Nonprofits play an important role in addressing social issues, supporting communities, and driving change. However, managing a nonprofit’s finances can be overwhelming, especially when you have limited resources and staff. Bookkeeping is a critical part of ensuring that your nonprofit stays compliant, transparent, and efficient.
We will break down the essentials of nonprofit bookkeeping, including key concepts, best practices, and tools to help you manage your finances effectively. Whether you’re a new nonprofit founder or an experienced manager looking to improve your bookkeeping system, this guide will help you navigate the complexities of nonprofit financial management.
Good Bookkeeping Ensures That:
- You maintain transparency with donors, funders, and stakeholders.
- You stay compliant with legal and tax regulations.
- You ensure proper allocation of funds and resources.
- You can make informed decisions.
- You can provide better reports and secure more funding.
Differences Between Nonprofit and For-Profit Bookkeeping
Purpose: Nonprofits focus on mission-driven activities rather than generating profit.
Revenue Sources: Nonprofits rely on donations, grants, and fundraising, while for-profits earn revenue through sales of products or services.
Financial Statements: Nonprofits use statements like the Statement of Activities and Statement of Financial Position, while for-profits use traditional income statements and balance sheets.
Bookkeeping Basics for Nonprofits
What is Bookkeeping?
Bookkeeping is the systematic process of recording, categorizing, and managing an organization’s financial transactions.
Why Bookkeeping is Critical for Nonprofits
Transparency and Accountability: Donors, board members, and stakeholders expect nonprofits to use funds responsibly and transparently. Proper bookkeeping demonstrates how funds are allocated and ensures compliance with donor restrictions.
Compliance with Legal and Regulatory Requirements: Nonprofits must adhere to tax laws, reporting standards, and grant conditions. Accurate bookkeeping ensures compliance with regulations, reducing the risk of penalties or legal issues.
Effective Financial Management: Bookkeeping provides real-time insights into the organization’s financial health, enabling informed decision-making. It helps nonprofits track cash flow, manage budgets, and plan for future programs or initiatives.
Grant and Donor Reporting: Many grants and donations come with specific reporting requirements. Bookkeeping ensures that nonprofits can provide detailed reports on how funds were used, building trust with funders.
Audit Readiness: Nonprofits are often subject to audits by government agencies, donors, or independent auditors. Organized financial records make audits smoother and help identify areas for improvement.
Sustainability and Growth: A strong bookkeeping system supports long-term sustainability by identifying trends and optimizing resource allocation.
Setting Up Your Nonprofit Bookkeeping System
Choose the Right Bookkeeping Method: Cash vs. Accrual
Nonprofits can choose between two primary bookkeeping methods, each with its own advantages:
Cash Basis Accounting: Records income and expenses when cash is received or paid. It is simple to implement, provides a clear picture of cash flow. It’s best for small nonprofits with straightforward financial transactions.
Accrual Basis Accounting: Records income and expenses when they are earned or incurred, regardless of cash movement. It offers a more accurate financial picture by matching revenues with expenses. It’s best for larger nonprofits or those managing grants, restricted funds, or complex transactions.
While cash basis accounting is simpler, accrual basis accounting is often required for financial reporting under Generally Accepted Accounting Principles (GAAP).
Select A Good Nonprofit-Specific Accounting Software
Choosing the right accounting software can streamline your bookkeeping processes and improve accuracy.
Features to Look For:
- Fund Accounting: Allows tracking of restricted and unrestricted funds separately.
- Grant Tracking: Helps monitor grant expenditures and compliance with donor requirements.
- Customizable Reports: Generates reports for donors, board members, and audits.
- Budgeting Tools: Assists in planning and tracking expenses against budgets.
Popular Options:
- QuickBooks for Nonprofits: Offers fund accounting, donor management, and reporting features.
- Aplos: Designed specifically for nonprofits, with built-in tools for fund accounting and online giving.
- Blackbaud Financial Edge: A robust solution for larger organizations managing multiple funds.
Choose software that integrates with your donor management system to simplify data sharing and reporting.
Setting Up a Chart of Accounts Tailored for Nonprofits
A well-structured chart of accounts (COA) is the backbone of a nonprofit’s bookkeeping system. It organizes financial data into categories that reflect the organization’s unique activities and funding sources.
Revenue Categories:
- Donations (e.g., individual, corporate, in-kind).
- Grants (e.g., government, private, restricted, unrestricted).
- Program Revenue (e.g., fees for services, event income).
- Investment Income (e.g., interest, dividends).
Expense Categories:
- Program Expenses: Costs directly related to mission-driven activities.
- Administrative Expenses: Overhead costs like salaries, utilities, and office supplies.
- Fundraising Expenses: Costs for events, donor outreach, and marketing.
Other Categories:
- Assets (e.g., cash, equipment, receivables).
- Liabilities (e.g., loans, accounts payable).
- Equity (e.g., retained earnings, net assets).
Regularly review and update your COA to reflect changes in your programs or funding sources.
Establishing Internal Controls to Prevent Fraud
Internal controls are essential for safeguarding your nonprofit’s assets and ensuring the integrity of financial processes.
Segregation of Duties:
- Assign different financial tasks to separate individuals (e.g., one person collects donations, and another records them).
- Limit access to financial accounts based on roles and responsibilities.
Approval Processes:
- Require multiple levels of approval for significant expenditures or fund transfers.
- Maintain a clear policy for expense reimbursements and petty cash usage.
Regular Reviews and Audits:
- Conduct periodic internal reviews of financial statements to identify discrepancies.
- Schedule external audits to ensure compliance and transparency.
Secure Record-Keeping:
- Use password-protected accounting software and limit access to authorized personnel.
- Store financial records in a secure, organized manner, whether digitally or physically.
Tracking Daily Financial Transactions
Recording Donations, Grants, and Program Revenue
Categorization: Clearly identify whether incoming funds are restricted (earmarked for specific purposes) or unrestricted (available for general use). Record each transaction in the appropriate account or sub-account within your chart of accounts.
Documentation: Maintain detailed records of all donations, including donor names, amounts, and any restrictions or conditions. For grants, retain copies of grant agreements and related correspondence to ensure compliance with funder requirements.
Acknowledgement: Issue receipts or acknowledgement letters to donors promptly, including required details for tax purposes.
Categorizing Expenses by Program, Administration, and Fundraising
Program Expenses: Direct costs associated with delivering services or fulfilling the nonprofit’s mission (e.g., supplies for a community project, program staff salaries).
Administrative Expenses: Costs related to the overall management of the organization, such as office supplies, rent, utilities, and executive salaries.
Fundraising Expenses: Costs incurred to raise funds, including event expenses, donor outreach, and marketing materials.
Organizing Receipts and Documentation for Audits
Receipt and Invoice Management: Collect and store all receipts, invoices, and financial documents related to income and expenses. Ensure each document includes key details, such as date, amount, and purpose.
Digital Tools: Use tools like Expensify, QuickBooks, or Google Drive to digitize and organize receipts for easy access. Implement a naming convention for digital files to simplify searches (e.g., “Donation_2025-01-13_JaneDoe.pdf”).
Audit Readiness: Conduct regular internal reviews of financial records to identify and address discrepancies before an audit occurs.
Tracking Volunteer Hours (If Applicable)
Volunteer hours represent a valuable in-kind contribution to the nonprofit and may be required for reporting purposes.
Why Track Volunteer Hours? – Many grants and funding applications require documentation of volunteer contributions. Volunteer hours can be monetized as in-kind donations for financial reporting or tax purposes.
Tracking Methods: Use tools like spreadsheets, time-tracking apps, or volunteer management software (e.g., VolunteerHub or SignUpGenius) to log hours. Include details such as volunteer names, dates, activities performed, and hours worked.
Reporting: Share volunteer contributions in annual reports, impact statements, or grant applications to highlight community engagement.
Managing Restricted and Unrestricted Funds
Donor Restrictions and Fund Allocations
Nonprofit organizations often receive contributions with specific instructions or restrictions from donors. These restrictions can be broadly categorized as:
- Restricted Funds: Contributions earmarked for specific purposes, programs, or time periods. Examples include grants for a specific project, donations for a capital campaign, or endowment funds requiring principal preservation. Restricted funds must be used solely for their intended purpose, as stipulated by the donor. Misuse can lead to legal consequences and loss of donor trust.
- Unrestricted Funds: Contributions that can be used at the organization’s discretion to cover operational costs, administrative expenses, or any other needs.
Clear communication with donors about how their funds are being used fosters confidence and encourages future contributions.
Best Practices for Tracking and Reporting Restricted Funds
Maintain Separate Accounts or Sub-Accounts: Set up individual accounts or sub-accounts within your accounting system to track restricted funds separately from unrestricted funds. Ensure that all expenses and revenues related to restricted funds are recorded accurately to avoid commingling with unrestricted funds.
Develop a Clear Fund Allocation Policy: Establish internal guidelines for how restricted funds are allocated and spent. Train staff on the importance of adhering to donor restrictions.
Regular Reporting to Stakeholders: Provide detailed reports to donors on how their contributions have been utilized, including financial summaries and impact statements. Present fund status updates to board members during regular meetings to ensure oversight and accountability.
Audit Trail: Maintain thorough documentation of all transactions involving restricted funds, including donor agreements, invoices, and receipts.
Periodic Reconciliation: Regularly reconcile restricted fund balances to ensure accuracy and compliance.
Reconciling Accounts
What is Reconciliation?
Reconciliation is the process of comparing your financial records with bank statements to ensure that all transactions are accurately recorded and accounted for.
Why Reconciliation is Essential for Nonprofits
Detecting Errors or Discrepancies: Reconciliation helps identify mistakes such as duplicate entries, missing transactions, or bank errors. Early detection ensures that financial reports are accurate and reliable.
Ensuring Accurate Financial Reporting: Regular reconciliation ensures that all transactions, including donations, grants, and expenses, are properly recorded. This accuracy is crucial for generating financial reports for donors, board members, and audits.
Maintaining Transparency and Accountability: Nonprofits rely on donor trust. Reconciliation ensures that funds are being managed responsibly and transparently. It demonstrates to stakeholders that the organization is committed to financial integrity.
Preventing Fraud: Reconciliation can reveal unauthorized transactions or fraudulent activity. Regular reviews act as a safeguard against potential misuse of funds.
Supporting Decision-Making: Accurate financial data enables nonprofits to make informed decisions about budgeting, resource allocation, and program planning.
Step-by-Step Process for Reconciling Bank Accounts
- Gather Documents:
- Obtain your bank statement and financial records for the same period.
- Ensure that all relevant records, such as receipts and invoices, are available for reference.
- Compare Transactions:
- Match each transaction on the bank statement to the corresponding entry in your accounting records.
- Highlight any discrepancies, such as missing or mismatched amounts.
- Identify and Resolve Discrepancies:
- Investigate missing transactions, duplicate entries, or amounts that don’t align.
- For example, a deposit recorded in your books but not on the bank statement could indicate a delay in processing.
- Adjust Records:
- Make necessary adjustments in your accounting system to reflect the accurate transaction details.
- Record bank fees, interest, or other charges that may not have been initially included.
- Verify Balances:
- Ensure that the ending balance in your financial records matches the bank statement balance.
- If discrepancies persist, recheck all transactions and consult with your bank if needed.
- Document the Process:
- Maintain a record of the reconciliation, including notes on discrepancies and adjustments made.
- This documentation is essential for audits and future reference.
Common Reconciliation Challenges and How to Address Them
- Uncleared Checks:
- Challenge: Checks issued by the nonprofit that remain uncashed for an extended period.
- Solution: Follow up with recipients to confirm receipt and encourage timely deposit. Consider voiding and reissuing checks if necessary.
- Bank Fees and Charges:
- Challenge: Bank fees not recorded in your accounting system.
- Solution: Regularly review your bank statements for fees and immediately record them in your financial records.
- Timing Differences:
- Challenge: Transactions recorded in the books but not yet reflected in the bank statement (or vice versa).
- Solution: Note these as reconciling items and ensure they are cleared in the subsequent period.
- Errors in Data Entry:
- Challenge: Mistakes such as transposed numbers or incorrect amounts in financial records.
- Solution: Double-check entries during reconciliation and correct any errors promptly.
- Fraudulent Transactions:
- Challenge: Unauthorized or suspicious transactions appearing on the bank statement.
- Solution: Investigate immediately, report to your bank, and implement stronger internal controls.
Financial Reporting for Nonprofits
Nonprofits rely on financial statements to provide a clear and accurate picture of their financial health. These reports not only ensure compliance with legal and donor requirements but also help in effective decision-making and strategic planning. Below are the essential financial statements every nonprofit should prepare:
1. Statement of Financial Position (Balance Sheet)
A snapshot of your nonprofit’s financial standing at a specific point in time.
- Key Components:
- Assets: What your nonprofit owns, such as cash, investments, property, and receivables.
- Liabilities: What your nonprofit owes, such as accounts payable, loans, or deferred revenue.
- Net Assets: The difference between assets and liabilities, categorized as restricted or unrestricted.
- Why It Matters:
- Provides a clear view of the organization’s financial stability.
- Helps stakeholders understand the resources available for mission-critical activities.
2. Statement of Activities (Income Statement)
A report showing your nonprofit’s revenue, expenses, and changes in net assets over a specific period.
- Key Components:
- Revenue: Includes donations, grants, program income, and fundraising proceeds.
- Expenses: Categorized into program, administrative, and fundraising costs.
- Net Assets: Tracks the increase or decrease in assets due to operational activities.
- Why It Matters:
- Demonstrates how funds are being utilized.
- Highlights financial trends, such as growing or declining revenue streams.
3. Statement of Functional Expenses
A detailed breakdown of expenses, showing how funds are allocated across programs, administration, and fundraising.
- Key Components:
- Program Expenses: Direct costs related to fulfilling the nonprofit’s mission.
- Administrative Expenses: Overhead costs, such as salaries, office supplies, and utilities.
- Fundraising Expenses: Costs associated with donor outreach and fundraising campaigns.
- Why It Matters:
- Provides transparency to donors and board members.
- Helps identify areas where costs can be optimized.
4. Cash Flow Statement
A report tracking the inflow and outflow of cash within the nonprofit.
- Key Components:
- Operating Activities: Cash generated or spent on day-to-day operations.
- Investing Activities: Cash used for purchasing or selling assets, such as property or equipment.
- Financing Activities: Cash received or repaid through loans or grants.
- Why It Matters:
- Helps ensure the organization has enough liquidity to meet its obligations.
- Highlights potential cash shortages or surpluses.
Using Financial Reports for Decision-Making and Grant Applications
Financial reports are powerful tools that guide nonprofits in making informed decisions:
- Budgeting:
- Analyze past revenue and expenses to create realistic budgets.
- Identify areas for cost-saving or additional investment.
- Fundraising:
- Use financial data to demonstrate funding gaps and justify fundraising goals.
- Show potential donors how their contributions will be utilized.
- Strategic Planning:
- Evaluate financial trends to plan for future growth or expansion.
- Assess the feasibility of new programs or initiatives.
- Grant Applications:
- Grantmakers often require detailed financial reports to assess an organization’s stability and accountability.
- Use reports to showcase your nonprofit’s ability to manage funds responsibly and achieve measurable outcomes.
Reporting Requirements for Board Members and Donors
Nonprofits must ensure that stakeholders receive timely and accurate financial information to maintain trust and transparency:
- Board Members:
- Provide regular financial updates, including all key financial statements.
- Share insights into budget performance, cash flow, and fundraising progress.
- Use reports to facilitate informed decision-making during board meetings.
- Donors:
- Share impact-focused financial summaries, emphasizing how their contributions are making a difference.
- Provide annual financial reports or donor-specific updates to highlight transparency and accountability.
Mistakes Nonprofits Make in Bookkeeping
1. Failing to Separate Restricted and Unrestricted Funds: Mixing restricted and unrestricted funds can lead to improper fund usage, which may violate donor agreements and harm your nonprofit’s credibility. E.g. Spending a grant designated for a specific program on general operating expenses.
2. Not Reconciling Accounts Regularly: Failing to reconcile bank accounts, credit cards, and other financial records regularly can result in undetected errors, fraud, or discrepancies. E.g. Missing a duplicate transaction or an unauthorized charge because account balances were not reviewed.
3. Misclassifying Expenses: Incorrectly categorizing expenses can distort financial reports and lead to compliance issues with grantors or regulatory agencies. E.g. Classifying program expenses as administrative costs, making it appear that less funding is going toward mission-critical activities.
4. Overlooking Volunteer Hours and In-Kind Contribution: Not tracking volunteer hours or in-kind donations can lead to incomplete reporting, which may affect grant eligibility or tax benefits.
5. Delaying Data Entry: Procrastinating on recording transactions can result in forgotten details, leading to inaccuracies in financial records.
Glossary of Nonprofit Bookkeeping Terms
Restricted Funds: Donations or grants given to a nonprofit with specific conditions or limitations on how they can be used. These funds must be spent according to the donor’s restrictions, such as for a particular program, project, or purpose, and cannot be used for general operating expenses.
Unrestricted Funds: Contributions that can be used by the nonprofit for any purpose that supports its mission. These funds are not subject to donor-imposed restrictions, providing the nonprofit with the flexibility to allocate them as needed for operations, programs, or administrative costs.
Fund Accounting: A specialized method of accounting used by nonprofits to track and report financial resources based on their restrictions. Fund accounting ensures that restricted funds are spent only for their designated purpose, while also providing transparency about how different funds are managed.
Statement of Financial Position: Also known as the Balance Sheet, this financial statement provides a snapshot of the nonprofit’s financial health at a specific point in time. It lists the organization’s assets, liabilities, and net assets, showing the balance between what the nonprofit owns and owes, as well as the residual interest available to support its mission.
Statement of Activities: Also referred to as the Income Statement or Profit and Loss Statement, this report outlines the nonprofit’s revenues, expenses, and changes in net assets over a specific period. It shows how the nonprofit’s financial position has changed, indicating whether it has generated a surplus or incurred a deficit during the period.
Form 990: A tax form that most tax-exempt organizations in the United States are required to file annually with the IRS. Form 990 provides detailed information about the nonprofit’s financial activities, executive compensation, programs, and governance. It is used to ensure compliance with tax-exempt status and promote transparency to the public.
Net Assets: The difference between a nonprofit’s total assets and total liabilities. Net assets represent the organization’s financial equity and are categorized into restricted and unrestricted funds, reflecting how much of the nonprofit’s resources are available for use and how much is reserved for specific purposes.
In-Kind Donations: Non-cash contributions, such as goods, services, or volunteer time, that are donated to the nonprofit. These donations are valued and recorded at their fair market value for accounting and reporting purposes.
Donor Restrictions: Conditions or stipulations placed by donors on how their contributions can be used. These restrictions can be temporary (e.g., funds must be used within a specific timeframe) or permanent (e.g., funds must be invested and only the income can be used).
Functional Expenses: Expenses categorized by the nonprofit’s primary activities: program services, management and general, and fundraising. This classification helps provide transparency into how funds are allocated to support the nonprofit’s mission versus operational and fundraising costs.
Cash Flow Statement: A financial statement that tracks the flow of cash into and out of the nonprofit over a specific period. It provides insight into the nonprofit’s ability to generate cash, manage expenses, and ensure liquidity for operations and program delivery.
Audit: An independent examination of the nonprofit’s financial records and statements to ensure accuracy, transparency, and compliance with accounting standards. Audits are typically conducted by certified public accountants (CPAs) and may be required for larger nonprofits or those receiving government funding.
Endowment Fund: A fund established by a nonprofit to provide a permanent source of income. The principal of the endowment is invested, and only the earnings (interest, dividends, etc.) are used to support the nonprofit’s activities, ensuring long-term financial sustainability.
Accrual Basis Accounting: A method of accounting in which revenue and expenses are recorded when they are earned or incurred, rather than when cash is received or paid. This method provides a more accurate picture of a nonprofit’s financial health, especially for those with long-term projects or grants.
Cash Basis Accounting: A method of accounting in which revenue and expenses are recorded only when cash is received or paid. This method is simpler but may not reflect the nonprofit’s true financial position, especially if there are significant receivables or payables.
Program Expenses: Expenses directly related to the nonprofit’s mission and program activities. These are costs incurred in delivering services or carrying out the nonprofit’s programs, such as salaries for program staff, supplies, and direct service delivery costs.
Administrative Expenses: Costs associated with the general operation and management of the nonprofit. These expenses include executive salaries, office supplies, rent, and other overhead costs that are not directly tied to program services but are necessary for the nonprofit’s functioning.
Fundraising Expenses: Costs incurred to raise money for the nonprofit’s operations, programs, and initiatives. These expenses include event costs, marketing, donor communications, and other activities aimed at generating donations and support.
