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Navigating Nonprofit Accounting: Best Practices and Tips

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Published June 13, 2023 Reading Time: 5 minutes

Accounting may not be the most glamorous part of any business, including nonprofits, but it’s instrumental in keeping your organization running smoothly.

From compliance to financial management, accounting provides the systems and information needed to keep a nonprofit’s finances in check.

However, understanding and evaluating financial data can feel daunting when getting started—but it doesn’t have to be. Our guide details how you can take care of all your accounting needs and sustain your nonprofit’s financial health for the long term.

5 Ways Nonprofit Accounting Compares to For-Profit Accounting

For-profit businesses have well-established accounting practices that you might already know. There are plenty of commonalities between these processes and the guidelines nonprofits must follow in accounting. However, there are also a few key differences to keep in mind.

  1. Taxes: Approved nonprofits hold tax-exempt status with the Internal Revenue Service (IRS), unlike for-profit businesses that must pay income taxes for employees.
  2. Financial statements: Instead of a balance sheet that for-profit companies keep, nonprofits must maintain a statement of financial position. Additionally, nonprofits keep a statement of activities rather than an income statement like for-profit businesses.
  3. Equity versus net assets: When a for-profit business has a surplus, that money goes to the shareholders as equity. With a nonprofit, that money goes toward the organization’s net assets.
  4. Governance: A private owner (or public stockholders) typically runs a for-profit business. With nonprofit organizations, a volunteer nonprofit board of directors oversees them. This impacts the reporting and accountability structure within the accounting.
  5. Revenue: The income for a for-profit business comes from the sales of goods and services. Within a nonprofit, this revenue comes primarily from fundraising and grant management.

Nonprofit Accounting Best Practices

Every nonprofit is different and requires a custom approach to accounting. However, there are a few basic steps that all charities in the nonprofit sector should follow. Whether a seasoned professional or just starting, here are a few suggestions for making the most of nonprofit accounting.

1. Establish a Budget

A budget is your financial blueprint. It’s where you include your anticipated revenue and expenses for the upcoming year based on the previous year’s performance. This helps inform your team’s forecasting exercises and spending plans. Be sure to plan for contingencies, too.

Stick to your budget as closely as possible. Take the time to review it on a monthly basis to evaluate your progress and pivot if needed. Your organization’s operating budget should serve as your guide, but it’s also critical that each department have an operating budget that ladders back up to your nonprofit’s larger goals.

2. Select an Accounting Software

The right digital tool can help you track your finances more reliably. With plenty of options available, take time to select the one that best suits your unique needs, experience, and budget. For example, QuickBooks and FreshBooks are two commonly used accounting solutions.

The best nonprofit accounting system will help you:

  • Manage a journaling system
  • Connect to your bank account
  • Create and manage budgets
  • Calculate your cash flow
  • Generate reporting and financial statements

3. Build an Accounting Team

Every nonprofit should have someone responsible for the finances of its organization. This might be a single person like the chief financial officer, or it could be an entire team depending on the size and complexity of your organization.

You don’t need certified public accountants (CPAs) on your team, but it certainly helps. The most important thing is to hire someone who understands the language of the Generally Accepted Accounting Principles (GAAP) and is capable of routinely executing accurate financial reports. A board member well-versed in accounting is also an asset to your team.

It might be worthwhile to partner with a specialized nonprofit accountant or a larger external accounting firm to help with reconciliations and audits. Their objectivity and specialization in accounting will serve as a major bonus. However, because there are countless accounting firms, it’s best to choose one that shares your values and has experience with nonprofit organizations.

4. Keep Track of Your Records

Hopefully, you track all your nonprofit’s financial transactions, including expenses, invoices, and receipts. This helps to ensure your internal records match your balance sheet, which will make your annual nonprofit audit much easier.

It’s best to save these records digitally in your accounting software, but holding on to paper records for the short term is helpful to verify everything is correct. Proper record keeping is vital to sound accounting and complying with IRS and not-for-profit regulations.

5. Reconcile Your Accounts Regularly

Reconciling your accounts means comparing your bank statements to internal accounting records. Bank reconciliation is the practice of comparing your records to what’s actually in your organization’s bank account to ensure that these records match.

This process helps catch any errors and discrepancies or may potentially catch fraud should there be any suspicious activity within your organization. It also keeps you from falling behind with your bookkeeping efforts.

You can reconcile many accounts, including cash flow (which includes reviewing payments to and from your organization), accounts receivable, accounts payable, and staff payroll. All these accounts are vital to accurate financial reporting in your organization.

6. Conduct an Annual Financial Audit

An audit is a formal examination of your financial records, which can reveal any potential problems and keep you in compliance. You might be able to conduct the audit internally or may have to hire an external firm to run the audit, depending on your size and budget.

This isn’t just an oversight from the IRS but a healthy regular practice to ensure your nonprofit organization’s bookkeeping is well-maintained. The findings from this single audit can fit into your nonprofit annual report and simplify your fundraising.

Nonprofit Accounting Terminology to Know

Accounting can be a highly technical and jargon-filled process. So understanding the relevant key terms is a crucial step toward better nonprofit accounting. Here’s a list of some of the most common phrases you’ll need to know:

  • Accounts receivable: The money owed to an organization, or in the instance of a nonprofit, the donation fund.
  • Accounts payable: The amount owed to others for services or goods received by the nonprofit organization.
  • Chart of accounts: The list of accounts that sends or receives money. These are typically listed as assets, liabilities, net assets, revenue, and expenses.
  • Cash flow: How money moves in and out of an organization, especially how much liquid cash is on hand at any given time. This is typically reported on the statement of cash flows.
  • Assets: The value of anything your not-for-profit owns, including cash, goods, investments, intellectual property, or physical property.
  • Liabilities: The sum of what your organization owes, including any debts.
  • Depreciation: The loss of value over time for assets held.
  • Statement of activities: The summary of your nonprofit’s revenue and expenses over the reporting period. This is similar to a for-profit’s income statement.
  • Fund accounting: The recommended form of accounting for nonprofits because it separates money into separate accounts for various activities, such as programming, marketing, admin, and fundraising.
  • GAAP: The Generally Accepted Accounting Principles are the standards for accounting in the United States.

Keep Your Nonprofit’s Accounting in Check to Raise More for Your Mission

Proper accounting is vital to every organization in the nonprofit sector, regardless of its mission or size. Following correct accounting procedures isn’t difficult but requires an educated team and focused efforts to stay on track.

This is one of the primary reasons why Classy prioritizes robust and clear reporting in its system. Having access to these reports directly within your donations platform makes it that much easier to manage your internal accounting processes.

Follow these steps to get a handle on today’s nonprofit accounting best practices to keep your organization compliant and running smoothly.

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