How to Comply with Accounting Standards for Nonprofits

Accounting standards for nonprofits are probably not the first thing you think about, but are crucial for your organization to succeed.

Nonprofit organizations distinguish themselves from for-profit entities through their purpose and mission. Their mission is usually anchored on a cause or social purpose, not on the generation of profits.

Because of their unique structure and operational model, nonprofits must comply with various accounting standards that are, in many ways, different from for-profit organizations.

In the United States, these Generally Accepted Accounting Principles (or GAAP) are set by the Financial Accounting Standards Board (FASB). NPOs must adhere to these accounting policies to remain compliant with the law and maintain their tax-exempt status.

The consequences of not adhering to accounting standards can be severe, leading to:

  • Inaccurate financial reporting
  • Hefty fines and penalties
  • Reputation damage
  • Loss of confidence from donors and stakeholders
  • Funds being frozen or withheld
  • Highest risk of failure and even closure
  • IRS audits
  • And in some cases, the revocation of the organization’s tax-exempt status

Here’s what you need to do to remain compliant:

Understand the Basics of Nonprofit Accounting

Nonprofit accounting is a unique process of planning, recording, and reporting the financial activities of a nonprofit organization. The goal is to create an accurate and comprehensive record of all transactions that can be used for both internal and external reporting, including audits and tax returns.

In the FASB 117, the IRS establishes the core accounting standards for nonprofits, which include:

  • Unrestricted, temporarily restricted, and permanently restricted funds
  • Fund accounting
  • Cash-basis and accrual-basis accounting
  • Presentation of financial statements such as statements of functional expenses, cash flow statements & statements of cash flows
  • Accounting for donated assets

Ideally, these standards should help your nonprofit maintain transparency and accountability with donors, grant funders, and the public. They also help the nonprofit to allocate their resources properly, keep them organized and only spend on expenses that are essential to the organization’s mission.

This is fundamentally different from for-profit accounting, which is geared towards generating profits and returns for its owners (stockholders). Another difference is in fund accounting. Whereby nonprofits must track their funds separately according to unrestricted, temporarily restricted, and permanently restricted categories.

Section 501 (c)(3) organizations must also adhere to specific tax-filing requirements that are uniquely different from for-profit entities, as outlined in the Internal Revenue Code.

Some of these include:

  • File Form 1023 with the IRS to apply for recognition of the organization’s 501 (c)(3) tax-exempt status after incorporation by the state
  • File form 990 (990-N for nonprofits with less than $50,000 in annual revenue and form 990-EZ for those with between $50,000 and $200,000) that discloses your revenue, expenses, and changes to net assets
  • File Form 8868 to request an extension for filing form 990
  • Pay federal tax Unrelated Business Taxable Income (UBTI) that’s more than $1,000

Identify Relevant Accounting Standards 

The truth is, you can’t truly comply with accounting standards without first identifying which ones are applicable to your organization.

First, nonprofits must follow GAAP, the Generally Accepted Accounting Principles. GAAP’s main objective is to ensure that all financial information is reported accurately, consistently, and transparently. This includes financial statements such as:

  • Income statements
  • Balance sheets
  • Statements of cash flows
  • Statements of functional expenses.

In addition to GAAP, nonprofits must also comply with FASB 117, the Financial Accounting Standards Board’s Statement of Financial Accounting Standards No. 117 (FASB 117). FASB aims to develop and issue accounting standards through an inclusive and transparent process intended to promote useful information and decision-making by the NPO board, donors, grant funders, and other stakeholders.

There are ongoing efforts to establish International Financial Reporting Standards (IFRS) for nonprofits, which, if successful, could result in greater consistency and comparability of financial information across countries.

The Chartered Institute of Public Finance and Accountancy (CIPFA), together with Humentum, are working to develop these standards under a project titled  “International Financial Reporting for Nonprofit Organizations (IFR4NPO)” and has already released an Exposure Draft to establish a framework for their use.

Implement Internal Controls 

To ensure compliance with accounting standards, you must have proper internal controls in place. Internal controls are a set of written policies, processes, procedures, and systems of authorization, reconciliation, documentation, security, and separation of duties.

These financial practices:

  • Promote accountability
  • Ensure the integrity of financial and accounting information
  • Help improve operational efficiency by improving the accuracy and timeliness of financial reporting.
  • Help protect against fraud, embezzlement, and mismanagement of assets and resources.

Internal controls also provide reasonable assurance that things won’t go sideways and mitigates human error or malicious activities. For example, having one person responsible for recording expenditures and another approving the payments ensures that someone continually monitors all financial transactions.

Other common nonprofit internal controls include:

  • Establishing financial policies and procedures
  • Implementing an audit process
  • Creating a risk assessment process
  • Setting up a system for tracking expenses.
  • Generating and storing critical supporting documentation
  • Segregation of duties (SOD)
  • Access rights and roles to critical financial applications
  • Multilevel review of financial statements and other reports
  • Monthly bank and credit card reconciliations
  • Periodic review of vendors receiving fees/checks from the nonprofit
  • Background checks for employees and board members

Monitor Compliance 

Compliance monitoring is a continuous process of tracking and evaluating data to ensure that your nonprofit complies with accounting standards. This can be achieved by:

  • Keeping up with new regulatory developments
  • Regularly reviewing financial statements
  • Conducting internal audits
  • Setting up a process for monitoring compliance
  • Evaluating the effectiveness of internal controls, financial policies, and procedures
  • Regularly assessing risks and making necessary changes to mitigate them.
  • Creating procedures for taking corrective action when necessary.

Depending on the organization’s size, you can have a single person (such as a CFO) or an audit committee to monitor compliance.

Work with Compliance Experts

Complying with accounting standards is critical to ensure your nonprofit’s credibility, sustainability, and stability. But this can be hard, especially if you don’t have requisite accounting experience.

To ensure that your organization is properly complying with accounting standards, it’s important to work with experienced compliance experts, such as The Charity CFO.

Our experts give you an independent, third eye visibility, and objective review of your financial practices to ensure you remain compliant. Our qualified compliance experts can advise you on best practices and provide support to ensure your nonprofit organization follows industry-specific accounting.

Contact us today to learn more about our services and how we can help your nonprofit organization stay compliant for years to come. 

 No time to read this article now? Download it for later.

Budgets for Nonprofits: Get ready for 2023

Financial planning and budgeting are vital for the success and sustainability of any nonprofit organization. 

Without a clear understanding of income and expenses — it’s impossible to deliver on your organization’s mission, vision, and goals effectively.

That’s why it’s important to start thinking about your budget for 2023 now. By taking the time to assess your current financial situation and map out your anticipated income and expenses for the year ahead, you can make sure that your nonprofit is on track to meet its goals.

Budgeting should go beyond simply tracking money in and money out. 

A well-crafted budget can be a powerful tool for decision-making, helping you to prioritize spending in line with your strategic goals. It can also be a valuable communication tool, providing clarity for staff, volunteers, and donors about where their money is going and how it’s making an impact.

A nonprofit budget helps your organization:

  • Stay fiscally healthy
  • Allocate resources
  • Set spending priorities 

However, if you’re not careful, it’s only a document. 

Only through regularly reviewing and updating a budget does it accurately reflect your nonprofit’s current financial situation. Using the budget, not only creating it, gives you a clear roadmap to follow and ensures your organization stays within the precincts of its tax-exempt status.

Intro to Budgets for Nonprofits

Budgets differ greatly between nonprofits and for-profits. The biggest distinction is that nonprofits don’t exist to make a profit; they exist to further their missions. Therefore, their budgeting process must be geared towards achieving mission-related goals, rather than maximizing financial gain.

A nonprofit budget is typically a planning document that shows how the organization plans to raise and allocate its money to support its programs and operations. The budget will include both income and expenses and will be based on the organization’s strategic plan.

The budgeting process should involve all members of the organization, from the Board of Directors and committees, to the staff and volunteers. Everyone should have a clear understanding of the organization’s financial situation and be able to provide input on where money should be spent.

The budget should be reviewed and updated regularly, at least on an annual basis. As your organization’s financial situation changes, so too should your budget.

There are two main types of nonprofit budgets: static and dynamic.

  • A static budget is a detailed plan that uses predicted amounts for a given period. It does not change regardless of deviations in revenue and expenses and is typically used for short-term planning. A static budget is ideal for small nonprofits with simple financial structures.
  • A dynamic budget is more flexible and can be adjusted to reflect changes in income and expenses. It allows nonprofits to respond quickly to fluctuations in their funding and better manage their resources. A dynamic budget is a good choice for larger nonprofits with more complex financial structures.

There is no rule that a budget must be one type or the other; it can be a mix of both. The important thing is to use the type of budget that makes the most sense for your organization and its specific needs.

During your budgeting process, you should constantly monitor your situation and make adjustments as needed. The goal is to have a budget that is realistic and achievable so that you can stay on track and deliver on your mission.

7 Steps to Your Budget

1.    Determine a timeline

We are approaching the end of the year, so you may want to start thinking about your budget for 2023 now. By taking the time to assess your current financial situation and map out your goals, you can ensure that your budget is well-crafted and accurate. Allow time for review and discussion, set a target date for board approval, and ensure that everyone understands the budget and their role in it.

2.    Clarify context and articulate goals 

Assess the current alignment of organizational values, reflect on successes and failures, identify opportunities and challenges, and set goals for the upcoming budget year. These goals should be specific, measurable, achievable, relevant, and time-bound (SMART). Input from various stakeholders will be critical at this stage. The budget should reflect the collective vision of the organization, and everyone should have a chance to provide input.

3.    Decide on the budget structure

What is the primary purpose of your budget? Is it a monitoring tool, a funder compliance roadmap, or a blueprint for change? Your answer will determine the structure of your budget. A results-based budget, for example, focuses on outcomes rather than inputs and is often used to demonstrate impact to funders.

On the other hand, an activity/program-based budget is more commonly used to track expenses and income related to specific programs. Other budget structures you can adopt include time-based, source-based, impact-based, and cash-flow budgets.

4.    Develop a draft income budget

This is where the rubber meets the road. Once you have decided on the structure of your budget, you can begin to fill in the details. Begin with a list of all income, including both one-time and recurring items. Project income for the upcoming year based on past performance, current trends, and any known changes. If your organization is expecting any grant funding, make sure to include the conditions of the grant in your budget.

5.    Create a draft expense budget

Articulate the direct and indirect costs associated with each goal. Indirect costs, also known as overhead costs, are those that cannot be assigned to a specific program or activity. They include items such as rent, utilities, and administrative salaries and should be allocated in a fair and reasonable manner. Once all expenses have been accounted for, compare your total income to your total expenses to ensure that you are not overspending.

6.    Review and revise the budget

Discuss potential risk areas, including any potential changes in funding, unanticipated expenses, or unrealistic income projections. Make any necessary changes to the budget and get feedback from key stakeholders. Create a consolidated budget spreadsheet that addresses values, goals, and named priorities. Revise the budget to make sure that it is achievable and realistic.

7.    Finalize the budget

Present the budget to the board for approval, get sign-off from the executive director, and distribute the budget to staff. Make sure that everyone understands the budget and their role in achieving the organization’s goals.

Ensure that all decision-making processes and rolling forecasts are documented for easier monitoring. Ensure that you review and update the budget regularly to account for any changes in funding, new programs, or unanticipated expenses.

Specialized Nonprofit Budgeting Help

Budgeting for a nonprofit organization can seem daunting, but it doesn’t have to be. The most important aspect is to identify all possible sources of income and expenses. Once you have a clear understanding of the organization’s finances, you can begin to develop a budget that meets the needs of the organization.

Having a well-thought-out strategic forecast and budget can help your nonprofit gain better visibility with donors and funders, manage expenses more effectively, and make sound financial decisions. These are all important factors in ensuring the long-term sustainability of your organization.

But with all the moving parts of a nonprofit organization, it can be difficult to know where to start. That’s where we come in. Our team at The Charity CFO has extensive experience in nonprofit budgeting and can help you develop a budget that meets the specific needs of your organization. Having worked with over 150 nonprofits, we understand the challenges you face and can offer tailored solutions to help you overcome them.

Contact us today to learn more about our nonprofit budgeting services. We’ll be happy to discuss your specific needs and provide a no-obligation proposal outlining how we can help you achieve your goals and mission.

No time to read this article now? Download it for later.

The 5-Minute Guide to Nonprofit Finances

It’s a myth that all stakeholders need to be experts in every aspect of nonprofit finances. Even on nonprofit financial committees, some members may be skilled in accounting, others in banking, and others in investing or financial analysis.

Yet all nonprofit leaders, including board members, directors, and finance committee members, should have at least a basic understanding of nonprofit finances.

But if you bring zero experience in accounting or financial management to your organization, that’s okay. Because the basics of nonprofit finances are easy to grasp. 

In this article, we’ll walk you through the elements of nonprofit finance that every executive director, CFO, and accountant should know.

Step #1: Money In / Money Out

You can see how much revenue comes into an organization and how they spend that money by looking at the Statement of Activities (also called the Income Statement) or an updated Budget report (also referred to as the Budget vs. Actual report).

But you won’t understand a nonprofit’s finances based on financial statements alone. To start grasping a nonprofit’s finances, you should have in-depth conversations with staff to understand the various programs and major fundraising initiatives.  nonprofit_finances_expenses_revenue

Money In: Revenue

Start by investigating how the organization earns money and who pays them. 

For example, is the organization dependent upon special event fundraising? Or is it heavily funded by complex government grant funding And are there seasonal trends in funding, like a school with revenue during the school year but zero income during the summer? Or a big once-per-year fundraising event?

Understanding the sources and seasonal flow of revenue into the organization will help you anticipate needs and set realistic expectations.

Money Out: Expenses

Once you understand the revenue side, familiarize yourself with how, why, and when the organization is spending its money.

Close to 60% of expenses go to staffing pay and benefits in most nonprofits. Is that the case here? If not, where is the money going instead? And what makes up the balance of expenses? Are they going toward occupancy costs? Does the organization make grants to other nonprofits? Or does it spend a lot of money on supplies needed to execute its programs?

Once you understand money in and money out, take a look at the assets the nonprofit owns and the liabilities that it owes to others to get a grasp of their financial health. nonprofit-finances-assets-liabilities

Step #2: What do they own? And what do they owe?

You can find a nonprofit’s assets and liabilities on the Statement of Financial Position (also called the Balance Sheet), which gives you a quick snapshot of the long-term position of the organization. 

But, as with revenues and expenses, you can only learn so much from the reports. You’ll learn a lot more from intentional conversations with people inside the organization who can help you understand what those numbers mean. For instance…

  • Does the nonprofit have enough cash to fund its programs and meet payroll? 
  • Are there complex investments or endowments restricted to specific purposes? 
  • Has the nonprofit taken on significant debt or been slow to pay its creditors?  

If a nonprofit has had long-term effective financial oversight, it should have enough cash, smart investments, and plenty of assets.

Well-managed nonprofits should also be collecting on pledges or accounts receivable on a timely basis. Similarly, healthy nonprofits should carry minimal debt and pay their vendors on time.  On the other hand, a poorly managed nonprofit will have little money in the bank, few other assets, an accumulation of debt with no clear plan to repay it, and a ballooning accounts payable balance. nonprofit-finances-compliance

Step #3: Understand compliance

To fully grasp your nonprofit finances, you need to start to understand the major compliance requirements that impact your organization.

In most cases, these include an annual audit and federal tax return. While reviewing the audit or the tax return might seem overwhelming at first, sitting down with the finance committee while the auditors present the audit and 990 is a great way to accelerate your learning curve.  The audit team will identify any deficiencies in the accounting, review the various reports and explain what they mean, and discuss major details of the financials.

By actively inserting yourself in this process and asking questions, you’ll quickly start to grasp financial concepts you thought were beyond your reach.

Step #4: Never stop learning

Understanding nonprofit finances is a core responsibility of board members and executives.

And in most organizations, others on your finance committee or accounting team are glad to help. So lean on them, ask questions, and be inquisitive.  Plus, there are numerous free resources specific to nonprofit accounting and governance. Resources may include white papers, articles or blogs, and even online courses. 

If you’d like to learn more, check out our free online course on nonprofit finances and financial reporting here: www.thecharitycfouniversity.com

How to Read a 990: What Do Donors Want to See?

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.

990_part_IX

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.

form_990_section_o

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!

Top 5 Nonprofit Financial Red Flags According to a CPA

Are you ignoring potential nonprofit financial red flags in your organization? Here are the top 5 to look for according to a nonprofit CPA.

501(c)(3) Donation Rules: The Ultimate Guide

[et_pb_section fb_built=”1″ _builder_version=”3.22″ global_colors_info=”{}”][et_pb_row _builder_version=”3.25″ background_size=”initial” background_position=”top_left” background_repeat=”repeat” global_colors_info=”{}”][et_pb_column type=”4_4″ _builder_version=”3.25″ custom_padding=”|||” global_colors_info=”{}” custom_padding__hover=”|||”][et_pb_text admin_label=”Text” _builder_version=”3.27.4″ background_size=”initial” background_position=”top_left” background_repeat=”repeat” global_colors_info=”{}”]

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 501c3?

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?

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.

Boosting your donations The Charity CFO

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.

Download the Article

3pages

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.

Get the free guide!

 

3pages

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.

Get the free guide!

 


 

[/et_pb_text][/et_pb_column][/et_pb_row][/et_pb_section]

5 Warning Signs of Nonprofit Cash Flow Issues

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.

 

Is your cash flow on track?

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.

 

Financial reserves drying up

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

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…

Schedule a call to discover how we can help you avoid a cash flow crisis

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.

Do Nonprofits Use Cash or Accrual Accounting?

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 when you 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.

accrual_accounting_nonprofits

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

cash_accounting_nonprofits

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.

nonprofit_cash_vs_accrual_comparison

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.

The rules governing independent financial audits for nonprofits can be complex, so do your research. But here are a few triggers to look out for:

✔️ 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… 

Reach out to discover how we can make your life so much easier 

We’ll show you how much more enjoyable it can be to run a nonprofit when you’ve got all the financial data you need at your fingertips!

3 Types of Nonprofit Fraud to Watch Out for Today

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

Fraud in Nonprofits - 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: 

    1. 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.
    2. Extortion is obtaining an asset via the use of force or threat of force.
    3. Conflict of Interest corruption may 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

Fraud in Nonprofits - 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

Fraud in Nonprofits - 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. 

✔️ Participate in a financial statement audit. Have your Statement of Financial Position and Statement of Activities reviewed by a professional auditor to identify suspicious numbers you may miss.

Solving Nonprofit Fraud Starts with Prevention

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.

If accounting and bookkeeping are keeping you from accomplishing your mission, please reach out to see how we can help you!

Statement of Activities: Reading a Nonprofit Income Statement

No time to read this article now? Download it for later.

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.

What’s on the Statement of Activities? 

The Statement of Activities contains 3 main sections:

  1. Revenue
  2. Expenses
  3. Change in Net Assets 

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.

NOTE: For a nonprofit organization, revenue also includes non-cash gifts, like in-kind donations of goods or services.

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).

To comply with Generally Accepted Accounting Principles (GAAP), you must separate your revenue into at least 2 categories:

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.

statement_of_activities_revenue

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.)

statement_of_activities_download


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. 

statement_of_activities_expenses

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.)

statement_of_activities_download

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.

No time to read this article now? Download it for later.

Fund Accounting for Nonprofits & Charities

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. 

And the issue of restricted funds presents unique bookkeeping and accounting challenges for a nonprofit that a for-profit company doesn’t face.

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.

We’re going to focus specifically on how it’s applied to small and mid-sized nonprofits and charities. If you’re looking for info on fund accounting in government here is a great resource for you.

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.

fund_accounting_for_nonprofits

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.

Here are some common fund designations you’ll find on the Statement of Financial Position of many nonprofits:

Unrestricted net assets:

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.