Navigating nonprofit accounting: Key terms and best practices

Accounting may not be the most glamorous part of running a nonprofit, but it’s instrumental in keeping your organization running smoothly.

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

Understanding and evaluating financial data can feel daunting when you’re getting started, but it doesn’t have to be. This guide covers the accounting practices every nonprofit should follow, along with the key terms, like fund accounting, a statement of financial position, and a statement of activities, you’ll need to know to make sense of your organization’s finances.

5 ways nonprofit accounting compares to for-profit accounting

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

Nonprofit accounting best practices

1. Establish a budget

A budget is your financial blueprint. It lays out your anticipated revenue and expenses for the upcoming year based on the previous year’s performance, which helps your team forecast and plan spending. Build in contingencies, and review the budget monthly so you can evaluate progress and adjust as needed. Each department should have its own operating budget connected to your broader organizational goals.

2. Select accounting software

The right digital tool helps you track your finances reliably. QuickBooks and FreshBooks are commonly used solutions for nonprofits. Whatever you choose, your accounting system should manage a journaling system, connect to your bank account, create and manage budgets, calculate your cash flow, and generate reporting and financial statements.

3. Build an accounting team

Every nonprofit needs someone responsible for its finances, whether that’s a single chief financial officer or an entire team, depending on your organization’s size and complexity. Certified public accountants are helpful, but the most important qualification is understanding Generally Accepted Accounting Principles and executing accurate financial reports consistently. A board member with accounting expertise adds value too. Partnering with specialized nonprofit accountants or external firms for reconciliations and audits brings objectivity and specialization, so look for firms that share your values and have nonprofit experience.

4. Keep track of your records

Track every financial transaction, including expenses, invoices, and receipts, so your internal records match your balance sheet and your annual audits go more smoothly. Proper recordkeeping is vital to sound accounting and to complying with IRS and nonprofit regulations. Digital storage in your accounting software is best, though keeping short-term paper records can help you verify accuracy.

5. Reconcile your accounts regularly

Reconciling your accounts means comparing your bank statements to your internal accounting records to confirm they match. This process catches errors, discrepancies, and potential fraud, and it prevents bookkeeping delays from piling up. Reconcile cash flow, accounts receivable, accounts payable, and staff payroll on a regular schedule.

6. Conduct an annual financial audit

An audit is a formal examination of your financial records that reveals potential problems and confirms compliance. Depending on your size and budget, you can conduct an internal audit or hire an external firm. An audit isn’t just an IRS formality. It’s a healthy regular practice that supports sound bookkeeping and can strengthen your case to funders through the findings in your annual report.

Nonprofit accounting terminology to know

Accounting can be a highly technical, jargon-filled process, so understanding the key terms below is a crucial step toward better nonprofit accounting.

What is fund accounting?

Fund accounting is the recommended method of accounting for nonprofits because it separates money into distinct funds based on how it’s meant to be used, such as programming, marketing, administration, and fundraising. Rather than tracking one general pool of money, fund accounting for nonprofits keeps each restricted or designated gift tied to its intended purpose, so your organization can show donors and grantmakers exactly how their contributions were spent. This structure also makes it easier to stay compliant with donor restrictions and grant requirements, since every fund’s activity is tracked and reported separately.

What is a statement of financial position?

A statement of financial position is a nonprofit’s version of a balance sheet. It shows what your organization owns, its assets, what it owes, its liabilities, and the difference between the two, its net assets, at a single point in time. Where a for-profit balance sheet reports shareholder equity, a nonprofit’s statement of financial position reports net assets instead, often broken out by whether donors have placed restrictions on how those funds can be used. Reviewing this statement regularly helps your board and finance team understand your organization’s overall financial health.

What is a statement of activities?

A statement of activities is a nonprofit’s version of an income statement. It summarizes your organization’s revenue and expenses over a reporting period, showing whether you ended that period with a surplus or a deficit. Revenue on a statement of activities typically comes from donations, grants, and program fees, while expenses are grouped by function, such as programs, management, and fundraising. Reviewing this statement alongside your statement of financial position gives you a fuller picture of both what your nonprofit owns and how it’s using its money.

• Accounts receivable: The money owed to your organization, or in the case of a nonprofit, the donation fund.
• Accounts payable: The amount your organization owes to others for services or goods it has received.
• Chart of accounts: The list of accounts that send or receive money, typically categorized as assets, liabilities, net assets, revenue, and expenses.
• Cash flow: How money moves in and out of your 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 nonprofit 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 your organization holds.
• GAAP: Generally Accepted Accounting Principles, the standards for accounting in the United States.

FAQ

What is the difference between fund accounting and regular accounting?

Fund accounting separates money into distinct funds tied to specific purposes, like programs or fundraising, while regular, for-profit accounting tracks one general pool of revenue and expenses. Nonprofits use fund accounting so they can show donors and grantmakers exactly how restricted gifts were used, not just how much money came in overall.

What is another name for a statement of financial position?

A statement of financial position is often called a nonprofit’s balance sheet. The two serve the same purpose, showing assets, liabilities, and the difference between them, just with net assets replacing shareholder equity on the nonprofit version.

Is a statement of activities the same as an income statement?

A statement of activities serves the same purpose as a for-profit income statement. It shows revenue and expenses over a reporting period. The main difference is how nonprofits categorize that activity, typically by program, management, and fundraising functions, rather than by product line or business segment.

Keep your nonprofit’s accounting in check to raise more for your mission

Proper accounting is vital to every nonprofit, regardless of mission or size. Following correct accounting procedures takes an educated team and focused tracking efforts. GoFundMe Pro prioritizes robust, clear reporting, giving your team access to these reports directly within your donations platform so internal accounting stays easier to manage. Following the steps above helps your organization remain compliant and operate smoothly.