Nonprofits are created to solve problems or meet needs that for-profits are not addressing because there is no profit in it. Yet nonprofits cannot be successful unless they can generate revenues--from grants, donations, contracts, and fee--in excess of expenses. The truth is that it can be difficult to generate more revenue than expenses in the nonprofit world. In almost all cases, we cannot total up our costs, add a slice for profit and new investment, and charge it back to a customer. In fact, for most nonprofits, our programs are an expense, not revenue.
Adding to the difficulty of our business model, there are many reporting requirements and special rules attached to money in the nonprofit sector. Nonprofits are subject to special tax rules at the federal, state, and local level, and much follow specific accounting rules.
Four Essentials of Nonprofit Financial Management
There are four essentials to managing your finances:
- Periodic outside review by an independent professional
- Clear policies and procedures, and strong internal controls
- Transparency, accuracy, and careful monitoring of financial conditions
- Board and leadership understanding of the financial reports
Audits and Other Outside Reviews
Neither donors nor boards and managers should rely on the audit process alone to assure that the organization is managing its finances appropriately. Most organizations should receive some level of independent financial assurance service. Annual audits are highly recommended for large organizations and those with federal contracts, while a two-to-three year cycle of audits and financial reviews are suggested for smaller organizations. If your organization is preparing for a financial audit, you will find some helpful information in this Nonprofit Audit Guide from the National Council of Nonprofits.
In addition, the National Council of Nonprofits article How Much Should an Independent Audit Cost? provides factors to help you negotiate audit fees and plan for the cost.
An organization that does not have the financial capacity to pay for an audit should periodically find an accountant or bookkeeper familiar with nonprofit financial requirements to review their books, financial reports, and processes. This will not be the same as an audit, but it can help you recognize and rectify major problems.
Get several Practical Tips for a Smooth Nonprofit Audit (even when it’s over Zoom), published by Nonprofit Finance Fund.
Policies, Procedures, and Internal Controls
The resources below provide guidance and tools so your organization will have key policies and internal controls in place. Small and/or all-volunteer groups: check out the resources below that are especially geared for you.
- We're A Small Nonprofit. What Internal Controls Do We Need to Have in Place? September 2013 guest post by Andy Robinson and Nancy Wasserman, published by Emerson & Church
- Duties of the Treasurer of a Nonprofit Corporation, published by Michele Berger April 2017 on the NEO Law Group Nonprofit Law Blog
- Internal Controls Checklist, from CompassPoint Nonprofit Services
- Checklist for Monthly Closing Process, published by Wallace Foundation
Monitoring Practices and Performance
The leadership and board must monitor the organization's financial performance to be sure that it's:
- Fulfilling grant and donor requirements
- Complying with GAAP financial practices (Financial Accounting Foundation)
- Managing cash position and cash flow (see below for more information)
- Monitoring the budget
- Meeting all tax obligations
- Ensuring staff have the resources they need to do their jobs
It is of vital importance you closely monitor both your organization's cash position, and cash flow. Cash position refers to the amount of available cash your organization has. Cash flow projects the amount your organization expects to receive and pay out over a period of time.
501 Commons has created this workbook to help you determine your cash position, and forecast cash flow: Cash Position & Cash Flow Workbook
For more information, see:
- Cash Flow in the Nonprofit Business Model (Nonprofit Quarterly)
- Cash Flow Management (Propel Nonprofits)
- The Nonprofit Cash Flow Cliff (Not For Profit - Beyond the Numbers)
- Introduction to Nonprofit Accounting (4 part series from Accounting Coach)
- Cash Flow Projection Template (Nonprofit Finance Fund)
- Understanding 5 Key Nonprofit Financial Documents (MissionBox)
Speaking of taxes, read What Not-for-profits Need to Know About Tax Compliance (Jacobson Jarvis & Co.) to ensure you understand your obligations, especially those unique to nonprofits.
Understanding Your Financial Reports
Your financial statements tell your story to government, donors, volunteers, and foundations. If you do not understand the story the statements are telling, your fundraising activities may not be as efficient as they could be.
- The income statement, also known as the statement of activities, reports on the organization's income and expenses for the period. It can hurt your fundraising efforts if this shows an unexplained large deficit or large surplus.
- The balance sheet, also known as the statement of financial position, describes the organization's assets, liabilities, and net value. If you have high liabilities compared to your cash, the organization may be seen as unstable.
- Funders and donors are also interested in understanding how broad the organization's sources of income are and the ratio of overhead and fundraising expenses to direct program expenses.
This one-page Financial Red Flags Checklist gives you some ideas about concerns a foundation, government contract officer, or individual donor may have based on a review of your financial statements.
Financial Management - National Council of Nonprofits; see 2018 Tax Law Checklist - New Federal Tax Law - Now What for Nonprofit Board and Staff Members? updated April 17, 2018; and, watch the information rich hour long webinar Now What: How the New Federal Tax Law Impacts Charitable Nonprofits, from January 11, 2018
The Nonprofit Association of Oregon (NAO) Financial Oversight website provides Professional Development & Learning networks, workshops & webinars, plus resources
Nonprofit Accounting Basics - Greater Washington Society of CPAs Educational Foundation, updated February 2019
Does your organization have the right bookkeeping software on hand? Check out this list of best accounting software for nonprofits.