns.
NOTE FOR STARTUPS: During the first five years of your operation as a nonprofit, you are not required to maintain a public support percentage above any threshold. But you ARE still required to calculate and report your public support percentage.
The public support percentage is calculated based on an accumulation of support received over a five-year period. So large private gifts from multiple years ago might still adversely impact your public support percentage.
How is fundraising different for a private foundation vs a public charity?
If you’re a public charity that wants to stay a public charity, you need to be careful about how your fundraising strategy impacts your public support percentage.
The first thing you should do is consult with your CPA to determine your current public support percentage based on your most recently filed 990. If you’re in danger of falling below the 33⅓% public support percentage threshold, you should develop a fundraising plan that enables you to diversify your funding sources.
Small-dollar gifts, government grants, and grants from other public charities will always improve your public support percentage, because those are all considered public support.
Meanwhile, large dollar gifts from private donors and grants from private foundations will decrease your public support percentage because those are not considered sources of public support.
So, should you start turning down all large-dollar gifts? No!
Most nonprofits solicit and receive large gifts to help fund their programs, and there is nothing wrong with that. They make your life a lot easier, after all.
However, you should always seek to increase revenue from those sources which will be deemed public support. And because the public support percentage is calculated on a five-year basis, you need to have a long-term fundraising strategy that anticipates what your needs will be down the road as well.
Foundations vs Charities: Wrapping It All Up
Private foundations and public charities are both 501(c)(3) nonprofits dedicated to advancing the public good. They’re simply organized differently and have to abide by different regulations.
There are many more charities than foundations in the USA, with charities accounting for over 75% of all nonprofit revenue. But the private foundation is actually the default organizational structure for nonprofits in the eyes of the IRS. Therefore, the burden of proof lies with a charity to prove they meet the requirements to maintain their special status.
Regardless of which type of organization you choose, you should be sure to seek out a knowledgeable legal counsel and a CPA or accounting firm with expertise in the nonprofit sector. They’ll help you understand what you need to do to keep your nonprofit compliant with the IRS and local government agencies.
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If your nonprofit uses donations of supplies, services, and even time to help fund your operations, you need to know about recent changes in accounting standards for in kind donations.
But because the new standards didn’t go into effect immediately, many organizations put off making the necessary changes. And many others never even heard about the changes.
But the deadline for making the changes has passed, and the FINAL deadline (for interim reporting periods) is coming up next month. So now is the perfect time to make sure you report in kind gift donations in compliance with GAAP standards in 2022.
When do the changes to in kind gift reporting go into effect?
The changes are effective retrospectively, starting with annual periods beginning after June 15, 2021. So if your annual reporting period follows the calendar year, you’ll be required to be compliant when you file your IRS 990 for the 2022 tax year.
The changes are also effective for interim periods within the annual period beginning after June 15, 2022. So, if you file quarterly reports, then you’ll need to be following the new standards by next month, if not sooner.
And if you’ve already implemented the changes below, you’re in luck because the FASB did specify that early adoption of these standards is okay.
Who do the changes impact?
The changes to in kind donation reporting are specifically for organizations that follow generally accepted accounting principles (GAAP) in preparing their financial statements. Typically, a CPA would prepare these statements as part of a yearly review or audit.
The changes impact the presentation of your data, so you may not need to change the process for how you track or account for in kind contributions internally. And even if you’re not fully GAAP-compliant currently, implementing these best practices now will save you a lot of cleanup work later in the case you require a financial statement audit.
What exactly is changing about in kind donation reporting?
A few things are changing about how you show in kind gifts on your financial statements. The first one is about how you display them on your Statement of Activities. And the second will impact the information you include in your disclosures (footnotes) to your financial reports.
1 – Show in kind goods and services on Statement of Activities
Historically, nonprofits may not have shown in kind donations as a separate line item in the revenues and/or expense section of the Statement of Activities. The new standards require you to create a separate line item within each section to show which portion of your revenue and expenses can be attributed to non-financial assets.
2 – Break down how you used in kind contributions in disclosures
In the past, there was no clear direction for reporting details about the type of in kind gifts you received (goods vs. services) or how you used them. The new standard makes it very clear exactly how you need to display that information in the future:
You must show each type of gift broken down by category (goods/services)
Within each category, you must include additional detail, specifically:
“Qualitative information” about whether you utilized or monetized the “contributed nonfinancial assets” during the reporting period. And, if you utilized the contributions, you need to disclose a description of the programs or other activities where you used those gifts
Your organization’s internal policy concerning monetizing vs. utilizing in kind contributions (if you have one)
A description of any restrictions your donors attached to the gift of these non-financial assets
A description of the valuation techniques and inputs you used to determine the fair market value of the gifts (in accordance with Topic 820).
The principal market you used to arrive at a fair value measure if it’s a market that you can’t sell in based on restrictions your donors made on their gift.
We’ve paraphrased the actual text of the standards for this article. You can download the official release from FASB here, including some helpful examples of how to make the required declarations.
And, of course, don’t trust your finances to a blog (even a well-informed one). Always talk to your CPA to ensure your organization is in full compliance with new regulations.
Why is FASB making this change?
The update enhances your financial reporting by setting new standards for disclosing specific details about the in kind donations you receive. It makes it easy to see how much of your total revenue or expenses can be attributed to in kind donations.
This is especially important for nonprofits that receive substantial in kind contributions. Take the case of a food pantry, for instance. The majority of a food pantry’s product comes from in kind donations of food. If they report all of their revenue and expenses on one line, it would be impossible to tell how much cash they need to keep their programs running.
Hopefully, you can see why it would be important for donors and other interested parties to understand which portion of their revenue and expenses are cash vs. in kind gifts.
According to The Nonprofit Times, almost 80% of all nonprofit revenue comes from the US government in the form of federal grant funding or fees for services. Those numbers may be skewed by some outliers, like education, but, regardless, there is still a lot of federal money up for grabs.
If you’re like most organizations, you would love to get some of that funding to put toward your mission. But before you start searching for grants you need to ask yourself– is your organization ready for federal funding?
This article will help you determine if you are ready or not.
And, if not, what you can do to prepare yourself.
What do I need to be eligible for federal funds?
There are a lot of things to consider when you start thinking about federal grants or service contracts. But the first one is this–do I meet the basic eligibility requirements?
Here are the main points you’ll need to check off:
You have a 501(c)3 status in good standing with the IRS. (You have received your determination letter and you are filing your annual Form 990 or 990-EZ on time)
You have an active Employer Identification Number (EIN), which would be issued and maintained by the IRS.
You have registered your organization at grants.gov and sam.gov to be considered for grant proposals.
You have been issued a DUNS number (Data Universal Numbering System). You can follow the steps outlined in this article to get one.
If you meet all of the 4 above criteria, you are likely eligible to apply for federal funding. But that doesn’t necessarily mean you’re ready to do it
Are my programs ready for federal funding?
When searching for federal grant funding, you need to consider whether your program team can actually deliver based on the proposal. Otherwise, you could find yourself scrambling to fill roles and failing to follow through on your commitments. You could even find yourself in worse shape than if you’d never secured the funding.
Consider the following factors:
Do I have team members with the appropriate skills and experience to achieve the program outcomes?
Will I need to hire people if this proposal is accepted? If so, how easily or quickly will I be able to recruit and fill these positions?
Does my organization have the appropriate institutional knowledge to execute on this grant I win the award?
Do I have the software and physical infrastructure required to deliver on this proposal?
You don’t necessarily need to be ready to hit the ground running on day one. But you need be confident your organization can deliver on the proposal and any program outcomes within a reasonable period of time.
Here are some other factors to keep in mind:
It takes more work than ever to recruit, hire, onboard, and train new employees. It also takes time to build-out software and technology capabilities.
Will you need full-time employees or contractors (or both) to execute on the grant proposal. And will they require a specialized or hard-to-find skillset?
Neither of these factors alone can tell you not to apply for federal funding. Sometimes you need to make an aggressive move to push your mission forward. But be realistic about what you’ll be able to accomplish to avoid regretting your decision.
Are my finances ready to apply for federal grants?
Your financial system must be in good working order before you even consider applying for federal funding.
In fact, the government places very rigorous financial reporting requirements on organizations that receive federal funding. The Uniform Grant Guidance (UGG) outlines these rules that recipients of federal grants must follow to maintain compliance; and penalties for non compliance can be severe.
If your organization isn’t in a position to meet the requirements before you apply for funding, it’s highly unlikely you’ll be ready when you’re awarded funding. Therefore, it is imperative that you get your financial system ready before applying for federal grant funding.
The UGG is too extensive to explain here, but these are a few requirements you should consider:
You must be closing your books each month; that means reconciling all of your bank accounts and credit cards
You must be tracking your expenses in at least two dimensions; in other words, every expense must be recorded to a GL code/category and a funder/program/grant
You must have a documented, consistent, and reasonable approach to allocating shared expenses such as payroll, facilities, and insurance
The UGG also outlines requirements for unallowable expenditures, but every grant will have its own set of requirements. It is imperative that you read your grant requirements carefully and that you only use grant dollars to cover allowable expenses for your organization.
Do I need an audit to secure federal grant funds?
No, you don’t always need a nonprofit audit in order to qualify for federal grant funding.
However, if you receive more than $750k in federal grant money in any given fiscal year (even if this was the result of multiple smaller federal grants), you will be required to undergo what’s known as a ‘single audit’.
A single audit is different from a financial statement audit, but the process is somewhat similar. The purpose of a single audit is to test whether the organization complied with grant guidelines and only used grant dollars for allowable purposes.
An independent CPA must prepare the single audit, at the expense of the nonprofit.
And just because you required a single audit last year, it doesn’t mean you’ll be required to do one this year. It is important that you evaluate each year the total dollars of federal funding you will be receiving to determine whether a single audit is required.
Are you ready to prepare for federal funding?
Obtaining federal grant funding is a scary process for most nonprofits, especially the first time.
You should carefully consider your preparedness in advance of submitting proposals. Ensure you’re in a good position to obtain funding and deliver on your program outcomes.
If you’re concerned that your financial systems and processes aren’t ready to handle that level of scrutiny, reach out to The Charity CFO to see if we can help you.
We provide professional, outsourced bookkeeping and accounting support for 150+ nonprofit organizations, many of which have to meet federal guidelines. Our team of nonprofit financial experts will give you the support that your organization has been missing. Reach out for a free consultation.
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Unlike your personal tax return, anyone can request a copy of your Form 990 from the IRS or search for your filing several online databases. And when they know how to read a 990, they can find out A LOT about your organization.
Watchdog organizations, large donors, and grantmakers regularly use your 990 to uncover a nonprofit’s financial health in just a few seconds. In fact, all major funding sources will review your federal tax filings thoroughly before trusting you with a single penny of their money.
So what do your donors want to see when they read your IRS Form 990? We’ll show you how to read a 990 here, so you can see what they’re looking for. Let’s get started!
How financially healthy is your organization? Parts I, VIII, and X
Just by reading these three section of the 990, your donors can get a pretty accurate picture of the financial health of your nonprofit.
First, donors will jump to Part I for a summary of what your organization does. Here, they’ll find your declared mission and/or your activities for the past year. It’s essential that your mission statement on your 990 aligns directly with the declared tax-exempt purpose of your organization. And that the general information aligns with other documents, like your annual report. Inconsistencies will send a confusing message to potential donors.
Next, Section VIII shows them how you raised your money in granular detail, breaking down your funding sources into 6 categories–federated campaigns, membership dues, fundraising events, contributions from related organizations, government grants, and all other donations. They’ll also see detailed breakdowns of any investment income, unrelated business income, and revenue from gaming activities (including raffles, casino nights, etc.)
Finally, in Part X, they’ll see your balance sheet, giving them a quick look at your assets and liabilities to quickly understand the financial viability of your organization. They’ll be looking for any large loans, investments and net assets that are available for operations.
The IRS has different reporting requirements than GAAP, so the balance sheet section of your 990 may not match your audited financial statements. But it still gives anyone the ability to assess your overall financial status in just a few minutes.
How do you spend your money? Part IX (Statement of Functional Expenses)
When learning how to read IRS 990, Part IX tells donors the story of how you spend the revenue you receive. Not just the “form” of the expense–like payroll, utilities, rent, or office supplies– but also the “function” of those expenses, meaning the purpose that expense serves in your organization.
The IRS requires that you report expenses broken down into three categories on the statement of functional expenses: program services, fundraising, and management & general (administration).
Most donors want to see that at least 75% of your expenses are used to fund program services. You can see how you’re doing by dividing column B by column A. If you’re not at 75% (or very close, you should understand why and be prepared to explain your reasons to potential funding sources.
How much do you pay your executives? Part VII: Compensation of Officers, Directors, Trustees, Key Employees, Highest Compensated Employees, and Independent Contractors
Reading this section of a 990 pulls back the curtain on the inner workings of your leadership team. It can be pretty shocking to find out that anyone can find out how much money you make. But it’s not just you…it’s everyone on your management team, and more!
You’re required to report the compensation of all of your most important employees and even non-employee contractors that were paid large sums (over $100,000).
Donors and watchdogs look at this data closely to understand how responsibly you spent your donations. Of course, that doesn’t mean you shouldn’t pay yourself or your staff a fair salary. But you do need to be aware that the information is publicly available, and don’t be surprised or offended if someone asks about it.
How much do you spend on your programs? Part III – Statement of Program Service Accomplishments
Part III shows how much revenue each of your programs earns and how much you’re spending to keep it running. If there’s a significant gap between revenue and expenses at the program level, that could suggest a fundraising need.
Beyond the numbers, Part III is the perfect place for you to showcase your story. You’ll inform potential donors about your programs–how they work and who they benefit–and how each of those programs contributes to fulfilling your mission.
Part III is the perfect example of how the 990 is so much more than simply a “tax” form. The numbers you show work in conjunction with the words you choose to tell your board members, supporters, and potential funding sources about the IMPACT your programs make in the community.
What’s your story? Tell me more… Schedule O for Form 990
There are several “schedules” you may have to complete with your 990, depending on the complexity of your organization. But EVERY organization that files the full Form 990 (and certain organizations that file Form 990-EZ) must also file Schedule O.
According to the IRS, “An organization should use Schedule O, rather than separate attachments, to provide the IRS with narrative information required for responses to specific questions…and to explain the organization’s operations or responses to various questions.”
Did you catch that–”to provide narrative information?
That’s right– Schedule O gives you another chance to shape the story your donors will uncover when they read your 990!
In this section, donors can find things like why you’re filing late (if you are), reasons for amended returns, new programs you’ve launched, your process for determining executive compensation, conflict of interest disclosures, and more.
It’s a treasure trove of information for anyone who spends the time digging through it. And your important donors or grantmakers WILL read it.
It’s another chance for you to control the story your donors will read about your nonprofit–so don’t take it lightly! Answer the questions carefully and thoughtfully, and have someone experienced with 990’s review it to ensure that the story you’re telling is the story you want to tell.
What story does your 990 tell about your nonprofit?
Every nonprofit’s tax filing tells a story. And, now that you can read a 990, you’ve seen that you can shape the story it tells to your donors.
But Form 990 is still ultimately a financial document. So to start telling your story, you need reliable, accurate, and timely financial data.
If you’re struggling to produce financial statements that you can rely on or your internal team isn’t experienced enough to provide strong financial guidance, maybe it’s time to consider outsourcing your accounting and bookkeeping process to professionals.
The Charity CFO provides expert financial guidance and streamlined and efficient accounting services to 150+ nonprofits throughout the USA. We onboard a few new clients each month, but we have limited capacity, and space fills up quickly.
If you want to be sure your finances are perfect before your next tax filing, and you want an expert financial partner to help you tell your financial story the right way, then reach out to us for a free consultation. We’ll let you know how we can help you shape a story of success!
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Many nonprofit organizations both large and small need to undergo a financial statement audit every year. Preparing for a nonprofit audit can be overwhelming and anxiety-filled, especially if it’s your first audit or you don’t have a strong and experienced financial team.
But an audit doesn’t have to scare you or your management team. The most important thing you can do is be prepared. That’s why our in-house team of 6 former nonprofit auditors helped put together this guide to nonprofit audit checklist to make sure your audit goes as smoothly as possible.
What is a financial statement audit? And do you need one?
This article will discuss financial statement audits for nonprofit organizations. We won’t deal with other types of nonprofit audits, like compliance audits or governmental audits, which can differ in certain respects.
A financial statement audit is a thorough review of your financial statements to determine if your financial statements present fairly, in all material respects, in accordance with generally accepted accounting principles. The purpose of a financial statement audit is NOT to detect fraud.
If you’re not sure if your nonprofit needs an audit or not, follow this link to find out about nonprofit audit requirements. And if you know you need an audit and want to be prepared, keep reading!
How to prepare for your nonprofit audit:
Step 1: The Roadmap
Before we jump into the specific items to prepare, let’s look at the timeline for preparing for a nonprofit audit. You need to get started early (up to a year ahead of time, if you don’t already have a relationship with a CPA for your audits) to ensure everything runs smoothly.
Here are some of the milestones you should prepare for:
️ 6-12 Months Before Year-End
Send out an RFP and hire an independent firm to conduct your financial statement audit.
It’s getting harder to find CPA firms that conduct nonprofit audits, and their schedules fill up quickly. So don’t expect that you’ll find an available firm at the last minute. Ask your network for recommendations if you don’t know a firm and try to get someone lined up at least 6 months in advance.
️ 2 to 3 Months Before Year-End
The audit firm will do preliminary testing, familiarize yourself with your organization and ask for additional documentation.
Try to be as cooperative as possible with this vital step in your nonprofit audit prep. Your CPA firm will have its own audit checklist of things they need to accomplish now to complete your audit correctly and on time. Holding back information or not being responsive may delay your audit or cost you more money.
️ 2 to 3 Months After Year-End
The audit firm will come in to review your final end-of-year numbers and all the documentation they need to complete your audit.
Once again, be as cooperative as possible and set aside time to work with your firm and get them all the documents they need. If you’re not available, the auditors can’t do their jobs and may even suspect that there’s something you don’t want them to find.
Step 2: The nonprofit audit checklist
The easiest way to be prepared for an audit is to stay ready. That means keeping your paperwork organized, staying current on your reconciliations, tracking restricted funds, and accurately recording all your expense and revenue transactions each month.
Here is a checklist of things to do to be prepared for your nonprofit audit: the things you’ll want to do before handing your books off to the auditors:
Examine your prior-year balance sheet in the accounting software to ensure that every balance agrees with the prior year’s audited balance sheet. Investigate any discrepancies and remedy them before moving on.
Examine all account balances to ensure they are reasonable based on your knowledge of the business, i.e. Does the revenue reflect what you actually collected? Do your bank account and/or loan balances look accurate?
Reconcile all ending permanent account balances–like assets, liabilities, and net assets–to internal records, wherever possible. (Permanent accounts, or Real Accounts, are accounts that maintain ongoing balances over time. For more detail, refer to this article on permanent accounts.)
Examine all bank reconciliations for outstanding transactions which could be erroneous
Examine accounts receivable (A/R) aging summary for reasonableness
Examine accounts payable (A/P) aging summary for reasonableness
Record any year-end accrual adjustments, such as any required for Paid Time Off (PTO)
Record any year-end reclassification adjustments, such as any required to present current and noncurrent assets and liabilities appropriately.
Examine significant donor agreements for potential restrictions and ensure those funds are recorded correctly
Reconcile net assets (with and without donor restriction)
Examine the general ledger for expenses that should have been capitalized, income that should have been recorded as liabilities, or other unusual transactions
Examine A/R and A/P as of the balance sheet date and expense/revenue transactions in the three months subsequent to the balance sheet date to ensure transactions were recorded in the appropriate year.
Identify any income and expense transactions that arenot classified to a program or supporting service category and classify them appropriately.
NOTE: If your books are a mess and you need to get them cleaned up ASAP, check out this podcast with our onboarding manager Isabel Sippo for tips on how to clean up the financial skeletons hiding in your closet:
Step 3: Post-audit adjustments & reviewing the report
Before issuing the final audit report, the auditors will issue a draft of the audited financial statements and any necessary audit adjustments. You should meticulously review each proposed reclassification or adjustment to ensure they are reasonable and accurate.
Don’t just assume the auditor is right. They may be, or there could be something they misunderstood. Additionally, understanding why your auditor made a change can help you get it right up front next year.
After reviewing and agreeing to any audit adjustments, you should record the adjustments in your accounting system. And review the financial statement draft for the following:
Totals are calculated correctly
There are no spelling or grammatical errors in the footnotes
Every number agrees to the relevant account balance or general ledger transaction
Download the free PDF of our nonprofit audit checklist to share with your team!
Are you ready to fulfill your nonprofit audit requirements?
If your finances aren’t up to date or nobody on your team can confidently tackle the points on this checklist, then you may need help to get ready for your audit.
At The Charity CFO, we don’t perform audits, or audit-prep account cleanup for non-clients. But we do help our partners clean up, modernize and optimize their accounting systems as a part of our extensive 4-week onboarding program.
And we help ensure our partners’ books are always audit-ready each month, so you don’t lose any sleep when it’s audit season.
We also have 6 former nonprofit auditors on staff, so our team is trained to prepare your financial reports precisely how an auditor wants to see them. That helps you save back-and-forth during the process and helps avoid incurring additional expenses during the audit.
If you’d like to consider outsourcing your accounting to the nonprofit financial experts, reach out to us today to request a free consultation. We’ll let you know how and if we can help make your next audit stress-free!
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As a CPA working exclusively with nonprofits and a former nonprofit auditor, I’ve looked at thousands of nonprofit financial statements over the past 10 years.
Looking at that many balance sheets, you start to identify trends. And while some issues are evident to anyone, others only stand out once you know what to look for. Over the years, I’ve identified a set of 5 nonprofit financial red flags that are fairly common and almost always lead to trouble sooner or later.
Want to know if your nonprofit is headed for trouble? Or want to check out a nonprofit before you make a significant financial gift?
Keep reading to discover the 5 things to look out for!
Red Flag #1 – Insufficient Operating Reserves
Every nonprofit organization has swings in cash balances throughout the year. Sometimes they follow seasonal trends. Other times they may be a result of unexpected events or poor planning.
But maintaining an operating reserveof at least 25% of your annual expenses plays a major role in determining whether or not a cash flow problem turns into an existential crisis.
And it’s not just me– almost all large donors and grant makers will want to see 25% of expenses as a minimum operating reserve. And charity watchdogs like the Better Business Bureau and Charity Navigator use operating reserves as part of their calculations for what they consider a “Quality Nonprofit.”
So if you’re looking to build trust with government grant makers, foundations, or the general public, you’d better have some cash set aside for a rainy day.
What does a low operating reserve tell us?
In our experience, nonprofits with little in reserve and/or low cash balances tend to have financial management challenges, often including:
Poor collection of accounts or pledges receivable
Challenging vendor relationships (due to late payments)
Risk of defaulting on loans
Carrying high credit card balances
Over-reliance on high-interest short–term financing
Just because an organization’s reserves have dipped below 25%, it doesn’t mean it’s destined for failure. It may be a temporary blip. But if you want to keep the trust level high, shoot for that minimum level at all times.
Red Flag #2: Hidden Compliance Issues
When most nonprofits think about ‘accounting issues,’ they’re concerned about poorly prepared financial reports, bookkeeping errors, gaps in communication with funders, bad audits and a million more things in this vein.
And those are all valid concerns. But they often overlook compliance or regulatory issues that could be much bigger problems.
For instance, you’d be amazed how many times I’ve gotten deep into an organization’s books yet they’ve failed to mention that they haven’t filed an IRS 990 for 2+ years! If you don’t file your 990 for 3 consecutive years, you’ll lose your tax-exempt status. And it doesn’t matter how pretty your Balance Sheet is or how accurately you’ve tracked donor-restricted funds.
After learning the hard way, here are a few compliance questions I always ask:
Have you filed an accurate IRS 990 every year? If not, when was the last time you filed?
Have you failed to withhold the proper state and federal payroll taxes required for your employees? And have you been notified of any issues with your payroll tax filings or associated penalties?
Has the Department of Labor audited your organization for misclassifying contractors as employees?
If you answered “yes” to any of the questions above, you need to seek professional help immediately to help get them resolved.
DO NOT let compliance issues linger.
Tax penalties or compliance fines will not just go away. And the IRS will absolutely revoke your tax-exempt status (with no remorse). So don’t let fear or shame keep you from tackling these critical issues, or they could put your entire mission at risk.
Red Flag #3: Too Little (Unrestricted) Cash on Hand
Cash balances are not the same thing as your operating reserve. Your operating reserve includes other unrestricted assets you wouldn’t generally use to pay your bills.
For this reason, your “Days in Cash” metric is more helpful for managing the day-to-day business of a nonprofit. It will tell you how many days you would be able to operate with the cash you have in the bank today, assuming each day is an average day for your organization.
The calculation looks like this:
As a nonprofit, you need to concern yourself specifically with unrestricted cash and cash equivalents. One of the main differences between for-profit and nonprofit accounting is that much of your cash may have restrictions placed on it by your donors. This cash can’t be spent however you want, so it doesn’t come into play when calculating your Days in Cash metric.
At their lowest balance, all nonprofits should have no less than 30 days’ worth of cash on hand.
If a nonprofit falls below 30 days’ worth of cash on hand–even if they just ran payroll AND paid the rent yesterday–that’s a big red flag for me. Because learning to manage cash flows is the most important financial skill that a nonprofit leader must master to avoid an existential crisis for the organization.
Red Flag #4: Short Term Loans to Cover Operating Expenses
It’s an excellent idea for nonprofits to have access to a “Plan B” when liquidity problems pop up.
In fact, we recommend that our clients open a line of credit to fill the gaps, like when a funder is slow to pay, and you need some cash to keep things running. After all, it’s not like you can magically find a new donor to bridge that gap for you.
So the issue isn’t having a line of credit.
The issue arises when you constantly need to dip into your short-term funding, and you have no immediate ability or plan to pay it back.
In that case, these things tend to snowball. We’ve seen organizations max out their line of credit, take personal loans from founders or board members, hit up predatory payday loan services, and more.
But this road leads to trouble. And quickly.
When you’re running an organization on borrowed money, eventually you’ll have to pay it back. And if you’re waiting for a “big” donor to suddenly appear and bail you out, that’s a losing strategy. Instead, you need an actionable and disciplined plan to stop the bleeding and start digging your way toward financial freedom.
Strive to manage your nonprofit like you want to manage your personal finances–bring in more than you spend, pay off debt and build an emergency fund.
If you’re stuck in a starvation cycle, there is still hope. Check out this conversation about how to pull yourself out of the cash flow trap:
Red Flag #5: No Accountant or Bookkeeper
Yes, it may seem obvious, but you should have a dedicated financial professional to manage your books. Preferably someone with some accounting experience.
It’s a BIG red flag when a nonprofit tells us that they have a volunteer, a friend of a friend, or a board member managing their books. Or when a well-meaning but under-trained founder is doing the books themselves (along with half-a-dozen other roles).
It’s equally frightening when an organization doesn’t have accounting software, like QuickBooks, and runs its operation off of a bank statement.
Yet I bring these things up because they do happen. So if you feel “seen” right now, just know that you’re not alone. But you WILL need to make some changes.
Having a permanent and dedicated individual with accounting experience overseeing your books gives peace of mind to any banker, funder, or CPA looking at those books. But it’s not just the education and experience…
A consistent methodology for how specific types of transactions are recorded and reconciled brings stability to your finances. So having one person, doing it the same way every time adds tremendous value.
On the other hand, staff turnover leads to inconsistencies, mistakes, and a lot of wasted time. So, if you’ve had trouble maintaining consistency in your staff and procedures, you may want to consider an outsourced accounting firm. They can help your team build repeatable processes (and they won’t leave you stranded when a better job offer arrives).
Have Nonprofit Financial Red Flags? Maybe We Can Help.
The Charity CFO helps 150+ nonprofits simplify their accounting, create timely and accurate reports, and keep their books squeaky-clean so that any auditor, CPA, or grant writer sees exactly what they want to see.
Beyond the day-to-day accounting, we’re an expert financial partner too. So we’ll tell you when we see red flags waving in your books, and help you create a plan to get things back on track. We can help you with creating annual budgets, preparing for an audit, and much more.
If you need a nonprofit accounting expert to help get your financial house in order, reach out to us for a free consultation today.
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https://thecharitycfo.com/wp-content/uploads/2025/05/Blog-Images-1080-x-675-px-4.png6751080Paul Cook/wp-content/uploads/2025/03/fileuploads_222926_8055634_252-8e05624973e20b5de823aebdbcfd37df_LogoLeftAligned.pngPaul Cook2022-04-19 20:39:522025-05-01 09:02:26Top 5 Nonprofit Financial Red Flags According to a CPA
During the “Great Recession,” nonprofits have lost their accountants and financial directors at record rates. And finding new, qualified help that they can afford is nearly impossible…
At the same time, hundreds of nonprofits are waking up to realize that the financial structure they’ve always relied on doesn’t work as well any more. And they’re tired of the hamster wheel of hiring, re-hiring, training, and re-training bookkeepers and accountants.
So why do accountants leave nonprofit organizations? And what can nonprofits do to create consistency and predictability in the financial side of their operations?
Triná Owens is a former nonprofit financial director who left her job to become an Accounting Manager at The Charity CFO. In this episode, she and Tosha tell you the top reasons that your accountants don’t stick around. And show you how modern nonprofits are rethinking the way they handle specialized skills like HR and Accounting.
In this episode, you’ll discover:
The top 3 reasons nonprofit accountants walk out the door
Why turnover in the financial department is SO damaging for nonprofits
The reason your finance director spends just 25% of their time on finances
Why HR compliance issues are a bigger risk than tax compliance for most organizations (and why you shouldn’t trust your accountant with HR)
Thanks for watching. Be sure to subscribe for new episodes every week!
👇 Or scroll below to read the full transcript of our conversation
A Modern Nonprofit Podcast Why Do Nonprofit Accountants Quit?
4/15/2022
Tosha Anderson:
Hey friends. Welcome back to another episode of a modern nonprofit podcast. I, I say this every single episode, but I’m super excited to talk about this. Um, Sharon, a little bit about my story, but I brought along a friend of mine and also a fellow colleague at The Charity CFO. It’s we are going to talk about why nonprofits are quitting, their accountants. Yes. This sounds weird. Stay with us and we’ll help you explain. And maybe we’ll talk about why the accountants are quitting the nonprofits too. I don’t know. But, um, let’s just go ahead and dive right into the conversation. So some of you all probably know, or maybe you don’t know that when I started career, I started working in public accounting. I used to audit nonprofit organizations. Um, I, all of you that deal with auditors that come in on an annual basis, that’s essentially what I did.
Tosha Anderson:
So, um, it was at that time that I realized how vulnerable nonprofits are when they don’t have good financial management. And I thought I am going to commit my career to fix the, this problem. So that’s when I took a position as a CFO of a nonprofit organization, did that for four years. My official title was actually director of business and finance, which if anybody’s listening, you know what that means? I did all of the things I did accounting. I did HR. I did it. I did risk management. I did, um, quality insurance. Um, also the program side, like just making sure that everything was billed correctly and dealing with all of these things and was such a huge job. Now, my view, I only had a background in accounting. I was not prepared or equipped or skilled in any of these other things. And I’m not the only one that finds themselves in that situation. In fact, I think, what do we have? Like five or six people that has a similar story we have and Triná, you are absolutely one of those too. Trina, tell us a little bit about your background because you and I share kind of a similar path in terms of our career and what ended up leading us here.
Triná Owens:
Absolutely. And thank you for having me Tasha. This is absolutely cool. Um, so my background again is accounting, uh, over 10 years of accounting experience, but my last position held was the director of finance and administration, which again, as you just explained is finance and other things, finance and everything that’s not program. And so, um, that was the last position that I’ve held, um, which included payroll, HR, maybe of course it liaison duties because it’s usually outsourced. Um, so kind of that everything else position. So, um, yeah, definitely the same experience there
Tosha Anderson:
And just to put it in perspective, uh, Triná and I both worked for social service agencies that I would say were less than $10 million. So, uh, in the grand scheme of things, I think that’s probably in the same ballpark as as many nonprofit organizations tend to be, um, certainly smaller and have these hybrid roles. So we’re gonna craft this conversation around that, but Triná I’m super excited. Um, Triná is actually an accounting manager for us and she now helps co lead this firm to help us work with many, many nonprofit organizations. So we have some interesting, um, perspectives because we used to work for nonprofits. Um, Triná’s actually worked for a couple nonprofits, uh, in the similar capacity that you just described, Triná. Uh, and now we work with many, many nonprofits, I think right now we work close to 150 nonprofits every single month.
Tosha Anderson:
So, um, we talk to a lot of an individuals we help problem solve. Um, and more importantly, we talk about that transition plan for a lot of nonprofits that are dealing with, uh, the loss of their accountants. So, um, is that not even more clear in the last two years, uh, the, the need for transition, the need for succession plan, I’ve been hearing the consultants and the funders succession plan succession plan all of the years that I’ve been in this space, but it’s really been true, I think in the last two years, Trinity, I’m sure you would agree with that.
Triná Owens:
Absolutely, absolutely. It’s um, definitely time to, that’s the thing about nonprofits that I I’ve learned either. They have people that are there forever or people that are in and out in and out. Yeah. And so succession planning is very important. Um,
Tosha Anderson:
Yeah, yeah, yeah, totally. And there’s this concept, uh, that I find fascinating and I follow for a lot of reasons, not just because I lead this organization, but this concept of the great resignation, uh, nonprofits are not immune to this. Right. I mean, we see our clients constantly struggling, um, to find clinicians, uh, you know, educators, administrators, all sorts of backgrounds. Um, and they came across this article and this is not gonna come just a rise to anybody listening, but it says a recent article suggests that nonprofit staff are quitting for a number of reasons, including there’s limited growth for opportunity. They’re underpaid. The department is underfunded, the workplace isn’t modern or flexible and, or the workplace is toxic. All of those triggered me, uh, yeah. Which one resonated the most with you and why?
Triná Owens:
Um, so the most, uh, would be growth opportunities. I’ve left at least two organizations because of I had, I, I couldn’t go up anymore. Again, going back to, um, nonprofits, they have people that are in and out rotating doors and then they have people that have been there forever. And, you know, they’ve been there 20 plus years. And so if you wanna move up again, I’ve been financed trying to move up than the accounting departments. There’s nowhere else for me to go. So that’s the one that, um, resonates the most. The second one of course is the underfunded. Yeah. Um, you know, accounting and finance are pretty important to me, but from a mission standpoint and a program standpoint, it may not be the most important department right. To the nonprofit. So, um, underfunding also, you know, kind of strikes a nerve for me. You know,
Tosha Anderson:
You said something, um, that I talk about a lot, there’s nowhere else to go really when you are in these chief roles. Um, and when I said earlier, nonprofits are quitting, their accountants, what I really mean is they’re quitting their chief financial role. Um, and here’s what I’ve learned that 80% of the accounting done within a year for a nonprofit organization is a transactional input output. Um, some bookkeeping, some pretty basic accounting. Right, right. So this is, you know, I don’t wanna say entry level, but in many ways kind of entry level entry to mid-level. And when you have the CFO role, that is an, a player that you bring in that really loves so much more than just doing the 80% of the work. That’s 80% of their work they’re doing is likely things that aren’t gonna feed their soul. So what I’ve learned today, and you can speak to this too.
Tosha Anderson:
There’s actually two, probably more, but two main types of accountants. There’s the input outputs, the detail orientated, get things done, very consistent, thrives, and routine. And, and, and that’s amazing because 80% of the work, yeah. Those people though are not like the other 20% of accountants, which is more like strategy, problem solving exactly. Coming up with new solutions. And when we talk with nonprofits, you know, it’s, you know, I either have the 80% covered, but my person is limited in their skillset for that 20%. Or I have that a 20% person that loves the problem solving, but they’re bored out of their minds…
Triná Owens:
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80% of the work. And then when they’re in a place like you were just describing with nowhere else to go, when you sit and you think, is this it for me, if I’m spending 80% of my days doing things that are feeding my soul and there’s nowhere else to go, that I can get more into that strategy level. And I think that that’s the challenge that nonprofits are facing because they need both of these skill sets, but the budget, um, or the size or whatever, do justify the need to have two different people. Right, right, right. Would you, would you say that was your case too? It certainly was mine.
Triná Owens:
Definitely. I think in one position, again, not trying to name any names, um, but in one position, um, I did find myself stuck doing that, uh, day to day, those day to day operations. When I knew that I prefer to do more analytical work. Um right. But there was no time for that because of course it still had to be done. Um, and so maybe they couldn’t afford another hum, another person in that position. So, um, you do tend to get stuck in certain areas. And so it makes it very difficult to, uh, to advance really, you know, and as a, as a, as a professional, it’s important that I grow. And so that kind of stunt your growth as well as a professional, you know, as a professional you’re thinking, okay, I gotta make sure I’m, I’m getting better. I gotta make sure I’m learning more and doing more. But, um, when you get in some of those positions that the opportunity is just not there. The time is not there to do everything that’s required.
Tosha Anderson:
Well, and if was listening to this, like, you know, or whoever’s listening to this, you know, is an, a player you’re an, a player you wanna grow, you wanna develop, you wanna do
Triná Owens:
Absolutely
Tosha Anderson:
Any organizations would be thrilled to have you on board. But the challenge to me also goes back to the underfunded part of things where, um, you’re put in a role. So not just underfunded, but you’re put in a role where 80% of the accounting you’re doing, doesn’t be your soul then. And, and that’s only like 25% of your job is all the accounting combined. The other 75% are all of these other duties. And when you have an, a player, a top performer, somebody excited and interested in accounting and moving the needle and making the accounting to finance better, but they don’t have the ability to function, to focus solely on just the accounting. What they find in this is what, uh, I would say underfunded with mine. Um, and what led me to leave the organization and leave nonprofit. And the way that I worked with them was that I also like UTURN a, I’m an, a player I’m a top performer. I want to be really good at what I do, what I found myself. I was mediocre and everything at best. Yep. And at the end of the day, when you day after day, year after year are, you are a high performer. You wanna grow, you wanna enhance your skills, you wanna be creative and analytical and solve these big problems and move the needle for this organization. And yet you feel like you’re just failing every day, not at failing, but failing to be great, failing to be great.
Triná Owens:
You’re, you’re just getting things done. You’re just getting things done. You’re just getting it done. You’re be, you’re producing, you know, you, um, but you wanna do something greater. Right. And you know, you have the potential to do something greater. Um, absolutely. So that’s the, yeah, that’s definitely the thing. That’s
Tosha Anderson:
To me, how, whatever we would wanna call that into, uh, or call, call the call. That specific thing. I think that that’s why at least the former finance directors like said we have five or six now on our team that left organizations for similar reasons. And those are usually a lot of the reasons. Um, and you know, that’s an unfortunate thing for the nonprofits, but I think, Hey, knowledge is power and we can at least learn from absolutely understand. Absolutely. So switching gears a little bit, there are gonna be people that are listening to this, like, wait a minute, I’m gonna counting for a nonprofit. I’m just trying to keep my head above water. Yeah. So switching gears a bit, we both mentioned, we came with an accounting background. We accepted jobs that were accounting and all other things administrative. So what was the hardest part of your multi hat job? And then looking back, what advice would you give to those that have had this position? So kind of speaking to those, you know, unicorns, the Swiss army knife, the, you know, how did you learn, what was the hardest part of your job? We’ll start with that.
Triná Owens:
Um, the hardest part and again, in multiple positions is being that other, uh, anything outside of accounting and finance I say was difficult. I’ve done some operations, I’ve looked, looked into, um, uh, having to hire someone to fix boilers, you know? Right. Um, it looked into, uh, it, uh, companies outsourcing it. I don’t know anything about it. You know, what makes a good outsourced company? I don’t know. Um, I, somehow I made it to HR and payroll. Um, again, people assume that’s finance and accounting. It is not, um, right,
Tosha Anderson:
Right.
Triná Owens:
First organization, the HR wasn’t so bad, but when I go to the next organization, they really need a HR manager. They really need a HR director and I’m, you know, part of that. So I’m that per so that’s a totally different ballgame. Um, so I would say, you know, all of those, but I guess HR would be the hardest one because I feel like that’s a really a specialized field just like accounting and finance. And yes, I understand it, but I’m not a HR. I wasn’t, I wouldn’t consider myself having a HR back ground. Um, it just kinda landed on me. And of course, like you say, how did I learn it, Mr. Google, Mr. Uh, A society of human resource management. I, you know, became a member on my own dime. Again, I wouldn’t dare, you know, ask my employer to do it, you know, on my own dime. I became a member of that and, you know, looked at their resources. So just a bunch of research on my own time, on my own dime to again, make sure that I am successful because again, I can’t fail who, you know, it doesn’t matter that I don’t know anything about HR. I have to my department and I have to run it well. And I did that. So that’s the hard part is, you know, picking up this extra, um, area and then, you know, having that ownership, I’m gonna have ownership of it and I’m, I’m gonna try my best to do my best with it. So, um, HR was definitely the hardest
Tosha Anderson:
Me too. Me too. Me too.
Triná Owens:
Hiring. Firing.
Tosha Anderson:
Yeah. And it, wasn’t just the understanding of, I, I think why accountants inherit, inherit the HR function. We have an ability to decipher details and like read super boring contracts, I guess. I don’t know, there’s this perception that we have a high attention to detail, which PS remember, everybody has said there’s 80% of accountants that are super detail focused. And there’s the other 20% of us that really like financial modeling and yeah. Geeking out on Excel spreadsheets. Uh, I’m definitely that one.
Triná Owens:
I love a spreadsheet.
Tosha Anderson:
I’d be bored in tears, dealing with enrollment forms all day long. I did a lot of that though. Um, but one of the things that I think was a biggest struggle for me, it’s not just the paper pushing that is associated with HR. What I found is I am a trained accountant and yet I am now an HR director, but I’m also working through and with programmatic team members to deal with program staff, cuz that’s most of employees, right. That aren’t even my direct reports, nobody in the organization has any understanding of the true, like, uh, appropriate process to handle performance appraisals. So performance improvement plans, you know, having those difficult conversations up to and including, uh, you know, termination and hiring. Yes. And so it was almost like, well, you’re in HR, so you have to have the difficult conversations with people or you have to fire the people and say, wait a minute, these are your staff and Triná now, you know, I mean, we run this business and we have many staff people, we, as the managers direct supervisors, we have those direct difficult conversations with our team members. Yes. So I would say it, wasn’t just getting up to speed with the, with the HR staff, but it was also working through the program team and getting everybody else’s understand, cause I’m not a train HR person either.
Triná Owens:
Exactly, exactly.
Tosha Anderson:
Getting them to understand what their role is when I really don’t know what I’m talking about either. So, um, but one thing I did learn, one thing I did learn and the advice that I would give to someone else in that position is you have to understand the really big, big red flags that can end the organization and really help water.
Triná Owens:
Yes,
Tosha Anderson:
Yes. Know what those compliance needs are. And Triná, we tell clients this all the time, everybody freaks out and thinks that they count team is what’s going to get them in big trouble. No, it’s the personnel issues. Um, whether it’s wrongful termination discrimination, failure to investigate back payroll tax issues, failure to file your, your returns
Triná Owens:
Document, document, document.
Tosha Anderson:
All of those things will be far more significant from a liability than, than what accounting could ever do. And so I tell people this all the time, don’t take the risk of combining your accounting and your HR functions. You’re two entirely, two different skill sets.
Triná Owens:
They are. They are.
Tosha Anderson:
Two different different bodies of regulatory information, two different sets of laws. Like it’s not even in the same space yet. So oftentimes it’s coupled. Um, Yeah. And that became, I would say I probably did 25% of my work in, or in accounting. Probably 50% of my work was HR.
Triná Owens:
Yep. Yep. Same. I was, I was 50, 50, well, not really 50 50, but yeah, a, a huge chunk, more HR than I was accounting at the time at, uh, when I left that position. Um, but you know, one thing, again, what I’m learning is, um, in every position I get added on a little bit, you know, you go in as one individual. Mm. And then by the time I leave, I’m three or four people and what I’m learning now, like it’s okay to say no, it’s okay to say, you know what? I can’t, I can’t do that. Or, um, not even because I can’t because I’ve succeeded. Right. I’ve figured it out. I’ve gotten it done. I’ve made sure employee files were in order. You know, I can, but I don’t feel comfortable taking on that additional responsibility. Maybe we need to figure out how to get someone and hired. Maybe we do need to outsource HR. Maybe we need, you need to outsource, you know, an additional accounting person. Right. Um, so yeah, I definitely I’m learning that. Like it, we, I have to say no, sometimes
Tosha Anderson:
Triná it’s funny. I think that the trauma that comes from this multi hat, um, I, I think speaks within our culture as a company, we are obsessive about streamlining and carving out very specific because I think we, so many of us were in roles where we had 10 different jobs and quite literal when I left my organization, um, there were at least two or three full-time hires that replace functions. So the HR, the, the actually accounting, we hired just a controller. That’s all she was doing, you know, was the accounting side. Um, but I think it’s so important and I’ve seen, and Trina you with me and seen how faster the, and, and further the business can move by streamlining these things. I, I know what many people probably thinking, oh, we use are for-profit that doesn’t make sense. And when you’re a startup business, whether you’re for-profit or non-profit, you have to be lean, you have to be resourceful.
Tosha Anderson:
I mean, the challenges are still very similar. Um, but this sooner that you pair those responsibilities down and to let people focus on the area they’re experienced in the area that feeds their soul and giving them the bandwidth and the capacity to not only do their day to day stuff, but Triná, like you were saying, like the opportunity to be creative and refine and improve what they’re already doing. I never had a moment to do that ever, uh, in you you’ve said the same thing. So yeah. So I’ve seen this trend, as I mentioned earlier of nonprofits that are quitting their accountant. So I talk with a lot of nonprofit organizations that are interested in working with us, or I’m asked to speak on different panels about, um, you know, accounting, financial management within nonprofits. So what I meant by, and I alluded to it a little bit earlier, they’re moving away from this full-time CFO role or the accountants that happens to do accounting and all other things.
Tosha Anderson:
You’re kind of moving away from that role and looking for a little bit more creative ways on, on, on handling the back office function right now. I think this is a couple different reasons. Number one, I saw a disproportionate shift in the amount of, um, uh, organizations that reached out to us that, Hey, I had a part-time CPA. This person’s no longer willing to do our work, cuz they have to scale back their work. Now the pandemic, certainly as we know, disproportionately affected women in the workforce and there were many of these women that did on nonprofit, accounting is a side gig that simply had to step away. So I saw several clients came to us for that reason. Um, then as we all know, there’s a huge talent shortage for any specialized skill accounting as no to that. So the cost of that talent has now gone up.
Tosha Anderson:
That’s now cost prohibitive to nonprofit organizations. Um, and then I think there’s also this area where people are realizing, Hey, there could be other ways we can do this to do this. Yes, yes. Trinity, what we’ve seen is a trend in organizations, instead of saying, we’re gonna hire an accountant and we’re gonna have the accountant do the accounting and all of the other things too, what we’ve seen is organizations looking for more of an operations role. So like a chief operating officer, an operations manager, um, someone that really, if you think of like, um, like a hub and spoke, like serves as the hub and then they deal with all of these spokes and get the spokes, the contract, what they need. So we’ve had clients that have now or outsourced their HR. They have now outsourced their accounting. Those really highly regulated, specialized technical skills they have contracted out. And then they have more of this operations person that’s serving as the liaison. And then they’re dealing with all the other issues that come up on site out related to facilities and those sort of things. So today, what are your thoughts on this initially? Um, I know we’ve had some clients that, that have gone this route and been successful,
Triná Owens:
Uh, abs- um, so, so far it’s been, it has been very different and I do enjoy it again, being on the other side, right. Because I’m, I’m on the other side now. And, and the path asked, I have had a negative experience with the outsource accounting and I was like, oh, you know, I don’t like it, but now that I’m on the other side so I can see, okay, how do I make this relationship successful? And so I do have a few clients that have that person that’s in the office, that operations person that’s doing the accounting and other things. And so, so one of the things that, uh, the charity CFO we pride ourselves in is becoming, is being this innovative assistant. You know what I mean? We come in with all these processes that make everything so much more efficient. Yeah. And when you talk to that person again, you’re liaison with the organization and say, you know what, we’re gonna come in here and we’re gonna help you with this.
Triná Owens:
And this is gonna make your job a million times easier, or we’re gonna handle take this off your plate. We’re gonna take this off your plate. And then you have time for that. You know, maybe you have time to do your fundraising. Maybe you have time to do more, uh, applying for more grants, you know? And so, so far I’ve seen it again, um, be very successful, very successful. And it’s, I think it’s the approach. It’s all about the approach and it’s all about again, um, letting them understand we’re there to help. We’re there to help where, you know, take those little things off their desk. And so far it’s been very, you know, um, the clients I’ve worked with have been very, very happy with this.
Tosha Anderson:
I think you bring up a good point. That reminds me of whenever I was, um, working for a nonprofit that time I ever even pondered the idea of changing something, for example, oh yeah. I wanna change payroll providers.
Tosha Anderson:
No way hard paths for me, because for me it was not just the time that I had to invest in changing the payroll provider and implementing the migrating and then yeah. And then it’s the, okay, we’re live. And then there’s gonna be the troubleshooting and the tweaking and fixing the stuff that will inevitably go wrong. Yeah. There was just no bandwidth to do that. And I think that some people think, oh, my gosh, outsourcing is creating so much work. Yeah. But where I think is outsourcing, um, which goes back to some of the things that we were talking about earlier, the very beginning of this conversation where nonprofits aren’t modern or flexible. Yes. What’s really interesting is we’ve seen organizations reach out to us, Hey, we need to be a paperless system. We wanna be a virtual team. We want something more modern. Our systems are old and outdated and, and antiquated.
Tosha Anderson:
So what contractors that we worked with, we use contractors internally ourselves too. Yes. That, and we have like a hub and spoke kind of model where we outsource different functions. And then we have people internally that deal with those contractors that you rely on the contractors to come in and say, we’ll do the updates for you. Yes. We will create the processes for you. We will even train your team members on exactly what they you need to do to get. So it removes that I don’t have time to do this implementation. I don’t have time to update things. I don’t, I don’t have the bandwidth to do that. You rely on these contractors to do that for you. And I think that that makes it a lot easier because I know that that’s one of the reasons why I just kept doing the same thing because I’ve always done it that way. I had no place to breathe when I was the CFO of a nonprofit that I wasn’t about to change anything. Cuz I can’t deal with anything breaking. No, you
Triná Owens:
Know? No. And especially once you get the people on board with a process, how hard it is to tell your organization, okay, we’re moving to this. I mean, that’s a part of it as well. And so again, we have to be very careful with how we come in in our delivery and you know, again, that’s why we’re, um, so big on assisting, like you said, we train, we will train if we need to, um, we will, you know, make this, we wanna make this process as easy as possible. And in the, in the end, I mean the organizations are usually more, a lot more efficient because we find out they’re doing things that they’ve just been doing for 20 years. Not necessarily because it’s the best way, but it’s just been done for 20 years. And so nobody thought to, um, improve it, the process at all.
Tosha Anderson:
Well, I’ll tell you, I don’t see this trend slowing down that nonprofits are quitting their accountants because of all the things that we talked about funding is always gonna be scarce and the talent is gonna continue to be expense of, um, we have an ongoing need to be modern and flexible. Yes. And technology is always changing. So, um, having a partner that you can work with, it constantly stays, uh, on the forefront of all of those emerging technologies and how things work and all those sorts of things. Um, and then just giving people space to grow and not have their departments underfunded because they’re trying to do too many things for too many people. I just don’t see this trend slowing down. No. Um, so it’s been, it’s been an interesting reflection when I saw this article and I knew you were the perfect person to talk to because I know we could share war stories back and forth.
Tosha Anderson:
Oh yes. All things were difficult for us. And I guess sadly kind of what led to us leaving, um, the industry in that way. But it’s been really cool to work with the organizations in a different way. And that’s where it’s um, I think both of us are relieved to say like, okay, we can, we can just do the accounting now. I think that’s what you said when you first came on board. You’re like, I’m just happy. I can just work on the accounting. Yes, yes. And not everything else. And so my hope is that this conversation just allows people to think about things a little bit differently and how can they be creative in solving their back office issues without facing so much of that burnout. So much of the underfunding, the so much of the we’re doing things, but I’m afraid. I don’t know what I don’t know.
Tosha Anderson:
And I’m gonna end up on the front page of the paper because I’m gonna do something wrong. That was a fear of mine. Um, yeah. Yeah. Then hire the people. There’s a lot of really great consultants out there. Not just certainly for accounting, but your HR, your it, and then consider what this hub and spoke model might look like for your organizations and how that might be helpful in succession planning and cross training. And we found it much easier to have those processes documenting and farming out these really key processes of the organization. Yes. So that when you do have turnover and you will, we all will that you’re not starting from scratch with all of these functions at
Triná Owens:
Every time. Yeah.
Tosha Anderson:
So important.
Triná Owens:
And I’ve seen that and you lose, you lose a lot when you do that. Um, that’s the other thing about having that person? That’s the Jack of all trades. Yeah. You don’t know what they did until it’s not done. And that is, you know, for a small nonprofit, a midsize nonprofit. Yeah. You know, that’s just, that’s, you know, the, I could be, have a very negative effect.
Tosha Anderson:
So Trina also part of her job, she takes on new clients and most of them are, um, transitioning away from full-time, uh, accounting hires. Um, and best scenario, we’re always transitioning from one firm to the next and that firm is still there and we can ping back and ask questions. But so often, you know, Triná, you’re dealing with situations where the finance director or whatever that role is or whatever that title is, has left. And I, I know that we go through our onboarding call and we start asking really detailed questions about four fundamental processes. Like how do we get paid from our funders? And it’s a little terrifying that they’re
Triná Owens:
They don’t know. They don’t know
Tosha Anderson:
We don’t know. Uh, we don’t know. And so diversifying those key processes, then I think the pandemic taught us that I don’t see that changing anywhere. And, and we practice what we’ve preach. We do the same thing here. I’m pretty much obsessed with it ever since I left, um, working for a nonprofit, uh, and it took a six month transition time, um, a couple hires wow. Months of training, uh, to make sure the organization can continue on without hiccups. So anyway, hopefully this was helpful for you all listening. Triná, thank you again. We’ll have you back. We’ll continue sharing some of our stories on if we know, if we knew then what we know now, how
Triná Owens:
Would we, that’s a good one. Yeah,
Tosha Anderson:
Yeah, yeah. Um, thank you again for joining me. And if you all are interested in hearing more about the work that we’re doing, go to thecharitycfo.com. We have a blog on there. We don’t just talk about accounting. In fact, I love talking about operations at the nonprofit in general. So we often have guests on there to speak about fundraising and grant writing and insurance and cyber security and all of the other areas, um, that you can possibly think of. So go check out our website until next time. Bye everybody.
https://thecharitycfo.com/wp-content/uploads/2025/05/PODCAST-Blog-1-2.png6751080Abstrakt Marketing/wp-content/uploads/2025/03/fileuploads_222926_8055634_252-8e05624973e20b5de823aebdbcfd37df_LogoLeftAligned.pngAbstrakt Marketing2022-04-15 13:37:002025-05-28 13:55:01Why Do Nonprofit Accountants Quit?
501(c)(3) donation rules are crucial for any nonprofit organization to understand.
Donations are the lifeline of any nonprofit organization. While some nonprofits depend more on government contracts or foundations, many rely on donations from individuals as their primary funding source.
One essential tool that you can use in your nonprofit is donation tracking software that can help you keep track of incoming gifts. Software helps ensure transparency and accuracy in keeping financial records and tracking restricted funds, crucial in maintaining your nonprofit.
In this guide, you’ll learn the rules nonprofits must follow when accepting and accounting for donations.
What is a tax-exempt status?
Most nonprofits have tax-exempt status with the Internal Revenue Service (IRS), which means their revenues, gross receipts, or income are exempt from the federal income tax rate. Tax-exempt status allows you to use your money to fulfill your mission instead of giving a significant chunk to the IRS as for-profit businesses must do.
The tax-exempt status can benefit charities, churches and religious organizations, schools, educational organizations, social welfare organizations, civic leagues, social clubs, labor organizations, business leagues, and political organizations.
What are the benefits of donating to a 501(c)3 organization?
501(c)(3) nonprofits are a specific class of nonprofit organizations recognized by the IRS, including most charitable organizations and churches.
Donations to 501(c))3) nonprofit organizations are tax-deductible. Individuals can deduct up to 100% of their income in qualified donations. Corporations are limited to a deduction equal to 25% of their taxable business income.
Large corporations actively seek the tax deduction, so they often will not give money to organizations that do not have a legitimate 501(c)3 status.
Donating to a nonprofit with the correct tax exemption status also helps ensure your money will be put to good use, as 501(c)3 organizations are held accountable to legal standards enforced by the federal government.
Can you donate to a nonprofit without a 501(c)3 designation?
A nonprofit organization doesn’t need to have a 501(c)3 designation to accept donations. But, as a donor, if you donate to an organization that doesn’t have the correct designation, you cannot claim the tax deduction when you file your tax return.
Nonprofits without the correct designation will often turn to crowdfund sources or GoFundMe programs to collect donations.
PRO TIP: If you donate to an organization that has applied for tax-exempt status but has not yet received a letter of determination from the IRS, your donation will be exempt from taxes only if their application is eventually approved.
Is my political contribution considered a donation?
One of the restrictions placed on 501(c)3’s is that they cannot use funds for political lobbying purposes.
Political nonprofits exist, but they fall under the 501(c)4 designation instead with specific tax exemptions and a different way of handling political contributions. A donation to any of the following is NOT tax-deductible according to the IRS:
A political candidate
A political party
A campaign committee
A newsletter fund
Advertisements in convention bulletins
Admission to dinners or programs that benefit a political party or political candidate
Political Action Committees (PACs)
As a donor, can I put a restriction on my donation?
Yes, donors can place restrictions on how a nonprofit may use its funds.
Nonprofits are required to adhere to these donor requests by creating accounts to track restricted funds separately from other funds and reporting restricted fund balances on their financial statements.
Can my 501(c)3 I donate to another 501(c)3?
Yes, you can. It’s quite common for nonprofits to support other nonprofit organizations, especially if they share a common mission or serve the same community.
Before donating, you should do your due diligence and ensure that the nonprofit you are giving money to is reliable and worthy of your funding– this could help you prevent potential damage to your reputation if that organization isn’t using their funding appropriately.
Can a 501(c)3 nonprofit organization donate to an individual?
Yes, 501(c)3 nonprofits can gift money to individuals, provided the individual falls under the primary demographic the nonprofit assists and the donation falls within your organization’s mission as declared to the IRS.
3 Tips For Boosting Your Donations
Getting more donations is vital in raising funds to keep your nonprofit going. Because of this, nonprofits are getting creative with fundraising events to entice more sponsors and donors. Here are some of the different trips on how you can increase donations to your nonprofits:
Partner up with a fellow nonprofit with a similar mission
Nonprofits love to partner with other nonprofits to multiply resources and help accomplish a common goal. Search for nonprofits that cater to the same audience as you and propose hosting joint events or fundraising ventures.
By partnering with other nonprofits, you are dividing the responsibilities, and both organizations can help achieve their goals which creates a win-win for both.
Host virtual or in-person events
Because of the COVID pandemic, most in-person events transitioned to virtual events. The good news is that virtual events are cost-effective and can reach a much wider audience. Just because you are holding a virtual event doesn’t mean that you can’t be creative and have fun with it!.
Tap into technology to reach a wider audience
Social media is a quick and easy way to reach your audience and bring awareness to your cause. It’s an instant way to reach thousands (or millions!) of people. And thanks to easy online payment options, people don’t even have to leave their phones to send money!
When posting to social media, be sure to always include a call-to-action. Don’t be afraid to ask for donations, and provide easy options for them to pay you now, like text-to-donate services or Live Donations through Instagram .
Still Confused About 501(c)3 Donations?
At some point, every nonprofit organization needs someone to turn to for answers. But too often, there’s nobody there.
The rules for nonprofit bookkeeping and accounting are complex and confusing. So having an expert financial partner on your side can help you sleep better at night and keep your organization out of trouble.
The Charity CFO provides full-service bookkeeping and accounting services for over 100 nonprofit organizations in the USA. We’re experts on everything from time-saving bookkeeping software to financial reports and audits.
Our team of experts can help answer your questions about donations, taxes, audits and more. Are you ready for on-demand support from a world-class nonprofit financial team?
No time to read this article now? Download it for later.
Do You Struggle to Make Sense of Your Financial Statements?
Get our FREE GUIDE to nonprofit financial reports, featuring illustrations, annotations, and insights to help you better understand your organization’s finances.
Do You Struggle to Make Sense of Your Financial Statements?
Get our FREE GUIDE to nonprofit financial reports, featuring illustrations, annotations, and insights to help you better understand your organization’s finances.
Cash flow isn’t just an issue for small nonprofits that depend on donations to meet payroll each month. A lack of cash on hand impacts nonprofit organizations of all sizes.
Take this example…
A few years ago, we were working with a fully-funded nonprofit.
This organization’s revenue was secured by government contracts and a few key foundations. Their budget projected a surplus, and they were hitting those numbers.
Everything was looking not just good, but great.
So when they came to us, they couldn’t understand why they didn’t have the cash flow to make payroll or pay the heating bill on time.
After all, their financial reports showed they had much more revenue than expenses. They were hitting their budget numbers month after month. And their revenue sources were 100% committed.
On paper, they were a flourishing organization— a model of nonprofit success. But behind the scenes, their management team was losing sleep.
Why did reality not match up with the numbers in their financial statements? We’ll tell you exactly what happened to them here below.
And then, we’ll give you 5 simple indicators that anyone can watch to see if nonprofit cash flow is becoming an issue for your organization.
Why does nonprofit cash flow matter?
Cash is king, as they say. But why, exactly?
In an accrual accounting system, financial reports are complex documents. And not every number on your financial statements reflects cash changing hands.
For instance, you may record donations or grant revenue this year but you will not receive the cash until next year. Or you might bill a funder for services provided but have to wait 2 months to get paid.
In those cases, your revenue numbers look great on the reports, but you haven’t received the cash that those revenue numbers appear to indicate.
And that’s exactly what happened to the nonprofit we talked about above. They delivered the agreed-upon services and were entitled to payment by their funders. But they weren’t doing the necessary legwork to actually get paid.
In fact, their team was billing their funders incorrectly and their payment requests kept getting kicked back for revisions. Nobody was taking charge of the situation to get the much-needed payments approved, so money stopped flowing into their bank account.
By the end, they had blown through nearly half of their operating reserves and were quickly running out of money, despite being quite profitable on paper.
If you want to avoid a similar situation, look out for these 5 signs that you’ve got a nonprofit cash flow problem on the horizon:
1. Accounts Receivable Keeps Climbing
Accounts receivable (AR) is the red flag that should have alerted our client above— if your AR keeps increasing and your cash decreases, you know you’re earning revenue but not collecting it.
You should jump into action to see if one of these issues is causing your incoming cash to dry up:
Failing to submit invoices to your donors and funders
Submitting invoices but not doing it accurately or timely
Key funders and donation sources are behind on payments, and your team isn’t following up (or isn’t letting you know)
It is easy to pinpoint if accounts receivable are becoming an issue. Simply compare your AR balance on your Statement of Financial Position to the balance from previous months. If you see a significant change from month to month, ask your financial team to investigate.
If you do this consistently, you’ll start to understand the seasonal flow of funds in your business. And that will help you identify and resolve nonprofit cash flow hiccups before they turn into major problems.
2. You’re Not Paying Your Bills
If you’re not paying your bills, it may be a sign that you don’t have the money to pay them.
So if you notice your accounts payable balance creeping up—or you’ve heard from vendors that your payment is late— it’s a big red flag you should investigate immediately.
It may be sloppy bookkeeping (which you should also address) causing the late payments. Or it could be that your cash flow balance is low and your team has to choose who to pay and who not to pay.
Regardless of the reasons, we’ve seen many nonprofits in desperate situations after tarnishing relationships with their key vendors. In today’s world of ACH transfers and credit card payments, vendors expect to be paid quickly, and the days of 30-day or 60-day remittance periods are mostly a thing of the past.
PRO TIP: AP is a big challenge for nonprofits running on a reimbursement grant funding cycle. You won’t get paid for 30 to 60 days in some cases, even if you do everything perfectly. But your vendors probably won’t be happy to wait 2 months to get paid. So we’d suggest either building a healthy operating reserve and/or opening a line of credit to help you fill that gap.
3. Operating Reserves are Drying Up
A nonprofit’s operating reserve is kind of like its savings account or rainy-day fund. It’s a reserve of cash (or highly-liquid assets) that you can use to get through periods with less cash coming in than you need to spend.
You build it the same way you create your personal savings account— by putting some money aside when cash flow is strong. If you don’t have a reserve, it tells donors that you haven’t historically been able to bring in more cash than you spend, which is a big red flag for them.
Nonprofit best practices suggest you should have 30 to 90 days worth of operating expenses on hand as a reserve. But not all of that has to be cash in your bank account. Use this formula to calculate your operating reserve, and then try to watch it each month.
The balance may decrease at times— that’s okay, it’s what it’s there for— but you should see it start to build back up once the short-term cash flow issue is resolved.
4. Decreasing Working Capital Ratio
Your Working Capital Ratio is an important indicator of whether your nonprofit has enough working capital to cover obligations. It calculates how long your organization could sustain its current programs without generating new revenue.
You can calculate you working capital ratio like this:
Working Capital Ratio = Working Capital ÷ Average Total Expenses
You primarily want to watch for changes in your working capital ratio from one period to the next. So you need to calculate it consistently (monthly, preferably) and be on the lookout for any significant increases or decreases.
5. Too Many Restricted Funds
In a nonprofit, not all “cash” is created equal.
Unrestricted cash that you can use for anything your organization needs is the most sought-after (and hardest to secure) type of funding.
Unfortunately, many nonprofits struggle to build large reserves of unrestricted funds. So it’s essential to know how much of your cash has restrictions at all times.
We’ve seen too many instances of nonprofits “robbing Peter to pay Paul” by using restricted funds to cover operations, intending to pay it back later.
And while this isn’t necessarily illegal, it is not a recommended financial practice. Because these same organizations inevitably find themselves in trouble when they fail to pay back the funds as intended.
So keep an eye on your restricted vs unrestricted assets each month to be sure that you can actually use the money you have for the things you need.
On-Time Accounting is the Key to Avoiding a Nonprofit Cash Flow Crisis
What do all five of these warning signs have in common?
You’ll never see ANY of them coming if you don’t have updated accounting information on a timely basis.
And THAT is where 9 out of 10 of nonprofits really drop the ball.
At The Charity CFO, we help 150+ nonprofits execute accurate bookkeeping and create timely financial reports while actively looking out for issues that may be looming on the horizon.
So if you want a financial partner that can give you accurate numbers and help you understand them too, look no further…
We can’t raise money for you, but we can help you see what’s happening in your business so that you can make critical informed decisions that move your organization forward.
If you’re like many people, you probably think that there is a single set of accounting rules that every company must follow.
But that’s not quite true—nonprofits face a decision between 2 different accounting methods for tracking their financial activity: cash accounting vs. accrual accounting.
Though both systems use the same numbers, looking at those numbers differently can give you a very different perspective on the state of your finances. And understanding the key differences between the two systems will help you minimize confusion when discussing your financial position with board members, funders, or other stakeholders.
So which accounting method is right for you? Is your nonprofit required to use accrual accounting? And is it time for you to switch to accrual from cash basis accounting?
If you’re searching for answers to these questions, you’ve come to the right place!
Cash vs. Accrual Accounting: What’s the difference?
The core difference between cash and accrual accounting systems is whenyou record financial transactions.
In a cash accounting system, you record and recognize revenue when money is received. And you record and recognize expenses when you spend money or pay bills. Cash accounting is the more straightforward option, since it follows the movement of cash into or out of your checking account similar to how you might manage your personal checkbook.
In accrual accounting, you record revenues when they are earned or pledged. And expenses are recorded when they are incurred. So the accrual accounting system doesn’t focus on when cash changes hands. Instead, it is concerned with when services are rendered, or a commitment is made.
Accrual basis accounting is the more accurate accounting method because it matches revenues with expenses in the same period in which they occurred.
PRO TIP: Most very small nonprofits operate on a cash basis because it is easier to understand and requires less accounting experience. As an organization grows, it will generally switch to accrual-basis accounting for reasons we explain below.
What is the Accrual Accounting Method?
When using the accrual method of accounting, your nonprofit records money when it is pledged (or earned), regardless of when the money is received. You also recognize expenses when they’re incurred rather than when the payment is made.
Under this method, pledges are recognized as revenue on the date the pledge is made, not when you receive the money. So, if today a donor pledges to donate $100 to you next year, you’ll record that donation today rather than next year when the money will arrive in your bank account.
Similarly, if you receive a $100 electric bill on December 30th, you’d record that expense when you receive the bill (this year), and not when you pay it 2 weeks later (next year).
Accrual accounting allows you to match your expenses with your revenue in the period in which they occurred. It also allows you to properly recognize the value of non-cash assets or liabilities that may offset revenue or expenses in that period (like when you sell inventory or receive in-kind gifts).
Furthermore, accrual accounting is required by Generally Accepted Accounting Principles (GAAP) because it gives you a more accurate picture of your organization’s fiscal situation and allows for easier side-by-side comparison with financial statements of other organizations. And many large grantmakers, foundations, and banks may insist on accrual-based financials to give you funds.
A note about accruals and accrual accounts:
‘Accruals’ are the basis of accrual accounting. An accrual is an adjustment made to your book without cash being exchanged. So when you record a pledged donation that you haven’t yet received, that is an accrual entry.
Accrual accounts exist to track your accrual transactions and their balances, according to the type of transaction. Common accrual accounts include:
Accounts receivable
Prepaid expenses
Inventory
Fixed assets
Investments
Accounts payable
Accrued expenses
Notes payable
What is the Cash Accounting Method?
The cash accounting method requires companies to report money when it is received, which means nonprofits will record cash as revenue the moment they deposit it in their bank account. It’s easier than accrual accounting because it mostly tracks the flow of cash in or out of your bank accounts.
Consider the same example as above: A donor promises today to donate $100 but they won’t give you the money until next year. If you run a cash accounting system, you would only record that donation in your books next year when you receive the money in your bank account.
The scenario is similar for expenses–imagine you receive a $100 electric bill on December 30th and pay it 2 weeks later. Under the accrual accounting you had to record the expense in December, when you received the bill. But under cash accounting, you would record the $100 expense in January, when you paid the bill.
Cash accounting is less complex than accrual accounting. And it may be the right choice for small nonprofits that don’t have experience with accounting, the budget to hire help, or time to learn.
In a cash system, the permanent accounts consist exclusively of cash and equity accounts, so there are no accounts payable, receivable or fixed asset accounts. And cash basis reporting may be used for some tax purposes, even for accrual-based organizations. (Fortunately, most accounting software makes it easy to switch between cash and accrual-based reports with the push of a button.)
Cash accounting does not comply with Generally Accepted Accounting Principles (GAAP) for nonprofit organizations. So if you expect to grow or search for new sources of funding, you’ll probably need to graduate to accrual-basis accounting.
PRO TIP: Only organizations with less than $26M in gross receipts over a 3-year period are eligible to use cash accounting, per the IRS. Also, revenue must be recorded when it is actually or “constructively” received. Income is constructively received when an amount is credited to your account or made available to you without restriction, regardless of whether or not it’s been deposited in your bank account.
What is Modified Cash Basis Accounting?
Some nonprofits use a hybrid accounting system called modified cash basis accounting. In this system, you generally recognize revenues and expenses as you would in cash-basis accounting (when money enters or leaves your account).
But modified cash accounting also allows you to record long-term assets according to the matching principle. This means that you may have accounts for things like fixed assets, investments, and notes payable that you would track using accrual accounting methodology.
Which accounting method is more effective?
When deciding between cash vs. accrual accounting for nonprofits, there are a few things you should keep in mind.
Amount of accounts payable and receivable – If you only have significant unpaid invoices or pending gifts, accrual basis accounting is probably a must to help you accurately understand what you owe to others and what is owed to you.
Bookkeeping staff/volunteer expertise — Accrual accounting is more sophisticated and time-consuming. When determining which approach to utilize, consider the expertise level of the person who will be doing your books.
Cash flow situation – When cash flow is a concern, accrual accounting can help you see upcoming revenue and expenses to better understand what your future holds.
Your organization’s size – A small nonprofit can continue to operate on a cash basis relatively smoothly. As increasingly complicated transactions develop, a firm that seeks to grow will almost certainly switch to accrual accounting.
Financial statement audit or review – if you are required to undergo a financial statement audit or assessment, using the accrual method to be in accordance with GAAP will make the process much smoother and less expensive.
Is Accrual Accounting a Requirement For You?
Here are some additional reasons why organizations should utilize accrual accounting:
Do you need to undergo an audit?
If your bank, funders, or state of legal domicile require an annual audit of your financial statements then you’ll need to use the accrual basis of accounting.
✔️ You receive over $750,000 per year in federal funds ✔️ You are in one of 26 states that require an audit of all nonprofits ✔️ An annual audit is required by your organization’s bylaws ✔️ You spend over $500,000 per year (in most states) ✔️ You want to get serious about grant funding ✔️ You want to apply for a loan
This is not a comprehensive list, so speak to your lawyer or financial professional to be sure whether or not you require an audit.
Accurate Budgeting for Your Nonprofit
Cash accounting is simpler and faster but it’s not ideal for creating accurate and actionable financial plans. By matching revenues and expenses in the period they occurred, accrual-based accounting gives you a more accurate picture of when you’re making or losing money.
And when you use your financial reports to create plans and budgets, having that accurate month-by-month data will help you develop more accurate projections to use your resources more effectively.
For these reasons, accrual accounting is preferable for organizations planning for growth. But whether you start with accrual accounting now or make the switch later depends on the day-to-day reality of your nonprofit today.
Need to get Your Accounting in Order?
Whether you’re running an accrual or cash-based accounting system, at some point most nonprofits need to turn to outside help to get their financial house in order.
The Charity CFO helps over 150 nonprofits nationwide modernize, optimize and digitize their bookkeeping and accounting to save thousands of hours every year.
Outsourced accounting from expert nonprofit accountants could be the secret sauce your organization needs to finally create the time, space, and resources to pursue the growth you’ve dreamed of.
If you’re struggling to build the right team to get your finances on track, maybe it’s time to stop struggling…
Nonprofit fraud makes for great headlines— like the Minnesota nonprofit Feeding Our Future accused this year of squandering $48 million of federal funding on luxurious trips, fancy mansions, and other personal costs.
Fraud losses in the charitable industry destroy an organization’s reputation, future financing opportunities, and capacity to carry out its mission. According to The New York Times, the value of nonprofit fraud is approximately $40-50 Billion each year. Nonprofit fraud impacts nearly one in five nonprofit organizations, according to some estimates.
While most nonprofits work tirelessly to make a difference in the community with a shoestring budget and tiny workforce, these highly-publicized cases of nonprofit fraud erode public trust and cause people to hesitate to give their money to worthy organizations.
So let’s take a look at what nonprofit fraud looks like so you can know what to look for and help keep your organization out of trouble.
The Case of the Missing $48 Million
On January 20, 2022, the FBI raided the offices of Feeding Our Future in Minneapolis and the home of its founder. Feeding Our Future received funding from the United States Department of Agriculture through the Child and Adult Care Food Program and the Summer Food Service Program—money intended to provide meals to children. But investigators allege the organization used most of that money to fund personal costs, like luxury cars and lakefront homes.
How was this fraud uncovered?
The education first department reported Inconsistencies to the USDA in 2020. They lacked evidence to explain a significant spike in the number of community locations Feeding Our Future claimed to support.
And in early 2021, the department labeled Feeding Our Future “seriously defective” due to incomplete financial audits and lapsed IRS nonprofit registration. As a result, they suspended all payments to the organization.
Now, the BIG question— how did this happen?
Officials from the Minnesota Department of Education told FBI agents that the USDA’s loosening of restrictions during the COVID-19 outbreak rendered these programs more prone to exploitation.
The USDA relaxed the rules for those who can participate in the programs, allowing for-profit restaurants to join and allowing meals to be packaged and consumed off-site.
Moreover, the USDA dropped in-person surveillance restrictions due to the pandemic, making it easier to cover up potential deceit.
The Feeding our Future case is unusual in the scale of the alleged fraud, but assuming criminal activity took place, it must have required collusion between multiple parties. Proper accountability, oversight, and separation of duties in nonprofits would prevent grift on this scale from taking place.
Let’s look at the 3 types of fraud impacting nonprofits most frequently today.
3 Common Types of Fraud in Non-profits
Fraud committed by nonprofits organizations frequently follows a similar pattern. The three typical fraud schemes include:
#1: Corruption
Corruption is the improper use of influence in a business transaction to obtain benefits for oneself or others at the expense of one’s employer. Corruption is involved in 43% of occupational fraud cases across all industries.
According to Merriam-Webster, corruption is “dishonest or illegal behavior especially, by powerful people.” In this case, nonprofit corruption generally involves the senior leadership of a nonprofit organization.
Corruption can include:
Bribery occurs when cash or another asset is taken or offered in exchange for assistance in the scam. This often takes the form of invoice fraud and vendor kickbacks or bid-rigging schemes.
Extortion is obtaining an asset via the use of force or threat of force.
Conflict of Interest corruptionmay involve purchasing schemes with related parties (i.e., paying too much for services or goods and not getting competitive bidding beforehand), fictitious vendor schemes, or billing schemes.
The most common type of corruption found was conflict of interest, which resulted in a median loss of $200,000 per event. Bribes were the second most common form of corruption, accounting for one-third of individuals reporting fraud. Cases involving improper gifts resulted in the highest corruption losses, with a median cost of around $3 million per instance.
How Can You Avoid Corruption In Your Nonprofit?
✔️ Board Oversight – The board needs to understand where the funds are coming from and our significant expenses. And then ask the right questions to understand the organization’s financial position.
✔️ Annual conflict of interest statement – All senior leadership and board members should fill this out and must disclose any related party.
✔️ Annual independent financial audit – An auditor can find numbers that don’t make sense and may help head off schemes before losses are too large. It’s also an excellent deterrent to would-be offenders.
✔️ Segregation of duties – Ensure that no senior leadership member is driving critical processes in the organization. Have a whistleblower policy, and individuals within the organization share the responsibility.
Check Tampering
Check tampering is essentially forging or manipulating checks written. Check tampering is one way of “asset misappropriation,” which is the theft of tangible assets— in this case, stealing money.
Check tampering usually happens when:
Checks are altered after they are signed by the appropriate person (changed amounts, vendor name, mailing address, etc.)
An unauthorized person forges checks.
Unauthorized people make transfers or bill payments that are not approved. This can also include inappropriate charges or cash advances on credit cards.
Other examples of asset misappropriation include theft of cash on hand, theft of cash receipts (posting payments received in the accounting system without depositing them), expense reimbursement fraud, and vendor payment schemes.
How Can You Avoid Check Tempering?
✔️ Create a check-signing policy that ensures multiple layers of review
✔️ Implement segregation of duties so that the person who prepares checks is not the same person who initiates the payment request
✔️ Use a 3rd party check paying system, like Bill.com, to ensure physical checks cannot be tampered with
✔️ Strictly limit access to check stock to authorized employees
✔️ Review checks carefully to ensure the vendor’s name on the invoice matches the vendor’s name on the check
✔️ Review bank statements carefully to ensure that all checks cleared are to familiar vendors.
✔️ Review online bank and credit card activity to be sure electronic withdrawals and charges are appropriate and reasonable
Billing Fraud
Billing fraud typically happens when services are paid for by funders but not delivered.
Billing fraud is so common because many medium to large-sized nonprofits have government contracts. And many government grants pay for services on a cost-per-unit basis rather than issuing a large one-time check.
Each month, a nonprofit must tally up the services rendered and bill funders based on the agreed-upon rate. If they simply say they’ve delivered more units of service than they did, they can secure extra funding. And it can be very hard to detect.
Several factors cause the incentive to inflate their billing numbers:
Pressure from upper management on programmatic staff to increase impact and number of people served. By inflating billing numbers, it appears they had a more significant effect.
Financial struggles. The organization will receive additional funds that they may feel they “need” to stay operational by billing more units.
Dishonest staff. In some cases, a staff member is expected to deliver a specific number of services. By falling short, they may fear their job is at risk. The team may be motivated to exaggerate the volume of services and clients they are working with to stay in good standing with their supervisor.
Pressure from funders. Funders make allocations to organizations with the understanding that all services included in the contract will be rendered. Organizations understand that failure to exhaust these contracts fully will result in reduced funding next year.
How Can You Avoid Billing Fraud?
✔️ Oversight and management. Regularly review the volume of clients and participation records (attendance records, case notes, client files), periodically to ensure that your participants are real and are receiving services.
✔️ Develop expectations. Understand the status of grants and funding throughout the year. Understand any trends or seasonality in the delivery of services (i.e., the school-based program ends in summer; therefore, we expect fewer services). Monitor fluctuations regularly to ensure you are on track.
✔️ PTO policies and cross-training. Ensure that there is cross-training and forced PTO for those that compile billing numbers. Having a rotation will ensure a consistent process is followed.
✔️ Have a relationship with your funders; if there are any discrepancies or instances of inadequate or inappropriate documentation, have an open-door policy.
While it is critical to respond immediately to fraud, the best method is to avoid the scenario in the first place. It is impossible to expect a nonprofit organization’s governing body and leadership to eliminate the danger of fraud, but you can take practical actions to reduce it.
You can avoid putting your nonprofit’s hard-earned reputation at risk by creating an environment where ethical behavior is expected. And by creating robust internal controls a proactive fraud detection and response program.
And, of course, the cleaner and more accurate your accounting, the easier it will be to find numbers that don’t make sense. If you’d like help modernizing your accounting system and keeping a closer eye on what’s happening with your money, reach out to The Charity CFO for a free consultation.
We provide outsourced nonprofit bookkeeping and accounting services for over 150 US-based nonprofit 501(c)(3) charity organizations. Our team of financial experts include former nonprofit CFOs and auditors, so we can help you find and fix your biggest issues before the auditor comes knocking.
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Your tax-exempt status has benefits, but it doesn’t exempt you from oversight. In fact, as a nonprofit organization, the expectations for transparency and accountability are higher than those for for-profit businesses.
Why do nonprofits need to file Form 990?
When you received your tax-exempt status as a 501(c)(3) organization, you committed to serving a specific purpose. And Form 990 is the IRS’s way to ensure that your organization follows through on that commitment.
It’s a tool for ensuring transparency, disclosure, and accountability to the public.
Form 990 is a public document available to anyone with a simple online search. Potential donors, existing donors, and watchdog agencies can see where your money comes from, how you’re spending it, and even how much you pay yourself or your executive team.
But, most importantly, you need to file Form 990 because it’s the law. If you don’t file for 3 consecutive years, you’ll automatically lose your tax-exempt status.
When is IRS Form 990 due?
You must file Form 990 for every year your nonprofit organization is operating.
Regardless of the version, your Form 990 is due on the 5th day of the 5th month following the end of the fiscal year.
That’s four and a half months from the end of your fiscal year. So if your fiscal year ended on December 31, your Form 990 is due on May 5.
Which 990 should I file?
There are four versions of Form 990 that may apply to most nonprofit organizations. Which one you file will depend on the type of organization and your size (annual revenue). We’ll look at each of the options below so you can determine which one is right for you.
PRO TIP: If you’re still waiting for your Form 1023 (application for tax exempt status) to be processed, you should still file Form 990 in anticipation of your application being approved.
1. Form 990-N Simple e-postcard for nonprofits earning less than $50,000/year
Form 990-N is a virtual postcard which must be filed online. It simplifies the filing process for very small and startup nonprofits.
Only tax-exempt organizations with less than $50,000/year in annual revenue receipts are eligible to submit Form 990-N. However, there are a few exceptions for newer organizations.
Your organization can file the very simple 990-N if it:
Exists for 1 year or less and is reporting less than $75,000 in revenue
Exists for 1-3 years and is reporting less than $60,000 in revenue
Exists for 3+ years and has reported less than an average of $50,000 in annual revenue over the most recent 3 years (including the current year)
The information included on Form 990-N is straightforward and standard to all versions of Form 990:
Legal name and any trade names
Name of the principal officer
Whether or not the organization is still operating
Federal Employee ID Number (EIN)
Current address
Form 990-N is a breeze compared to the following two options, Form 990-EZ and Form 990.
It’s reasonable that a nonprofit could handle filing Form 990-N on its own. But if you have a CPA, it’s still a good idea to have them look at it rather than putting your tax-exempt status at risk.
2. Form 990-EZ Short form for nonprofits earning $50,000-$200,000 a year
When you see the “EZ” don’t make the mistake of thinking it will be easy. The 990-EZ may be simpler than the full form, but it’s still a complex declaration of your organization’s finances.
Small to mid-sized nonprofits with annual revenue receipts between $50,000 and $200,000 or total assets valued at less than $500,000 can use this form.
The filing can be as short as four pages. Or as long as fifteen. It all depends on the complexity of your organization and funding sources.
Overview of your Board of Directors and executive salaries
Programming report: overview of functions, mission, and budget
Declaration of any conflicts of interests related to the mission
5-year breakdown of financial records
Information on donors who give more than $5,000 a year
If your organization falls into the $50,000-$200,000 range but must complete an annual audit for funding or GAAP purposes, it is wise to skip Form 990-EZ and head straight to the full form.
3. Full Form 990 For nonprofits earning over $200,000
If your nonprofit has gross annual revenue receipts greater than or equal to $200,000 OR a total asset valuation greater than or equal to $500,000, you’re required to file the full form 990.
And it’s a beast–the full Form 990 can be up to 50 pages long.
The full Form 990 asks for a lot of detail, but if you want the benefit of tax-exempt status, the IRS needs to know how you’re operating, where your money comes from, and exactly how you’re spending it.
Here is what you’ll find in Form 990:
Twelve sections that report demographic and accounting information, similarto the info Form EZ, but in greater detail
Information to classify expenses according to function (programming, administration, and fundraising) and detail what that money accomplished for each function)
16 “schedules” that provide supplemental information on funding sources, campaign activities, international activities, in-kind donations, etc. (your responses in the initial 12 sections determine which schedules you’re required to file)
NOTE: In most cases, the full form 990 is not a DIY IRS return. We recommend you always partner with a CPA familiar with nonprofit accounting to ensure compliance and proper reporting.
Additional 990 forms:
Almost all nonprofit organizations will use one of the three Form 990 variants above. But there are 2 other special-use 990 forms you should know:
As you may know, there is one exception to the “nonprofits don’t pay federal income tax” rule, and that’s for unrelated business activities.
If your nonprofit earns $1,000 or more in gross revenue from activities unrelated to our legally declared mission, you must report that revenue on form 990-T and pay taxes on it.
How do you know if your revenue is unrelated business income (UBI)? Revenue must meet these 3 requirements to be considered unrelated business income:
It is a trade or business – meaning the activity produces income from selling goods or services.
It is regularly carried on – the activities demonstrate frequency and continuity
It is not substantially related to furthering the exempt purpose of the organization – they don’t contribute significantly or directly to accomplishing the organization’s declared mission (SOURCE: Colorado Nonprofit Association)
As with all things IRS-related, there are some exceptions and exclusions you’ll want to check out. If you’re not sure if your income is business-related or not, check with your CPA or legal team.
Form 990-PF: for private foundations
Form 990-PF is used exclusively by private foundations as an alternative to the full form 990. It requires private foundations to disclose information on investments, endowments, earnings, and capital gains, and report any donations received from the public.
Like all form 990s, the 990-PF proves to the IRS that the foundation is operating according to its declared mission and distributing funds as required. It may also be the only public source of full grant lists for some smaller foundations that don’t issue annual reports to the public.
Want a stress-free 990 filing season?
When is the right time to start preparing for your next 990 filing? Every single day.
The easiest way to create a stress-free filing process is to keep your bookkeeping up to date and execute accounting best practices daily.
At The Charity CFO, we work with over 150 small to mid-sized nonprofits to help them automate and optimize their bookkeeping. And implement foolproof systems for tracking restricted funds, functional expenses, and more.
When you outsource your bookkeeping and accounting to us, we’ll ensure your books are always audit-ready. So when it’s time to file your 990, all you’ll need to do is review a few numbers and sign off on it.
We don’t file returns for non-clients because we’re dedicated to building long-term relationships with our nonprofit partners. If you want to see how done-for-you accounting can help you realize your vision for your organization, reach out for a free consultation today.
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What is a nonprofit Statement of Activities?
The Statement of Activities is the Income Statement of a nonprofit organization. It’s one of the core financial statements that all nonprofits need.
You may also hear it referred to as a profit and loss statement or income and expense report.
Simply, it reports your organization’s revenue and expenses during a specific period and the difference between them.
In the for-profit world, they call the difference between revenues and expenses net income (or profit).
But a nonprofit calls the difference between revenue and expenses change in net assets.
Like all nonprofit financial statements, the central role of the Statement of Activities is to provide transparency and accountability to your donors and board. But it’s also an excellent tool for understanding just how healthy your business is.
By starting with your revenues and subtracting your expenses, the report helps you answer the all-important question:
Did we bring in more money than we spent?
The Statement of Activities further breaks down your revenue and expenses according to any restrictions limiting how or when you may use them.
1. Revenue: How much money did you receive?
Revenue includes all flows of cash into your business. It includes donations, grants, fundraising, earned revenue, government funding, and special events.
If you use cash-based accounting, you’ll only record cash deposited into your bank during the reporting period.
But, since auditable nonprofit financial statements, we’ll talk about accrual accounting practices in this article. That means your revenue will also include any donations pledged in the period (whether you collected the cash or not) and any receivables (for services rendered but not yet paid).
Restricted Revenue shows funds with donor-placed restrictions on how or when you can spend the money. You can include all restricted funds together or segment them by donation type.
Unrestricted Revenue shows funds without donor-placed restrictions. You can use unrestricted funds for any mission-oriented purpose, including paying general operating expenses and salaries.
You may choose to break down your revenue into additional categories, such as:
Sources of Unrestricted Donations: Individuals versus organizations or foundations.
Federated Campaigns: Donations received indirectly from the public by a fundraising group, like United Way..
Government Funding: Funds from local, state, or federal government organizations
Earned Revenue: Income from the sale of goods, services rendered, or work performed Special Events: Revenue earned at fundraising events (You’re required to keep track of each event separately once it hits $5,000 in revenue.)
2. Expenses: How much money did you spend?
The expense section reports all cash that flows out of your organization, including pending expenses—those you know you’ve incurred but haven’t spent the money yet, such as payroll for hours worked the previous month.
NOTE: Nonprofit expenses include any outflow of assets, like in-kind donations and depreciation expenses (not only cash).
Since functional expenses are a big theme for many investors, particularly the percentage of money you’re spending on programs, most nonprofit Statement of Activities are organized according to functional expenses.
Expenses are shown by all significant or relevant categories. These are the most common:
Programs: expenses incurred while carrying out your mission through goods and services
Management and Administration: typically includes “overhead costs,” including operational expenses that don’t specifically relate to executing your mission or fundraising.
Fundraising: costs directly tied to raising money, including special event costs, advertising, and fundraising staff salaries.
3. Change in Net Assets: How much money did you make?
The Change in Net Assets is your bottom line– did you bring in more money than you gave out?
It shows you the “profit” of your nonprofit. But here, we call profit a “surplus” instead.
Yes, a nonprofit can make money. While the goal of a nonprofit isn’t to turn a profit, if you don’t bring in more than you spend, you won’t be able to survive. And a little “profit” helps build your operating reserves to help you survive a slow-fundraising quarter or unexpected expenses.
The Change in Net Assets section shows you how much money you made with a simple equation:
Net Revenue – Net Expenses = Change in Net Assets
Once you have the change in net assets, you can compare revenue and expenses by significant program activity (or function) to see exactly where you are making or losing money.
You should look at your Statement of Activities every month and compare to previous periods. Identify trends and changes in sources of revenue, expenses, and changes to net assets.
Almost all nonprofits will have deficits in specific periods. But those should be offset by surpluses in other periods.
But if you’re spending more than you bring in for several periods in a row, you’re headed for trouble. So you need to figure out what’s going on and fix it. Before you end up out of business.
What will your CPA look for on your Statement of Activities?
Your nonprofit Income Statement shows the year-over-year income and spending trends. And how those expenses relate to the work of carrying out your mission.
But, it also answers several questions about your organization’s overall financial health.
Here are just a few of the questions your CPA or auditor will be asking when reviewing your Statement of Activities:
Questions about Revenue
Where is the money coming from? Will we get it next year?
Is the revenue restricted in any way?
Do you have diverse revenue streams?
When you compare year-over-year, are you growing or shrinking?
Questions about Expenses
Are these expenses reasonable?
Are they going up or down? Can we understand why certain expenses are going up or down?
Is most of your money going to program activities (75% of each dollar should go to programming; 25% should go to management and fundraising)
The Difference Between an Income Statement and a Nonprofit Balance Sheet
A balance sheet is a term commonly known in profit businesses. In the nonprofit sector, there is a similar report known as a “Statement of Financial Position,” “Statement of Activities,” or a “Statement of Cash Flows.”
This type of report gives a quick look at the financial position of an organization. While very similar to an income statement, the balance sheet shows financial activities over a shorter period of time. The information is very similar including:
Assets: These include cash, cash equivalents, equipment, and property (among others).
Current Liabilities: Any accounts payables for the period covered by the balance sheet, debt payments, and other liabilities related to program expenses.
Net Assets: These are the remaining assets after liabilities, separated by general fund assets without donor restrictions and assets with donor restrictions. (Assets with donor restrictions meaning things like certain grant restrictions or even funds for a designated purpose by the individual or organization giving those funds.)
Need your Statement of Activities on time, every month?
At The Charity CFO, we help 150+ nonprofits get audit-ready financial reports monthly, like clockwork.
We can help you modernize and optimize your accounting systems while also taking the time-sucking bookkeeping tasks off of your hands. And be the trusted financial partner you can turn to for answers to your questions and expert financial advice.
If you’re ready for an accounting partner to ease the burden of monthly bookkeeping and accounting, reach out to us for a free consultation.
We’ll help you determine if outsourcing your accounting and bookkeeping is the right decision for your organization.
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Nonprofits often receive donations or grants designated for a specific purpose–like a donation to a specific program or grant you have to spend within a calendar year.
EXAMPLE: If you receive a donation that’s explicitly for purchasing computers for an afterschool program, you can’t use that money to buy office chairs.
We call revenue from these sources restricted funds because you’re not free to use them however you please.
To respond to those challenges, the nonprofit world uses a system of accounting called fund accounting. Fund accounting ensures you track restricted funds separately from unrestricted funds, so you can ensure you’re using funds correctly and demonstrate accountability to your donors.
Who’s Required to Use Fund Accounting?
Most not-for-profit organizations and entities–like 501(c)(3) charities, churches, religious institutions, government agencies, nonprofit nursing homes and hospitals, and educational institutions– are required to use fund accounting.
Both Generally Accepted Accounting Principles (GAAP) and Financial Accounting Standards Board (FASB) 116/117 require at least a minimum level of fund reporting, so you’ll need it in order to pass an audit.
If you’re a very small nonprofit, it’s possible you won’t have any restrictions on your donations. But once you start getting larger donations or grants, fund accounting quickly becomes a necessity.
What is fund accounting?
Fund accounting is a system of accounting created to help not-for-profit organizations and agencies manage streams of revenue designated for specific purposes.
Fund accounting differs from for-profit accounting in that it prioritizes accountability, though it does add some complexity to the bookkeeping and accounting process.
As a nonprofit, you have to share your profitability, revenue streams, expense reports, and net assets with many different people, including the general public. And fund accounting ensures that you’re maintaining the degree of transparency required of you.
How fund accounting works:
The core concept of fund accounting is the “funds.”
Think of each fund as a mini organization within your company, each with its own budget and financial statements that track revenue, expenses, liabilities, assets, and equity (net assets).
When a donation comes in, it’s assigned to a specific fund. Then you can track that money through your accounting system to see exactly how much is left, where it was spent, and how much value (net assets) it contributes to your organization.
The FASB requires that you set up at least 2 different “funds” within your accounts– one to track assets with donor-imposed restrictions, and one to track assets without donor-imposed restrictions. In many cases, though, you’re going to want to have more funds in order to optimize accuracy and transparency in your finances.
Common fund structures for nonprofits
The two main fund designations are “restricted” and “unrestricted” funds, as mentioned above. But you’ll often want to break those out by the type of restriction (temporary vs. permanent) or the funding source.
Beyond that, you may want to track grants, endowments, or large-money funders in funds of their own. That makes it easy for you to run fund-level reports to share with your benefactors.
Unrestricted funds often make up the majority of donations for small nonprofits. These funds have no donor-imposed restrictions. So you can use this money for any organizational need that aligns with your legally declared mission.
Examples of unrestricted funds:
Donations from general fundraising campaigns
Revenue from membership subscriptions
Revenue from an event or gala
Temporarily restricted net assets
Temporarily restricted funds must be used for a specific purpose or within a specific period. In some cases, the money becomes unrestricted when a timeline ends or the objective is met. In other cases, unspent restricted funds may need to be returned to the grant maker or donor.
Examples of temporarily restricted funds:
A grant that must be used by a certain date.
Donations received for a specific construction project (once the project is complete, those restricted funds may be able to be reclassified as unrestricted funds)
Permanently restricted net assets
Permanently restricted are typically large donations that function as investment accounts or an endowment fund. The money from the interest earned is designated for a specified purpose, and the principal cannot be touched.
Examples of permanently restricted funds:
An endowment whose capital can never be spent
Real estate that is donated for a specific use and can’t be sold for a capital gain
Other restricted net assets
If you have multiple endowments, grants or restricted large-dollar donations, it is recommended that you track them each in their own fund. Some organizations choose to track these funds outside of their official accounting structure (like in a spreadsheet), but setting up individual funds can help you establish transparency and accountability.
PRO TIP: The more exact and specific your accounting system, the more transparent it will be. And the more transparent your accounting system is, the more accountable you’ll be with the public and GAAP. Failure to accurately track restricted funds could jeopardize future contributions and your tax-exempt status.
Fund Accounting & Nonprofit Financial Statements
When you set up funds in your chart of accounts, they’ll show on your financial statements as well. This adds transparency to your finances, but it also makes them a bit harder to read.
So let’s take a look at where you’ll see restricted funds on your financial reports:
Statement of Activities
You’ll see restricted and unrestricted revenue segmented on your Statement of Activities. So you can see how much of the revenue you’ve generated in a certain timeframe as specific restrictions on its use:
Statement of Financial Position
On your Statement of Financial Position, your fund accounts will pop up in the Assets section (restricted cash balances, restricted fixed assets) and in the Net Assets section (restricted and unrestricted net assets).
The Easiest Way to Keep Tabs on Restricted Funds
The principles behind fund accounting for nonprofits and charities are pretty simple. But the execution is another story.
If you’re not recording every transaction, every month, as it comes in. Otherwise, going back and reclassifying a whole year’s worth of expenses will drive you crazy. And inevitably lead to mistakes.
As leaders in the nonprofit accounting industry, The Charity CFO manages fund accounting for 120+ nonprofits nationwide with precision and expertise.
We can handle your bookkeeping and accounting to deliver accurate financial statements every month that let you know which money you can spend, for which purpose, and when you can spend it.
Unlike most accounting firms, we work exclusively with nonprofit organizations like yours. So there’s nothing your organization can throw at us that we’re not prepared to handle.
Is it time to simplify your accounting process so you can finally focus on your mission?
Reach out to us today for a free consultation.
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Are audit services on your mind as a nonprofit organization leader?
Do you run a non-profit and worry about your fiscal fitness? Are your productivity and scalability as efficient as it could be? If you’re concerned about these things for your organization, then you should consider an audit.
As a non-profit, you owe it to your donors to stay as lean and as efficient as possible. And in order to maintain your NPO status, you need to keep good record books. So enlisting outside audit services can be just what you need to be successful.
And don’t worry if the mention of an audit sent a shudder down your spine. We get it, nobody likes the idea of getting audited, but outside of the IRS, an audit can be a valuable tool to assess your current situation and look at the areas that can be improved.
If you’re concerned about how to fully utilize an audit, keep reading. We’ve got you covered on the different types of audit services as well as how they can benefit you and your organization.
Four Different Types of Audit Services
Nobody likes the idea of an audit. However, when it comes to maintaining the financial health of your nonprofit business, audits are necessary. An audit can take less time if you can keep your financial paperwork organized and thoroughly documented.
There are several different types of audits that are done by different people and will give you different outcomes based on your goals. Some audits are done internally while others are external and require an outside point of view.
When many people think of audits they think of accountants scrutinizing your finances. But operational audits are also just as valuable to your organization.
1. Operational
An operational audit will look objectively at the systems and functions of your business. The audit will assess your business’ systems and productivity as well as your available resources. They will then make their recommendations for how these areas can be improved and what additional resources will be necessary to make the changes needed.
Operational audits can look at your systems and processes as well as your various departments; these can include IT, HR, and staffing. Additionally, if you find your organization continually missing your goals and objectives, then an operational audit can shine a light on this. You can learn why these goals weren’t met and what can be changed to start meeting your goals and objectives in the future.
2. Financials
A financial audit will evaluate your current financial situation for your business or nonprofit organizations. After their complete assessment, they will give their recommendations for how you can improve the fiscal health of your charity.
They will look at your accounting records as well as your financial reporting of accounts receivable and payable. So, it is vital to keep good records so you can get an accurate assessment of your financial situation within your nonprofit.
If you want your nonprofit to help as many people as possible, you must be fiscally responsible year after year. If you find your organization continually behind with your accounting then the help of a CPA can benefit your company.
A professional bookkeeper will help you keep your records so that you never again dread another audit. Audits are helpful and beneficial tools for your company. And having good records can make them smooth and seamless which will allow you to learn from them rather than stressing out about getting them the right records for their audit.
3. Internal
An internal audit is usually done by and for the management of your company. This form of assessment gives light to how your company can make improvements and grow in the company years.
Regular internal audits are important to shine lights on possible areas of growth within your company. It doesn’t do your business any good to continue to do things as they’ve always been done when there is a better way of doing it.
In order to truly grow your company and help more people with your non-profit, you need to continually be open to new ways of doing things.
4. External
An external audit is done by a neutral third-party person or group looking at your business or nonprofit from an outside point of view. These audits are just as important as internal audits and will provide your company with a much-needed alternate viewpoint.
Additionally, by conducting an external audit you open your business up to learning about possibly blind spots that you hadn’t noticed before. This external point of view is vital to growing a healthy business so don’t shy away from it. It can be difficult to ask the opinion of someone outside of your organization, but it is imperative to healthy growth.
By bringing in an external CPA to look at your records regularly you can ensure that your charity will be able to help as many people as possible. While it can be difficult to bring in an outside group of people to dive into your finances, this is a vital step to providing valuable insight and reassurances that you’re operating a successful business.
Keeping good records in accounting software is vital to quick and easy audits. Additionally, having a bookkeeper can improve your audit experience. By having a professional help you keep good records in an organized manner can help you to have a better audit.
Bottom Line: Keep Your Business Financially Healthy
As you can see an audit doesn’t have to be scary. In fact, it can be a healthy process to learn where your non-profit can improve over time.
And enlisting the help of external audit services can be a great way to take an objective look at your non-profit. You’ve put your whole heart and soul into helping those who can’t help themselves. Don’t risk everything by not keeping your organization running efficiently and financially responsibly.
So, if you think that an audit would be a good experience for your non-profit, then find a CPA you can trust to come and take an objective look at your company today. With the help of an experienced professional, you can ensure that your non-profit will be around for years to come to help many more people.
So, if you’re looking for help on anything from filling out your Form 990 to updating your bookkeeping, then let’s chat. We offer affordable services and can help you set up your non-profit for success today.
https://thecharitycfo.com/wp-content/uploads/2025/04/Screen-Shot-2020-10-12-at-11.10.33-AM.png318464Paul Cook/wp-content/uploads/2025/03/fileuploads_222926_8055634_252-8e05624973e20b5de823aebdbcfd37df_LogoLeftAligned.pngPaul Cook2020-10-12 16:17:032025-04-30 15:28:24The Different Types of Audit Services and What They Mean For Your Nonprofit
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