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The type of accounting your organization uses could be holding you back from getting the most out of your accounting system. While many nonprofits start with cash-basis accounting due to its simplicity, this method often falls short of providing a comprehensive view of a nonprofit’s financial health.
Transitioning to accrual-basis accounting can offer a more accurate representation of finances and enhance long-term planning. Let’s look at the differences between cash-basis and accrual accounting and why you might want to switch.
Before we can know why to switch accounting systems, it’s important to understand how each system works. The main difference between cash-basis and accrual-basis accounting is when revenue and expenses are recorded.
In cash-basis accounting, revenue gets reported only when the cash is physically (or digitally) received. Likewise, expenses are recorded when money leaves the organization’s account. Cash-basis accounting is most common for smaller nonprofits, where financials tend to be less complicated.
Accrual-basis accounting, on the other hand, records revenue and expenses when they are incurred. The accrual-basis method records transactions with the assumption that the money will physically change hands in the future.
For example, a nonprofit provides a paid service to a community member and issues an invoice. The revenue from the service is recorded now, even though the invoice hasn’t yet been paid.
Cash-basis accounting is a simple method that’s great for new or small nonprofits. However, there are two major limitations to using the cash-basis method:
The timing of an organization’s income and expenses in cash-basis accounting can misrepresent the actual financial state of the nonprofit. Additionally, the cash-basis method can make accurate forecasting and budgeting difficult.
Say a nonprofit hosts a large fundraising event in the second quarter. The costs for the event are all paid in the first quarter, but donation funds and other revenue won’t come through until the second quarter.
By using the cash-basis method, this organization would look like it’s struggling financially in the first quarter but has a major surplus in the second. The reality is somewhere in the middle, but the organization may be tempted to under budget for the first quarter and over budget for the second.
Switching to accrual-based accounting can have a lot of benefits for nonprofit organizations. Most importantly, making the switch can help your organization:
By recording revenue and expenses when they happen, instead of when cash is exchanged, helps provide a more accurate picture of the organization’s financial health at any given time. You’ll get a better view of long-term financial transactions, rather than just seeing what cash is currently in an account.
Accrual accounting also helps keep related revenues and expenses together. Matching revenues with the expenses incurred to generate them reflects the true cost of running programs and services.
Accrual accounting provides stakeholders with a detailed view of your organization’s financial activities, improving trust and confidence. Transparent financial reporting can also improve donor relations. With increased transparency through accrual accounting, donors can see how their contributions are being used and the impact they’re making.
Better transparency also helps you stay compliant with regulations or grant requirements. Many regulatory bodies and grantors require accrual-basis financial statements. Adopting the accrual method ensures compliance with Generally Accepted Accounting Principles (GAAP) and other relevant standards. By making the switch, you could open your organization up to more grants and funding opportunities.
A more accurate understanding of your organization’s financial health means nonprofit leaders can make better strategic, data-driven decisions. Accrual accounting provides the data needed to forecast cash flow, budget more effectively, and allocate resources where needed most.
An accrual-based accounting system also gives you insights into the efficiency and effectiveness of programs and services. Detailed financial reports generated using the accrual method can highlight inefficiencies and areas for improvement within your organization. By analyzing the financial performance of programs, you can determine which initiatives are delivering the most value–and which may need adjustments or more support.
The cash-basis accounting method is simple, but simplicity could be holding your organization back. Moving from cash-basis to accrual-basis accounting can help your nonprofit better manage its financial health and improve transparency.
While switching to accrual-basis accounting can be daunting, the easiest way to make the switch is to work with a trusted nonprofit accounting firm, such as The Charity CFO.
Our dedicated team of accounting professionals specializes in nonprofit accounting–ensuring your organization gets advice from accountants who understand the unique needs of nonprofits. Get in touch today to see how we can help you transition accounting systems!
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The middle of the year is the perfect time to pause and reflect on your nonprofit organization’s financial health. A midyear financial review helps you identify problems early and align your nonprofit’s financial performance with planned goals.
Conducting a review is important, but where do you start? Use this guide to help you better understand how–and why–to conduct a midyear financial review for your organization.
Most organizations know the importance of end-of-year reviews, but did you know a midyear review can have similar benefits? Doing a midyear nonprofit financial review provides three main benefits to your organization:
Each of these benefits helps ensure your organization stays on track to reach its financial goals by the end of the year.
Your midyear review will likely look very similar to a year-end financial review. This means your review should include all aspects of your organization’s finances–from budgets to grant status.
There are generally four categories you should include in your review:
Before jumping into the actual review process, you’ll want to prepare yourself for the review. This means gathering all of your organization’s relevant financial documents and reports. For example, you may need to collect the year’s cash-flow projections, budget to actual comparison, and ongoing grant information.
Additionally, you should involve key stakeholders in the review process, such as the board of directors, your financial or accounting teams, and program managers. Bringing stakeholders on board not only increases accountability and transparency but can also open new insights into financial processes during the review.
Once your review is done, it’s important to carefully record your findings and present them to the board of directors. Based on your insights and findings, you can also make recommendations to the board.
The process of conducting a review may vary slightly between organizations, but the general steps include:
You might encounter challenges when conducting your review, so it’s important to know how to overcome them. Luckily, many nonprofits have similar challenges when analyzing their finances, including:
Most nonprofit financial recording challenges, such as data accuracy and meeting legal and grant compliance requirements, can be solved using technology. Introducing technology, such as accounting software, can help your organization stay organized and maintain accurate financial records.
Other challenges, such as resource constraints, may require reallocating or changing resources to fit your needs. For example, if you don’t have time to conduct a review, you could hire an external accounting firm to perform an audit or reduced scope of work.
The findings of your review give you a better picture of the financial health of your organization. However, they offer so much more than that alone.
You can use your findings to analyze your current systems and processes to create more effective fundraising, accounting, and resource management. Your review can help you readjust budgets before the end of the year, which could help reduce financial strain or cash flow issues.
Likewise, your review findings can help with strategic planning for the remaining year and the year ahead. You can use your findings to make data-driven recommendations to the board and other stakeholders that can directly improve the financial health of your organization.
Reviewing the financial health of your organization helps you stay on track to meet financial goals. It can also be a good way to identify any financial struggles your organization might face. When caught in a midyear review you can address these financial concerns early.
If you’re overwhelmed by the idea of conducting a review, you’re not alone! An easy solution is to work with a nonprofit accounting and financial firm, such as the Charity CFO, to help you organize and complete your review.
The team at the Charity CFO can help you create and implement a plan of attack for your review. We specialize in nonprofit accounting, so you can be sure we understand the complexities of nonprofit financial documents.
Schedule a free call today to learn more about completing a financial review!
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