Nonprofit Accounting: 4 Key Practices for Financial Success

Whether your nonprofit supports the arts, strives to advance education, or responds to community needs, properly managing your resources is vital for fulfilling your mission and maintaining supporter trust. When your nonprofit is financially transparent and sustainable, you can retain more donors and better understand your nonprofit’s operational needs. 

To help improve your nonprofit accounting practices, this guide will look at four tips for maintaining organized, accurate, and compliant finances. 

Set an annual budget.

Developing an annual operating budget is a team effort. Your nonprofit’s accountant should provide financial reports that help you understand your predicted revenue and expenses, your treasurer must present and get your budget approved by your board, and your bookkeeper should keep careful records throughout the fundraising year to help you stick to your budget. 

To create a well-structured budget that helps you strategically allocate your resources, follow these best practices:

• Clarify your priorities. Many nonprofits are familiar with the experience of wanting to do more with limited resources. When outlining your budget, decide what is vital to fund and what can still operate with less. For instance, you might allocate additional funding to a program with high demand and consider how you can rework your administrative expenses to reduce unnecessary spending. 
• Make informed predictions. Budgets are built on assumptions about your nonprofit’s upcoming expenses and revenue. Leverage historical data, be aware of financial trends, and leverage financial software to make logical estimates. Ensure your CFO has the expertise to understand financial forecasts based on both your internal data and the greater nonprofit sector. 
• Be ready to make changes. Ultimately, a budget is a living document, and your nonprofit should regularly revisit it to make adjustments based on changing circumstances. For instance, your annual gala might bring in more revenue than expected, allowing you to increase program spending. Or, a major donor might announce they are cutting back this year, requiring you to delay the launch of your next capital campaign. 

Your budget should guide your team throughout the year, helping you understand what resources you have and how best to use them. When compiling your budget, ensure you properly understand your assets so you know exactly what funding you have available for which projects. 

Manage and understand restricted funds.

Nonprofit finances have a few key differences from for-profit organizations, and one of the most notable is restricted funds. Restricted funds are donations earmarked for a specific purpose, whether that’s funding a scholarship, purchasing equipment, or launching a program. 

Ensure your nonprofit’s financial team members understand the difference between restricted and unrestricted funding and how to handle them:

• Restricted funds must be spent on specific activities outlined by the donor. Usually, restricted funds are significant gifts made by major and planned gift donors, grantmakers, and corporate sponsors. When receiving this type of funding, ensure you have an agreement in writing clarifying how your restricted funds must be used. Then, make careful notes in your budget about these funds’ intended purpose.
• Unrestricted funds can be spent however your nonprofit sees fit. Often, these contributions are gifts to your annual fund and payments in exchange for goods or services like merchandise and event tickets. When allocating funds, unrestricted funding can be used to fill in the gaps in your programs and cover overhead costs that rarely receive restricted funding. 

Nonprofits that fail to properly manage restricted funds can end up with budget shortfalls due to assuming resources were available and potentially open themselves up to liability if restricted funding is misspent. Prevent this by hiring team members for your financial positions who are well-versed in nonprofit finances and educating all of your staff members on funding restrictions. 

Hire a bookkeeper and an accountant.

It takes a team to manage your nonprofit’s finances, and that team should include both a bookkeeper and an accountant. Bookkeepers maintain records of all of your nonprofit’s financial transactions, while accountants use this data to make strategic decisions about your nonprofit’s finances. 

Jitasa’s guide to nonprofit bookkeepers and accountants outlines the three methods you can use to hire these professionals:

• Hiring in-house. Large nonprofits with complex financial needs often have dedicated in-house accountants. These professionals are focused solely on your organization, resulting in fast but thorough work. However, this approach is expensive, and your nonprofit is on the hook for any mistakes your team member makes. 

• In-kind donations. Some accountants may provide their services to your nonprofit for free. While not needing to spend anything on your financial management is highly beneficial if your organization is just getting started, be aware that pro bono services can end at any time.  
• Outsourcing. Accountants and bookkeepers who specialize in nonprofit work can help manage your financial needs for you. This approach tends to be lower cost than bringing in new permanent team members, and you can reliably count on the firm to get your projects done. Most financial consultants serve multiple clients, which can result in longer turnaround times, although you can overcome this challenge with proactive communication. 

When it comes to hiring a bookkeeper and an accountant, assess your nonprofit’s needs and financial capabilities. If you have uncomplicated finances and a good relationship with a local accountant, you might continually rely on in-kind donations for help filing your tax returns. However, as your needs grow, you might start to consider outsourcing to an external firm.

Conduct regular audits.

Audits may sound scary at first, but they’re essential for understanding your nonprofit’s financial health. By routinely auditing your nonprofit’s finances, you can confirm how you’re allocating your resources, catch and rectify mistakes, and ensure your organization is maintaining legal compliance. 

There are three types of financial audits your nonprofit might undergo at some point, including: 

• Independent. When you hire an external auditing firm to audit your nonprofit, you’re conducting an independent audit. Independent auditors bring new perspectives and tend to provide objective reports about your nonprofit’s finances. 

• Internal. If your nonprofit’s team reviews your financial records and reports, then you’re performing an internal audit. While internal audits may be subject to some biases, these still provide a useful check on your nonprofit’s finances for your team’s reference. 
• IRS. If your nonprofit doesn’t file necessary tax forms or a discrepancy is discovered, you may be audited by the IRS. However, this type is less common than the other two, so as long as you’re staying on top of your tax filings, the IRS likely won’t come calling.

To ensure your independent and internal audits are helpful experiences, compile all necessary documents in a timely manner, research professional nonprofit auditing services, and work with your auditors to provide them with all of the information they may need.

With strong financial practices, your nonprofit can expand its mission, retain more donors, and build supporters’ trust. Create a solid foundation for your nonprofit by working with seasoned accounting professionals to create a budget, review your finances, and develop strategic financial plans for the future.