Financial literacy is an area where “fake until you make it” doesn’t apply. In a sector where budgets are typically tight, there is no position exempt from understanding some basic accounting principles. This blog will be a great place to start, but if you find yourself praying no one asks you questions about the financials in your next board meeting, you may want to check out our Nonprofit Accounting Essentials course in partnership with The Charity CFO.
I signed on to further a cause, not to be the accountant!
I’m guessing you were drawn to your current role because of the mission and impact, not the business model or financial challenges.
The unfortunate truth is that many nonprofit leaders never receive the education or have the experience necessary to handle executive-level accounting. While most undergraduate programs cover the basics of accounting, the practices of a nonprofit bring a new level of complexity to the art of numbers and reporting. Even if you have a bookkeeper maintaining your finances, at the leadership level—whether executive or programmatic—you need to understand some basics in order to provide clarity to your board and transparency to your community.
Whether you’re advancing from within an organization, assuming an executive director position, or starting a nonprofit, the budgeting process is the first step to grasping an organization’s financial health and future. You’ll learn quickly that “nonprofit” doesn’t mean “no profit.” After all, you need to build sustainable support for your programs.
Nonprofit Accounting Basic #1: What Sets Us Apart Financially
I once sat in a boardroom reviewing a forecasted profit and loss statement for an organization I was leading. The statement showed that the organization would have a handsome net income at the close of the year. As I delighted in this news, a board member to my left said, “Is this allowed?”
Nonprofit organizations are allowed to have profits. In fact, some retained earnings are a necessary protection from unstable economic conditions and unforeseen circumstances. What we cannot do is distribute these retained earnings to shareholders. A nonprofit is a community-owned entity stewarded by a board of directors. Profits need to be reinvested into the organization or saved.
Other unique accounting elements include…
Tax Exempt: Nonprofits are (typically) tax exempt, meaning they are not required to pay sales and property taxes.
Designated Funds: Funds donated or granted for a specific purpose. Unless the designation is lifted by the giver, these funds need to be tracked separately to ensure they are used for their intended purpose. Funding that is not designated is commonly considered part of an organization’s general operating fund or budget.
Form 990: Unlike their for-profit counterparts, nonprofits file a Form 990 as their tax return. Keep in mind that 990s are considered to be public documents. These can be searched and read through the IRS and organizations like Guidestar.
Unique Support Types: While nonprofits can sell goods, collect rent, and receive income in many of the same ways for-profit businesses can, they also receive funding in different ways. Income types that are unique to nonprofits include grants, donations, endowment funds, and government funding.
Checks and Balances: Having checks and balances isn’t just for nonprofits, but we are subject to certain requirements that protect the public nature of our work and funding. For example, depending on what state your nonprofit is in, you may be required to have your financial statements audited. (Note: some grantors also require this.) No matter where you are or what size your organization is, all nonprofits are federally required to have conflict of interest policies. These protect the organization’s assets and operations from private interests of involved parties.
Nonprofit Accounting Basic #2: Know Your Statements
There are some basic statements that should be familiar to every nonprofit and every leader within an organization:
Profit and Loss Statement (P&L)/Income Statement: This is a summary of the revenues and expenses of your organization, or a particular program, location, or event for a specified period of time—usually a month or a year. Often, the P&L is compared to the organization’s budget and/or the P&L of the previous period so performance can be tracked.
Balance Sheet: A statement of the organization’s assets and liabilities. This one reflects a moment in time rather than a period of time.
Check Register: This report is quickly becoming something of the past as more organizations switch to Venmo, credit cards, and Stripe. But, for now it’s still a thing. Basically, this is a way for your board or accountant to review all checks issued during a given period.
Nonprofit Accounting Basic #3: Build Budgets Upon Budgets
Budgeting can feel like throwing an aspirational dart at a wall of numbers, especially when you’re starting out. It’s important to build your operating budget from programmatic budgets. For example, let’s say you have a large annual gala. That gala will have expenses and revenue tied directly to its performance. Creating a separate budget for this event and measuring performance against this budget helps you predict what will happen in future years. Plus, it assigns an appropriate value to “fundraising events” in your operating budget.
The more you can drill down into the costs and revenues associated with your operations, the more accurate an operating budget you’ll be able to build. Here are some areas you should consider developing ad hoc budgets for:
- Programs where 25% or more of staff time is allocated
Our Nonprofit Budgeting Guide will help you understand the typical categories included in an operating budget and event budget. Make sure your design includes clearly defined dates and titles. It’s also a good idea to include a column for notes on how numbers were calculated or any unusual circumstances.
Nonprofit Accounting Basic #4: Know the “Big Picture” of Your Organization’s Finances
One of the best ways leaders can equip their team is to give them a high-level understanding of the organization’s support and expenses. A “high-level” understanding covers the major buckets of income and expenses. But, it doesn’t divulge privileged information like individual salaries or mundane details like the dollar amount spent on printer paper.
This “big picture” information equips your team to answer questions from the public and funders. It also fills in the gaps of what can’t be understood from public documents like annual reports or 990s. Here are some common questions that your overview should answer:
Where do you get your support?
Think of this in terms of a pie chart, not a donor list. Using percentages, demonstrate what categories provide your organization’s support.
What is your operating budget?
A common question on grant applications, the “operating budget” is usually considered to be the sum of all expenses for a period of time.
Which programs are self-funding? (Another way this might be asked is: What programs are solvent?)
See #2 above. Creating programmatic budgets allows your team to understand what programs bring enough revenue to cover their own expenses. It also shows which ones need extra support from the general operating fund.
Does your organization carry any debt?
This is also a common grant and funder question. Make your team aware of any debt, including land contracts, mortgages, or lines of credit. Explain the strategy behind why they are being utilized as well.
Other useful information your team should know:
- Your organization’s fiscal year. This is the date that your financials and budget reflect. Many organizations do not use the calendar year.
- Endowments and designated gifts. Do you have large sums of funding in an endowment fund or designated for a specific project? Make sure your team understands why and how these funds are used.
- The Treasurer. Ultimately, your nonprofit’s treasurer is responsible for your organization’s fiscal outlook. Make sure employees are familiar with this person and their role.
Nonprofit Accounting Basic #5: Understand Your Part
You may not be the one presenting the financial statements to the board this month. But, every person within an organization represents an activity behind those statements. Taking the time to develop an understanding of your organization’s financial position, challenges, and goals will help you serve with excellence. This will also help you support organizational leaders in meaningful ways.
Accounting is also an important piece of a strong resume and skill set. If you desire to lead, it’s crucial that you have a basic understanding of accounting and the unique elements of running a nonprofit organization. Check out the Nonprofit Accounting Essentials course by Charity CFO (included with a Cause Network Membership) for further study.