Importance of Nonprofit Accounting: What You Need to Know

As a nonprofit professional, you know that responsibly using resources and funds is necessary to keep your organization afloat and your mission alive, especially as individual giving continues to decline.

However, you may not be familiar with the ins and outs of managing these resources and making sure your nonprofit has sufficient funds to cover its costs. No matter your role at your organization, it is helpful to have a basic understanding of nonprofit accounting and why it is important so you can execute your daily tasks with this context in mind.

To help you out, we have created this quick guide to explain what you should know about nonprofit accounting. 

What is Nonprofit Accounting?

Nonprofit accounting involves recording, tracking, summarizing, and reporting financial transactions. While many of the core processes are the same as those involved in for-profit accounting, nonprofit accounting has some slight differences due to its focus on accountability and bettering society rather than making a profit.

That said, the main activities in nonprofit accounting include:

• Reconciling accounts, which involves comparing internal financial records against external statements to ensure accuracy
• Creating nonprofit financial statements, including the Statement of Financial Position, Statement of Activities, Statement of Cash Flows, and Statement of Functional Expenses
• Preparing for audits by compiling work papers and schedules for auditors
• Budgeting your revenue and expenses for the year and presenting the budget to your team
• Managing grants through recording, fund allocation, and reporting
• Maintaining compliance with Generally Accepted Accounting Principles (GAAP)

While both are related to financial management, nonprofit accounting differs from bookkeeping, which encompasses day-to-day financial activities like entering transaction data, maintaining organized financial records, managing accounts payable and receivable, allocating resources, and processing payroll.
 

Why is Nonprofit Accounting Important?

As mentioned above, nonprofit accountants are responsible for maintaining GAAP compliance. These rules and regulations standardize the field of accounting, allowing organizations of all types to generate accurate, consistent financial records.

In addition to regulatory compliance, proper nonprofit accounting is important because it allows your nonprofit to develop:

• Transparency with stakeholders. Grant funders, sponsors, and donors (or as Convergent Nonprofit Solutions refers to them, investors) make your operations possible through their generous contributions. In return, it’s up to your organization to not only use their funds responsibly but to show them you are doing so. Through proper resource allocation and financial reporting, you can be transparent with stakeholders and assure them their funds are making an impact.
• Effective financial planning. When you track your organization's financials and budget, you can allocate resources more effectively. As a result, you can power your programs and operations, make the most of the funds available to you, and navigate economic challenges as they arise.
• Long-term sustainability. Nonprofit accounting also helps you prepare for the future. By identifying trends in your financial data and forecasting future cash flow, you can proactively manage financial risks and ensure your organization remains financially stable and sustainable over the long term.
• Performance assessment. Compiling this data allows your organization to measure its financial performance. You can break down your reports to measure program effectiveness, identify fundraising strengths and improvement opportunities, and make more informed financial decisions moving forward.

Overall, nonprofit accounting is necessary for maintaining strong external relationships and improving internal operations—all in the name of upholding your mission and helping your beneficiaries.

What are Some Nonprofit Accounting Best Practices?

With a better understanding of what nonprofit accounting entails and why it’s important, let’s explore the best practices charitable organizations should implement. While you might not be the team member personally responsible for nonprofit accounting, it is still useful to have a basic understanding of how things work so you can communicate with your accountant effectively and consider how financial management overlaps with your role.

YPTC’s nonprofit accounting guide recommends following these best practices:

• Evaluate your budget regularly. After your budget is finalized, keep a close eye on it to compare your budgeted revenue and expenses against your actual revenue and expenses. That way, you can adapt to unexpected changes and adjust your resource allocation accordingly.
• Allocate funds for overhead expenses as needed. Many stakeholders will want to ensure their contributions go toward program costs, but overhead expenses are just as important. As Double the Donation’s nonprofit capacity-building guide explains, “Investing in tools and training that help team members perform their roles effectively makes day-to-day tasks more efficient.” Each nonprofit will have a different ideal overhead breakdown depending on how much you need to keep your nonprofit running smoothly and any new internal projects you’re taking on, such as developing new programming or acquiring new office space.
• Establish internal controls. To reduce the risk of fraud and human error, separate financial management responsibilities among different team members, and create clear financial policies for them to follow. Additionally, protect your physical assets by switching to an online bill payment system and keeping stock of valuable equipment like laptops and cell phones.
• Conduct audits. An independent financial audit allows you to verify that your organization is financially healthy and compliant with the help of an objective third party. Your auditor’s recommendations can help you strengthen your financial management and improve your organization’s financial stability. You can also publish your audit results once your audit is complete to demonstrate transparency to stakeholders.
• Use dedicated accounting tools. Lastly, use accounting technology to organize financial data and streamline financial management processes. Look for tools you can customize for nonprofit accounting procedures and your organization’s specific needs.

While implementing these tips, remind your team to refer to GAAP. These regulations should be at the core of your organization’s accounting function, so the more familiar staff members are with them, the better.

Although it is possible to handle nonprofit accounting in-house, outsourcing these responsibilities can help you access financial expertise at a lower price. Consider hiring an accountant or financial professional with experience working with nonprofits so they understand the nuances of nonprofit accounting and the unique challenges your organization faces.