How Nonprofits are Different: Accounting Questions Answered
For-profits and nonprofits treat accounting very differently from one another. The primary difference between the two types of accounting is the concept of accountability. While for-profits focus on profitability, nonprofits focus their accounting efforts on staying accountable to their supporters who have generously contributed. As your nonprofit collects donations from your supporters, the funds are…
For-profits and nonprofits treat accounting very differently from one another. The primary difference between the two types of accounting is the concept of accountability. While for-profits focus on profitability, nonprofits focus their accounting efforts on staying accountable to their supporters who have generously contributed.
As your nonprofit collects donations from your supporters, the funds are deposited into your bank and then allocated to specific projects. Your financial reports must reflect the segregation and allocation of your funds.
In this post, we put together this guide answering some common questions we’ve received from nonprofits about accounting issues. These questions include:
What is fund accounting?
How are taxes completed?
Should nonprofits make money?
How do nonprofits spend their money?
What does a nonprofit budget look like?
While hiring a nonprofit accountant is a great way to make sure everything is correct and well-taken care of, every nonprofit should have a basic understanding of nonprofit accounting principles. Ready to learn a little more and to get your questions answered? Let’s get started.
1. What is fund accounting?
We said in the beginning that nonprofit accounting operates differently from for-profit accounting. That’s because nonprofits use a system known as fund accounting for their finances.
When donors contribute to nonprofit organizations, the nonprofit within their right to restrict the use of the donation they give. For example, a university might choose to create a restricted fund for a particular scholarship program and direct their donations into it – restricting the use of these funds only for the specific scholarship program.
That’s one reason it’s so important for nonprofits to employ fund accounting. It allows them to allocate funds according to their restrictions and preferences. The accounting method helps the nonprofit maintain accountability for adhering to the wishes of their donors.
Invest in accounting software set up for fund accounting. Spreadsheets only get nonprofits so far in their finances. When you decide it’s time to scale up to a dedicated accounting software solution, make sure you look for one that allows you to conduct the necessary allocations for a fund accounting system. Donorbox allows integration with Quickbooks through Stripe with Commercesync, helping make accounting easier.
Work with a professional who has fund accounting experience. Whether you’re hiring an internal accountant or outsourcing the work to a professional firm (which is the approach we recommend), be sure your nonprofit works with an accountant who’s well-versed in the unique aspects of nonprofit fund accounting. They should have previous experience working with nonprofits like yours.
As you’re working through the various aspects of your business plan, preparing your budget, and launching fundraising campaigns, you should make sure a professional in fund accounting is the one to conduct final approvals for your different financial decisions.
Keep the necessity for experience in mind as you put together important documents and plans for your organization.
2. How are taxes completed?
You probably already know that taxes for nonprofits work a little differently. Specifically, you probably know that nonprofits don’t pay taxes. However, this doesn’t mean that your organization is completely exempt from the stress that comes along each tax day.
We’ll repeat ourselves: nonprofit accounting is all about accountability. Part of remaining accountable to your nonprofit’s supporters is offering a transparent view of your finances.
Transparency and accountability are both essential for instilling trust in your supporters and building relationships. These relationships tend to lead to increased retention rates and greater fundraising success.
That’s why, each tax season, nonprofits are required to fill out and submit annual Form 990. As is explained in this Form 990 filing guide, there are different types of Form 990s that your nonprofit may be eligible to file according to your gross receipts.
Types of Form 990.
Form 990-N. The Form 990-N is the shortest tax form that grassroots and very small nonprofit organizations file. It’s only eight questions and is completely administered online. Your nonprofit would be eligible to file this form if you make less than $50,000 in gross annual receipts.
Form 990-EZ. The Form 990-EZ is like the little brother to the Standard Form 990. It’s a four-page form that answers standard questions about your nonprofit’s mission, programs, funding sources, and expenditures. Nonprofits eligible for the Form 990-EZ are those whose gross receipts are less than $200,000 but greater than $50,000.
Standard Form 990. The Standard Form 990 is the longest of the three at eight pages. Nonprofits with gross receipts over $200,000 are required to file this form.
Form 990s are all public documents and are available for the scrutiny of nonprofit supporters. This means that your organization’s supporters will be able to review your financial documents to see how much you raised in total as well as how those funds were allocated to operational expenses, fundraising, and program costs.
While the 990-EZ and the Standard Form 990 are both currently available in paper format, the Taxpayer First act of 2019 has changed the expectation for nonprofits when it comes to filing annual tax returns. By 2021, all nonprofit tax forms will be filed online.
This is designed to make it easier for your nonprofit. Plus, because the Form 990s are public documents posted online each year, submitting all forms online ensures they’ll be posted more quickly.
3. Should nonprofits make money?
This tends to be a highly contested question about the nonprofit sector, especially in the past few years. The answer isn’t an easy one either because it requires balance.
The point of a nonprofit is to accomplish a specific mission. However, nonprofits should keep in mind that they also need to grow their organization and this takes some funding to do. Actually, when you effectively grow your organization, you’ll create a bigger impact on your mission. This brings the topic back to the need for balance.
Think about it this way, nonprofits start off small. An example would be a local animal shelter.
The shelter may start off with minimal resources and space, allowing them to rescue around 20 dogs in a single city each year.
As they raise funds, the organization spends money on veterinary expenses, leashes, and training programs for their dogs. They take good care of the dogs they have and decide to take on more animals. However, before they can take care of and find homes for 5 additional dogs each year, they’ll need to expand their facility and bring on an additional volunteer. Therefore, they’ll need to use some of their funding for additional shelter space and volunteer marketing. As you can see, they needed to invest some in their own services in order to grow their impact on the dogs they work with.
In this guide, we learn about the different strategies nonprofits use for growth and the plans that can help get them there. The important metric you should keep in mind is the return on investment. High return on investments allows you to grow and to have a greater impact on your mission.
Another important aspect to keep in mind is that nonprofits sometimes hit hard times. 2020 is the perfect example! Having a little wiggle room or savings set aside when these hard times occur can help organizations weather these difficult days and continue serving their constituents when they occur.
It boils down to this: If they spend too much on growth and neglect their mission, the nonprofit is no longer being responsible with the funds entrusted to them by their supporters. However, they do need to invest some in themselves to increase capacity and make a greater impact. Balance is key.
4. How do nonprofits spend their money?
We’ve touched briefly on the various ways nonprofits can spend the funds they earn from their fundraising campaigns. While the expenditures for each nonprofit will look slightly different from one another, some of the expenses you’ll probably encounter include:
Fundraising. Have you heard the phrase, it takes money to make money? That’s the mindset behind fundraising expenses. Sometimes it takes funding to generate more funding (this is where maintaining positive ROI is immensely important). You may spend your hard-earned funds on fundraising software to collect new donations, on virtual event promotion to increase registrations, and on CRM software to track campaigns.
Administrative expenses. These are the operating expenses it takes to run the organization. For instance, you may spend money on your office rent, monthly bills, and on your employees’ salaries.
Program expenses. Program expenses are the funds that you spend directly on your nonprofit’s mission. Regarding the animal shelter example we used earlier, these expenses would be those used to pay for the veterinary costs of each rescued animal or the training programs to rehabilitate them for adoption.
(These expenses just so happen to be the ones listed on your Form 990!)
When combined, your fundraising and administrative expenses are what make up your organization’s overhead. The Better Business Bureau (BBB) advises these funds make up 35% or less of your total expenditures. Meanwhile, program expenses should make up at least 65% of your expenditures.
As we mentioned, these expenses will look slightly different for each organization. If you’re curious about another organization’s expenses, we recommend taking a look at other nonprofits’ annual reports. These should give an accurate and detailed picture of the annual expenses and revenue for the referenced organization.
5. What does a nonprofit budget look like?
Your nonprofit’s budget maps out all of the anticipated fundraising and expenses that you expect to encounter during the upcoming year. Generally, these estimations are created based on the previous year’s successes and failures.
For instance, you might estimate that you’ll raise at least 85% of your fundraising totals from last year in individual contributions. Under your expenses, you may have fixed expenses such as your office rent and water bill as well as variable (estimated) expenses like the cost of programming supplies. You may increase this estimated expense by 10% to account for organizational growth.
After you’ve pulled all of your numbers together, your finished budget will look something like this:
Budgets can be somewhat tricky. Your planned expenses and revenue are never complete guesses, but rather, they’re educated estimations based on fact and another year’s financial records.
Not only that, but your budget is incredibly important. It’s not a one-and-done document. You should continuously refer to your budget throughout the year and use it to plan and guide your organization’s finances. That’s why we recommend leaning on guidance from an expert when it’s time for you to create your nonprofit’s budget.
You didn’t start working with a nonprofit to crunch numbers and analyze finances all day. You work with a nonprofit so that you can make a difference. However, the numbers play a fundamental role in advancing your cause! Understanding the basics of nonprofit fund accounting is a great first step to setting your organization up for financial success.
Remember to make sure that when you get in touch with experts, they have sufficient experience in the nonprofit sector and can help you achieve all of your accounting goals. Good luck!