Understanding the Challenges of Nonprofit Accounting

The purpose of a nonprofit entity is to fulfill a particular mission, rather than to generate a profit. The Financial Accounting Standards Board (FASB) requires that nonprofit organizations use fund accounting as a financial reporting tool. 

Most accountants work for profit businesses that operate using the balance sheet and income statement. Non-for-profit organizations, however, use a different system of accounting. Your accounting staff needs to understand some key concepts to use nonprofit accounting. 

A bookkeeper or staff accountant will perform many of the same accounting services, including bank reconciliations, working with general ledger, and maintaining the chart of accounts. However, the financial health of the entity depends largely on funding sources. You can find nonprofit accounting software to help you manage the process.

As an example, assume that Claire is the Executive Director of Bike Lane, a nonprofit that promotes the use of bikes for commuting and for recreation. Nonprofits produce reports that are similar to a balance sheet and income statement.

What is the Statement of Financial Position?

The statement of financial position is based on this formula: assets less liabilities equals net assets. Generally accepted accounting principles (GAAP) require a small business or a corporation to use equity in the formula, rather than net assets. Here are the definitions of each component:

• Assets: Items used to generate revenue for the entity, including cash, accounts receivable, and fixed assets.

• Liabilities: Amounts owed to other parties, including accounts payable and long-term debt.

• Net assets: Nonprofits are not driven by profit, and do not generate equity. As a result, assets less liabilities equals net assets.

The statement of financial position is generated as of a specific date. One financial management goal for a not-for-profit is to generate an increase in net assets each year. 

Reviewing current accounts vs. non-current accounts

Nonprofit organizations categorize assets and liabilities as either current or non-current. You can make an allocation in your accounting system for each account. These same categories are used in for-profit accounting.

• Current assets: These accounts include cash, and assets that are expected to be converted into cash within 12 months. Bike Lane has an account receivable balance for membership dues, which is a current asset account.

• Non-current assets: Assets that will not be converted into cash within 12 months. Claire’s nonprofit owns vans and trailers (fixed assets) that are used as support during group bike rides.

• Current liabilities: Balances owed that must be paid within 12 months, including accounts payable balances.

• Non-current liabilities: Account balances that are not due within 12 months. Bike Lane has a bank loan that is secured by the headquarters building.

The difference between assets and liabilities is net assets. As this podcast episode explains, planning requires management to forecast each asset and liability account balance.

Net assets, restricted funds, and unrestricted funds

If Bike Lane sold all of its assets for cash, and used the cash to pay all liabilities, any remaining cash would be defined as net assets. Nonprofits assign net asset balances as either unrestricted net assets or restricted net assets. If assets are unrestricted, the organization can use the assets for any purpose that serves the mission. 

As the name implies, restricted net assets include donor-imposed conditions. For example, Bike Lane received a $50,000 donation from the United Way that must be used to promote “ride your bike to school” events. The United Way donation cannot be used for any other purpose, and Bike Lane must report how the donated funds are spent. 

As you’ll see in the statement of activities discussion below, restricted funds are “released” to the unrestricted fund category when dollars are spent based on the donor’s conditions. Many nonprofits struggle to maintain a large enough unrestricted fund balance to support operations. If too many contributions are restricted, management has less flexibility to operate.

Here are some common transactions, and the impact on the statement of financial position. In each case, the formula used to create the statement (assets less liabilities equals net assets) remains in balance:

• $2,000 cash donation: Cash (an asset account) increases, and the net asset balance increases.

• $500 cash spent on marketing materials: Cash decreases, and the net asset balance decreases.

• Receive $1,000 bill for attorney’s fees: Liabilities increase, and the net asset balance decreases.

The statement of activities is similar to a for-profit company’s income statement.

Working with the Statement of Activities

The statement of activities reports a nonprofit’s revenue and expenses for a specific period of time (month or year). This statement also lists the change in net assets during the period. Here is Bike Lane’s Statement of Activities for 12/31/21:

There’s a great deal of information to digest, so it’s helpful to remember Bike Lane’s mission: to promote the use of bikes for commuting and for recreation. Bike Lane raises money and delivers programs that support the mission. Revenue includes contributions and program revenue (fees, membership dues, advertising revenue, merchandise sales). 

When restricted funds are released

Bike Lane released $87,000 of restricted funds, meaning that the funds were spent based on the donor’s restriction. For example, Bike Lane could spend United Way dollars on the “ride your bike to school” events. The statement reports that total restricted funds decreased by $87,000, and unrestricted revenue increased by the same amount. Once again, delivering programs that support the mission generates revenue.

Connecting expenses to revenue

Program expenses are incurred to generate program revenue. Assume that Bike Lane sponsors weekly group bike rides during the summer and early fall. Bike Lane raises program revenue from fees, and incurs marketing, labor, and supply costs to put on the events.

Nonprofits also incur support costs, including the cost to fundraise and to manage the enterprise. Finally, net assets increase for the year, because revenue is greater than expenses, and the total net asset balance also increases.

Other Financial Statements

Nonprofits also produce a statement of cash flows, a report that categorizes cash inflows and outflows. The statement assigns cash flows as operating, financing, or investing activities. 

The statement of functional expenses groups expenses by function, including specific programs, fundraising, and management/general. The functional expenses report provides more detail than the expense section of the statement of activities.

Most tax-exempt organizations use a CPA firm to file tax returns with the IRS. When an entity obtains tax-exempt status, the nonprofit must file tax forms that verify compliance with the tax code.

Managing a nonprofit organization is challenging, and automation can help you complete accounting tasks in less time. Stampli’s AP automation software for nonprofits makes it easier to approve spending, track purchases, and to process invoices.

How Stampli Makes AP Management Easier

Stampli AP automation and invoice management platform offers flexibility and visibility to everyone involved in the process. Everyone can document changes as they occur using the same communication tool, and you can get fast approval for any changes.

These issues apply whether or not you use a purchase order to buy items from a vendor. This is all possible within the Stampli platform, which provides these benefits:

• When an invoice is uploaded, Stampli uses AI and machine learning to auto-populate fields, such as the invoice number and GL accounts. Stampli will recommend approvers, based on past invoices. 

• Stampli provides a communication hub with each invoice, and each step in the process is documented from invoice field changes to invoice-related communications. Questions and answers are listed, so that everyone can review the status of an invoice. 

• Vendor relationships are important, and Stampli provides each of your vendors access to a vendor portal. Vendors can see the status of invoices that are being processed in Stampli. 

Stampli’s end-to-end AP automation platform gives you full control and visibility over all of your corporate spending — all in one place. Don’t just manage spend, control corporate spend with Stampli.