How to set up nonprofit accounting: a beginner's guide

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Setting up accounting systems for a nonprofit organization involves unique challenges and requirements distinct from for-profit businesses. Understanding the nuances of nonprofit accounting is essential to ensure financial transparency and regulatory compliance.

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At its core, nonprofit accounting emphasizes accountability, requiring meticulous tracking of restricted and unrestricted funds to ensure financial transparency and compliance with regulations. 

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Critical financial statements for nonprofits include the Statement of Financial Position, Statement of Activities, Statement of Cash Flows, and Statement of Functional Expenses, each offering insights into the organization’s financial health and operational efficiency. 

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Additionally, leveraging technologies like custom accounting software and adopting a custom chart of accounts tailored to the nonprofit's operational needs are essential for accurate financial management and reporting.

How is nonprofit accounting different from for-profit accounting?

Nonprofit accounting differs in its focus on accountability rather than profitability. Nonprofits need to track restricted and unrestricted funds separately, showcasing how they use donations and grants to further their mission. The goal of nonprofit accounting is to provide a clear picture of the financial status concerning the organization’s programs and services, which is crucial for maintaining donors' and stakeholders' trust.

Nonprofit accounting methods and reports

The type of accounting most suited for nonprofits is fund accounting. This method emphasizes accountability over profitability and is used to segregate an organization's finances into different funds, each with its own purpose as dictated by donors or regulatory bodies. This allows for detailed reporting on how money is being spent and how it contributes to the organization's objectives.

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Nonprofits must prepare several key financial statements, including:

1. Statement of Financial Position: Similar to a for-profit's balance sheet (further described below).
2. Statement of Activities: Outlines the organization's revenues and expenses over a period, demonstrating how funds have been used.
3. Statement of Cash Flows: Shows the cash coming in and out, providing insight into the organization's liquidity and financial flexibility.
4. Statement of Functional Expenses: Details expenses by nature and function, indicating how expenses relate to the primary mission and programs of the nonprofit.

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The statement of financial position provides a snapshot of the organization’s financial condition at a point in time. This report can answer important questions such as, "Do we have the necessary cash to pay our bills?" or "Could we pay back all our debts if they were due tomorrow?" It's essential for assessing the nonprofit's liquidity, operational efficiency, and overall financial health.

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The distinction between a statement of financial position and a for-profit balance sheet lies primarily in the treatment of restricted funds, which must be tracked and reported separately due to the fund accounting system employed by nonprofits.

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Restricted funds are donations or grants that come with donor-imposed restrictions on their usage. These funds are earmarked for specific purposes, projects, or timeframes and thus must be tracked and reported separately from general (unrestricted) funds. The meticulous handling of restricted funds is crucial for maintaining donor trust and demonstrating compliance with designated fund usage, which can influence future funding. 

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There are three elements to the statement of financial position: assets, liabilities, and net assets: 

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1. Assets: Valuables that the organization owns or has a right to. Assets can be cash, equipment, property, pledged donations, investments, etc. These are further divided into:

• Current assets: Cash or assets expected to turn into cash within a year. These include bank balances, accounts receivable, pledged donations, investments, and prepaid expenses.
• Fixed assets: Physical items or long-term assets such as buildings, vehicles, large equipment, etc. These also include accumulated depreciation.
• Non-current assets: Also known as other current assets, these are assets that are not expected to turn into cash quickly. They can include endowments, long-term investments, and intangible assets like patents or trademarks.

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2. Liabilities: Debts or obligations your organization owes to someone else. There are two types of liabilities: 

• Current Liabilities: Debts that must be repaid within one year, ex., outstanding bills, accrued expenses, short-term loans, etc.
• Non-Current Liabilities: Debts that are not due within the next year, such as mortgages and long-term loans.

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3. Net assets: This is the value of your organization – your assets minus your liabilities. It is the cumulative profit of your organization since its inception. For-profit businesses refer to this as “equity,” while nonprofits use the term “net assets.” 

Accrual accounting for nonprofits

Accrual accounting records revenues and expenses when they are earned or incurred, regardless of when the cash is actually exchanged, which aligns with the Generally Accepted Accounting Principles (GAAP) in the United States.

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Nonprofits can use either cash or accrual accounting, but accrual accounting is often preferred due to its ability to provide a more accurate financial picture. 

Benefits of a custom chart of accounts in nonprofit accounting

A custom chart of accounts is an essential tool for nonprofit organizations as it facilitates precise tracking of financial transactions tailored to their unique operational needs. 

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Given that nonprofits have distinct revenue streams primarily comprised of contributions and donations, the classification of finances into specially designated categories is paramount. 

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These specialized groupings include assets, liabilities, net assets, revenues, and expenses, each with further distinctions to adequately account for the flow of funds.

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A custom chart of accounts underscores the necessity of segregating expenses into functional areas such as programs, management, and general and fundraising expenses. This categorization is helpful for internal understanding of how resources are allocated and critical for external reporting requirements. 

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For instance, financial statements and IRS Form 990 require detailed disclosures about expenditures across these functional categories. 

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By adopting this clear separation, a nonprofit can transparently communicate to stakeholders the proportion of its resources that directly support its mission.

Creating a nonprofit budget

Budgeting is a vital aspect of nonprofit accounting as it acts as an operational guide, illustrating an organization's fiscal health and offering a comprehensive look at anticipated income and expenses. 

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Like for-profit businesses, budgeting directs decision-making, from hiring practices to project development, supporting the strategic objectives and mission of the nonprofit. An accurately planned budget also helps nonprofits navigate unexpected financial challenges and provides the requisite financial details needed in grant applications and financial reports. 

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Furthermore, budgeting helps maintain financial transparency and stewardship, necessary elements for earning and keeping the trust of donors, stakeholders, and regulatory bodies. 

Technology solutions for nonprofit accounting

Selecting the right accounting software for your nonprofit can be highly nuanced. The process requires a comprehensive assessment of how the software will integrate with existing technologies, address unique fund accounting needs, generate reports that reflect the distinct operational model of the nonprofit, and align with resources and budget constraints.

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It’s also important to evaluate nonprofit accounting systems on parameters such as compliance management, ease of use, customer support availability, and the potential for customization needed to meet the unique needs of the organization.

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With some customization, QuickBooks can be a cost-effective and user-friendly option for nonprofit organizations. The software includes features such as donation tracking, fund accounting, and financial reporting – practices that adhere to nonprofit accounting standards. 

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Nonprofit accounting requires a keen understanding of practices such as fund accounting and financial reporting and tailored accounting tools like a custom chart of accounts and software solutions. Having a reliable accounting partner experienced in the nonprofit sector can help you secure stakeholders' trust, improve credibility, and ensure the long-term financial health of your organization.

Ramp's corporate card for nonprofits

Whether you're a small or large nonprofit, Ramp is committed to helping you find the right financial solution with products—including corporate cards—to help you manage expenses and stretch your budget.

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Unlike most business credit cards, Ramp’s corporate cards come with no annual fees and no interest. Our repayment terms mean that you’ll never carry a balance on your card. It’s a good fit if your organization is looking for unlimited 1.5% rewards without any worries about overspending and racking up credit card interest.

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Ramp also comes with built-in expense management software. You can be proactive about spending with spend controls at the point of sale and configurable approval workflows to help you enforce your organization’s policies.