Not-for-profit organizations must understand nonprofit accounting practices to avoid jeopardizing their status. What are the key ways to remain compliant?
Nonprofit Accounting Practices
Although a nonprofit may have been founded out of a passion to carry out its mission, the nonprofit is not owned by anyone. Rather, it is a public trust directed by a board, staff, and Executive Director. Since it is not a public, for-profit corporation, there are differences in the financial management of a nonprofit. Nonprofit organizations and board members must understand these differences to avoid jeopardizing their nonprofit status.
There are key differences in financial management between a for-profit business and a nonprofit organization. We’ll focus on some of the best nonprofit accounting practices and procedures you can implement to remain compliant.
- Accounting for income and expenses are different. A for-profit business tracks revenue typically made from the sale of a product or service. This can be recorded in a general ledger under the appropriate chart of accounts, and will balance itself with a single transaction.
- A nonprofit uses a Statement of Financial Position. A for-profit business uses a balance sheet, which is a snapshot of the company’s assets and liabilities. Additionally, the balance sheet will show the owner’s equity, or net worth. This is extremely important to shareholders and investors.
- A nonprofit organization accounts for a statement of activities. While a for-profit company uses a profit and loss statement showing the profits made from the products and services sold, and reports that profit to shareholders, a nonprofit must use a statement of activities.
A nonprofit organization typically doesn’t sell a product or service for their revenue. Rather, they mainly operate on donations and grants that require special categorization to determine if the revenue is designated as restricted for its use, or is unrestricted. Some nonprofits do sell a product or service, such as arts organizations, musuems, or health care clinics, but even their revenue must be properly categorized to track the source of the revenue.
Besides tracking the funding stream has either as restricted or unrestricted, the nonprofit must classify the revenue to specific program areas that reflect the organization’s mission. So, if the money is restricted, the nonprofit organization can not legally take money earmarked for a program and spend it on any other area within the organization.
Therefore, each fund must be tracked separately, and expenses are tracked back to a single point of origin, or segments within the chart of accounts using fund accounting.
Because a nonprofit doesn’t have shareholders, and is a public trust, essentially owned by the public for public benefit, it uses a statement of financial position (SOP). Like a balance sheet, the SOP shows assets and liabilities. The difference lies in the balance once you subtract liabilities from the assets. Since there are no owners, it won’t show “owner’s equity”; instead the balance is called “net assets”. The net assets are then divided into two categories: With Donor Desginations and Without Donor Designations (Restrictions).
The net assets circle back to their point of origin, or the grant or donation it was tied to.
Revenue and expenses can overlap into various categories, and it is important for the financial management of the nonprofit organization that all revenue and expenses are tracked back to the origin of the program it is associated with. A nonprofit organization’s budget should the segregation of revenue and expenses by funding source and program. This provides the nonprofit with financial data that reflects whether or not there is enough resources for the nonprofit to fulfill each program’s mission.
By using a segmented chart of accounts that reflects the organization’s structure, the statement of will provide a nonprofit organization with the information needed to measure the resources available for their mission and helps management make more informed decisions. Following these nonprofit accounting accounting practices will ensure the mission doesn’t become endangered from poor financial management practices.
Feel free to comment with questions or feedback!