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

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Nonprofits don’t make money for owners or shareholders. Instead of giving profits to individuals, they invest surplus revenue in supporting their mission and activities.

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There were 1.97 million nonprofit organizations in the US—nearly 1.5 million of those operating as 501(c)(3) tax-exempt entities, according to the IRS. And they all depend on nonprofit accounting to maintain their financial health and advance their mission-driven goals. Reputation is everything, so they have to get the numbers right.

What is nonprofit accounting?

Nonprofit accounting is how nonprofits record, manage, and report transactions. They use the process to track their finances and comply with regulations. Accounting also helps build trust with donors and grantors, who often require the funds they give to be spent in specific ways. It allows the organization to show it’s putting that money toward its stated mission and practicing sound financial management.

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Nonprofit accounting stresses accountability, meaning nonprofits must pay keen attention to restricted and unrestricted funds and how both are used. Financial transparency is a top priority.

How does nonprofit accounting compare to for-profit accounting?

Nonprofits must track restricted and unrestricted funds separately, showcasing how they use donations and grants to reach their goals. ‍Restricted funds are donations or grants with donor-imposed rules on how or when they can be used. They’re tracked and reported separately from general funds.

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Nonprofit accounting and bookkeeping provide a clear picture of the organization's financial status in relation to its programs and services. Nonprofit accountants report on individual funds and their revenues, spending, assets, and liabilities.

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In contrast, for-profit organizations are concerned with maximizing shareholder value, so their accounting revolves around profitability and the bottom line. Their accounting practices and reporting focus on the company's financial health and performance.

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Nonprofit accounting reports and methods

Nonprofit fund accounting divides an organization's finances into funds, each with its own purpose dictated by donors or regulatory bodies. It allows for detailed reporting on money spent and the objective it fulfills.

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Nonprofits must prepare several key financial statements, including:

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• Statement of financial position: Similar to a for-profit's balance sheet
• Statement of activities: Also called an income statement, this outlines revenues and expenses over a period, spelling out the allocation of funds
• Statement of cash flows: Shows the money coming in and out, giving insight into liquidity and financial flexibility
• Statement of functional expenses: Details expenses by nature and function and covers how they relate to the organization’s mission and programs

The statement of financial position provides a snapshot of financial condition. It can answer 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 key to assessing liquidity, operational efficiency, and financial health.

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

Assets

Assets are valuables the organization owns or has a right to. They can be cash, equipment, property, pledged donations, or investments and can be 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, and large equipment; these also include accumulated depreciation
• Non-current assets: Also known as other current assets, these aren’t expected to turn into cash quickly; they can include endowments, long-term investments, and intangible assets such as an organization’s patents or trademarks‍

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Liabilities

Liabilities are debts or obligations your organization owes to someone else. There are two types: 

• Current liabilities: Debts that must be repaid within one year, such as outstanding bills, accrued expenses, or short-term loans
• Non-current liabilities: Debts not due within the next year, such as long-term loans‍

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Net assets

Net assets are the organization’s assets minus its liabilities, which for-profit businesses call “equity.” They, too, are tracked according to whether they’re restricted or unrestricted, and misclassifying them can mean financial reporting errors. Examples of how net assets might be used include:

• Determining whether a nonprofit can support a new project without additional fundraising
• Demonstrating to donors how funds are allocated within the organization
• Illustrating financial status in an annual report

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Statement of financial position vs. balance sheet

The difference between a statement of financial position and a for-profit balance sheet is mostly how they treat restricted funds, which must be tracked and reported separately due to the fund accounting system.Here’s a comparison of nonprofit fund types:

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Custom chart of accounts

A custom chart of accounts is an essential tool for nonprofit accounting. It allows organizations to track financial transactions in a way tailored to their unique operational needs.

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Since nonprofits rely on unique revenue streams from contributions and donations, organizing finances into specific categories is essential. 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 importance of separating expenses into functional areas such as programs, management, and general and fundraising expenses. This helps show how resources are allocated and is critical for external reporting requirements. 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 show stakeholders how many resources directly support its mission.

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Nonprofit budgeting

A nonprofit budget outlines anticipated income and expenses for a fiscal year and is put together with input from board members, executives, and other stakeholders. It aids decision-making, from hiring practices to project development, and provides the details necessary for grant applications and financial transparency. Components of a nonprofit budget usually include:

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• Revenue: Donations, grants, and income from services, membership fees, or events; may also cover investment income and other revenue sources, such as merchandise sales
• Expenses: Expected costs, such as program, administrative, and fundraising expenses
• Surplus or deficit: Total revenue minus total expenses
• Capital expenditures: Spending on long-term assets, including equipment or property
• Reserves: Money set aside as a financial cushion

Technology solutions for nonprofit accounting

Choosing the right nonprofit accounting software is like hiring a CPA: It involves careful consideration. It requires evaluating how the new platform will work with current tools, fulfill fund accounting requirements, produce reports on the nonprofit's operational framework, and fit within available resources and budgets.

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It’s also important to evaluate nonprofit accounting systems based on compliance management, ease of use, customer support, and customization options.

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QuickBooks can be a solid option for nonprofits. It includes features such as donation tracking, fund accounting, and financial reporting—all of which adhere to nonprofit accounting standards.

Ramp's corporate card for nonprofits

Whether you're a small or large nonprofit, Ramp helps you find the right financial solution with products to help with nonprofit bookkeeping, expense management, and budget discipline. It features strong internal controls and configurable approval workflows to help you enforce your organization’s policies.

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Companies that use Ramp’s accounting automation software save an average of 5% across all spending in their first year. On top of that, Ramp’s extensive accounting integrations can help you cut the time needed to close your books by an average of 22%.

‍Automate your accounting with Ramp and focus your time on fulfilling your mission.