With charities popping up around the globe to address social challenges, including food insecurities, shelter, economic infrastructures, healthcare, education, and innovation to address pollution, accounting needs to keep up and reflect the realities of these businesses that are not focused on making a profit, but are determined to make a difference in their communities on a local and global scale. Let’s learn what makes nonprofit accounting different from traditional accounting and how nonprofit financial statements look like.
What is Nonprofit Accounting?
Nonprofit accounting is a unique form of accounting used by charitable and mission-driven nonprofit organizations. It differs from for-profit accounting because it focuses on accountability rather than profitability. Nonprofit accounting uses specific rules and procedures to track how funds are being used and thus keep their leadership accountable to its donors and contributors. Most nonprofits rely primarily on donations and grants to fund their cause. Leftover funds at the end of the year are reinvested to further their mission.
Nonprofit accounting requires a special approach to recording and reporting revenue and expenses, which is known as “fund accounting.” With this approach, nonprofit organizations stay focused on their goals and adjust their fundraising, programming, and long-term investments to maximize their donor funding and thus fulfill their mission.
Recording transactions from funding sources, such as donations, memberships, and grants, requires reporting with transparency, thus building trust with your donors and board members as they see the money being used for the programs and purposes the givers intended.
Donations may also be restricted by the donor for specific uses, so the organization needs to be able to reflect that the funds were used for the designated purpose. Unrestricted funds could be used for the various needs of the organization, including operating costs and paying employees to further its mission.
Why Do Nonprofits Need Financial Statements?
In the United States, nonprofit accounting guidance is established by the Financial Accounting Standards Board (FASB), following Generally Accepted Accounting Principles (GAAP), which can be used to prepare financial statements required for reporting to their board members and donors.
Nonprofit accounting is similar to bookkeeping in for-profit companies but requires additional recordkeeping and reporting based on unique nonprofit rules. With accountability to donors being a key tenet of nonprofit accounting, financial statements are a must, as they show how the expenses align with donations to show the organization is using funds appropriately and uses restricted donations in line with the donor’s intent. Funds are recognized as assets of the organization, and their net assets are the money left over after all expenses have been paid. Typically, these funds are reinvested into the organization or returned to the donor in the case of restricted funds.
Differences between Profit vs Nonprofit Accounting
Accounting is a key aspect of the nonprofit sector. Having a general understanding of how it works can help you ensure your organization is making informed decisions and investing in the most impactful financial strategies that fuel growth. A systematic approach for organizing funds for projects and operational expenses. Unlike for-profit accounting, which focuses on controlling expenses and maximizing revenue for profitability, non-profits are focused on making sure their funds are being used in accordance with their mission and the requests of the donors in the case of restricted donations.
There are four main ways that fund accounting for nonprofits differs from for-profit accounting:
- Nonprofits focus on accountability
- Financial reporting differs for nonprofits
- Nonprofits don’t pay taxes
- Auditing differs for nonprofits
Despite their differences, some nonprofit organizations have furthered their mission by applying for-profit business approaches while still producing GAAP-compliant external reporting.
Each type of organization plays a role in their communities, but by understanding nonprofit accounting, you get a better insight into how organizations prioritize finances. Let’s dive into the type of financial statements a nonprofit organization will use to report its finances.
The 4 Nonprofit Financial Statements
There are four key financial statements that are tied to nonprofit accounting, which we will explore below. With these financial statements, your nonprofit organization can clearly demonstrate its accountability to donors and board members.
1. Statement of Financial Position
The statement of financial position is similar to the balance sheet. It reports the assets, liabilities, and equity of your nonprofit organization. This statement also lists the resources, obligations, and ownership details of a company on a specific date, thus providing you with a snapshot of what the company looks like. Your statement of financial position is also a historical report, meaning it can only show what was present on the day of the report. An income statement presents company activities over a period of time. The statement of financial position only records the company account information on the last day of the accounting period, which is typically 12 months. In this sense, investors and creditors can use these historical records to see the financial position of the nonprofit organization on specific dates.
Assets are represented on the left, and liability on the right. These assets and liabilities are further broken down into current and noncurrent, depending on whether assets can easily be converted to cash to settle liabilities.
2. Statement of Activities
The statement of activities emphasizes reporting revenue and expenses versus profit and loss but can be used like a P&L to determine areas of potential concern that need to be addressed.
3. Statement of Cash Flow
The statement of cash flow shows how money is flowing in and out of various accounts, reflecting how donations are being spent in line with the mission of the nonprofit.
4. Statement of Functional Expenses
The statement of functional expenses dives into three areas of expenses, the program; general and management; and fundraising. Depending on the requirements of your organization, this financial statement might be optional.
Together, these financial statements enable nonprofit organizations to evaluate their monthly cash positions, prepare for IRS filings, and support internal audits. Key indicators, including year-over-year donation growth, membership retention, and clients served, highlight whether your organization is fulfilling its mission and achieving the goals laid out in your strategic plan. That means your leadership can determine if marketing needs to increase or if expenses in some areas need to be trimmed down. These statements also give you the ability to enhance the trust of your donors because your stewardship of contributions is visible.
3 Great Examples of Nonprofit Financial Statements
Nonprofits must comply with the IRS and file four financial statements to ensure they follow strict nonprofit regulations. These organizations have a primary responsibility to their donors when filing and sharing these financial statements. By following basic accounting practices when filing their financial statements to share critical details in a way that donors understand.
Here are three great examples of nonprofit financial statements:
Wellington Zoo – Its annual report uses audited financial statements to show the organization’s financial health.
Heliconia Scholarship Foundation – This financial report is shared with the donors instead of a traditional annual report.
Save the Children – Their annual report includes an overview of the finances, including a statement of activities, a balance sheet, and a cash flow statement.
All three organizations utilize their financial statements to provide critical information to both their board members and donors, thus allowing them to achieve the transparency necessary to fulfill their missions.
Preparation of Nonprofit Financial Statements
Preparing financial statements for a nonprofit organization is similar to preparing them for a for-profit, as you will be gathering income and expense information. But how that information is presented is slightly different, reflecting the goals of transparency and accountability. Let’s review what needs to happen to create these financials and how they tell the story of your organization to donors and board members.
Statement of Activities and Changes to Net Assets
The statement of activities is a financial statement reporting the revenue and expenses of a nonprofit during a specific period, similar to a profit and loss statement. Your statement of activities is divided into three sections, revenue, expenses, and change in net assets.
Revenue includes all flows of cash into the organization, such as grants, donations, special events, fundraising, government funding, and earned revenue. It is then broken down into restricted and unrestricted revenue, showing how these funds can be utilized by the organization.
Expenses include all cash outflows and are broken down according to any restrictions limiting how funds may or may not be used. This is different from a for-profit, which breaks down its expenses into COGS and operating.
The change in net assets is calculated by subtracting expenses from revenue. Once you have this number, you can compare revenue and expenses by significant program activity to see where you are making money or losing it. Comparing it from month to month can help you to discover any areas where changes need to be made to maximize the benefits of your funds.
Statement of Financial Position – Balance Sheet
The statement of financial position is also known as the balance sheet. To determine the assets versus liabilities of your organization, you need to list all the assets of your nonprofit that can be used to cover its liabilities and help maintain its programs.
Liabilities, like a for-profit, are obligations that your organization has and owes to others. These can be divided into short-term and long-term, based upon when the liabilities are due. Short-term are ones due in a year, and long-term is anything over that.
Net assets represent what remains after the liabilities are subtracted from the assets, the residual interest in the assets of your nonprofit.
Statement of Functional Expenses
A statement of functional expenses breaks down its expenses by both nature and function. The report represents the relationship between functional expenses, such as program services and support activities, and natural expenses, including salaries, rent, utilities, and supplies.
This is an analysis providing an in-depth look at how nonprofits are spending toward their missions and requires consideration of the approach to allocation and reporting of functional expenses by auditors and preparers. This statement is necessary for purposes of the IRS 990 report and the organization’s audit, if applicable. Budgeting and reporting functional activities allow the leadership to be aware of how resources are being used to address their mission and infrastructure activities. Analyzing the functional expenses can help to determine if programs and activities are truly in line with the mission of the nonprofit, leading to discussions about whether a renewed commitment to fundraising is necessary to subsidize specific program activities or if those activities need to be phased out.
Statement of Cash Flow
A statement of cash flows provides a detailed account of the inflows and outflows of cash for a nonprofit over a specific period. It can help to identify areas where improvements can be made while also giving a clear picture of the overall financial health of the nonprofit.
This statement also offers insights into the nonprofit’s operating, investing, and financing activities, thus assisting in identifying over/underspending compared to the cash inflow. With a statement of cash flow, you can assess the ability of the nonprofit to generate cash, how day-to-day operations are financed, its ability to pay short-term debts, and what is being reinvested into the nonprofit.
For instance, if a nonprofit has an inflow of $20,000 and operating expenses of $24,000, then the organization would be in the red if that pattern continues. If they are in the red for too long, it could lead to the nonprofit shutting down altogether.
Frequently Asked Questions
How are nonprofit financial statements different from for-profit financial statements?
Nonprofit financial statements are focused on accountability and outlining how funds are being used to fulfill its mission, whereas for-profit financial statements are focused on the profitability of the business model.
Who typically uses nonprofit financial statements?
Board members, donors, the IRS, and potential donors
Are nonprofit financial statements audited?
Nonprofits are independently audited to inspire and maintain the trust of their donors, demonstrating financial transparency and accountability. Some private foundations also require that grant applicants and grantees submit audited financial statements to be eligible for funding.
State laws vary in the scope of their regulation of charitable nonprofits. Some nonprofits, based upon their size or sources of funding, may be required to complete an independent audit by state or federal law, but in other situations, a nonprofit may have a choice about whether or not to conduct an independent audit.
Charitable nonprofits expending $750,000 or more in federal funds during a year are also subject to special audit requirements.
Are nonprofit financial statements publicly available?
Yes, nonprofit corporations are required to make their financial statements available to the public. They are also required to complete a Form 990 each year and submit it to the IRS.
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Final Thoughts on Nonprofit Financial Statements
Nonprofits serve a valuable role in our communities and states, providing services and programs to address the social, physical, and emotional needs of our population. That being said, to build trust, nonprofits need to have accurate financial statements reflecting whether they are being good stewards of the funds given to them. The more transparent a nonprofit is, the better for the financial success of their organization and its ability to fulfill its mission.