How to Manage Non profit Accounting: Guide for Finance Leaders

Key Takeaways:

• Nonprofit accounting ensures accountability, focusing on tracking how funds are used, not profits.
• The 2024 FP&A Trends Survey reveals that up to 45% of FP&A time is still dedicated to manually cleaning and reconciling data, limiting the team’s ability to focus on value-added tasks.
• More than 40% of workers surveyed spend at least a quarter of their work week on manual, repetitive tasks, with email, data collection, and data entry taking up the majority of that time.
• Nonprofits are required to prepare four key financial statements: Statement of Financial Position, Statement of Activities, Statement of Cash Flows, and Statement of Functional Expenses.
• Compliance with GAAP and IRS Form 990 is mandatory for maintaining tax-exempt status and ensuring transparency.
• Modern FP&A tools can automate budgeting, forecasting, and reporting, reducing manual errors and improving efficiency.
  

Imagine a nonprofit CFO working late into the night, consolidating spreadsheets for an upcoming board meeting. They handle multiple donor reports, grant tracking, etc. only to realize that their team is still missing key data points. This all-too-common scenario is not only time-consuming but also stressful, putting the nonprofit at risk of missing crucial opportunities for growth.

In fact, the 2024 FP&A Trends Survey revealed that up to 45% of FP&A time is still dedicated to manually cleaning and reconciling data, limiting the team’s ability to focus on strategic analysis, a problem that worsens as organizations grow and complexity increases. 

Another study by Smartsheet showed that more than 40% of workers surveyed spend at least a quarter of their work week on manual, repetitive tasks, with email, data collection, and data entry taking up the majority of that time.

With each new fund or donor restriction, the work piles up.

What makes nonprofit accounting different from for-profit finance is its focus on accountability rather than profitability. Nonprofits must ensure funds are used exactly as intended by donors, which is why fund accounting plays a central role. This system tracks restricted and unrestricted funds separately, ensuring that organizations comply with legal and regulatory obligations. However, keeping up with these requirements can be a challenge, especially for growing organizations with limited resources.

In this guide, you’ll learn about:

• The fundamentals of fund accounting
• The four essential nonprofit financial statements
• Key compliance requirements
• Best practices for managing nonprofit finances

Let’s start with the fundamentals: understanding exactly what nonprofit accounting is, how it differs from traditional business accounting, and how the right cloud FP&A solution for nonprofits can help.

What Is Nonprofit Accounting?

Nonprofit accounting is the process of managing financial records for nonprofit organizations to ensure that funds are used as intended. Unlike for-profit businesses, where the goal is to generate profit for shareholders, nonprofit accounting focuses on accountability and transparency, ensuring that every dollar is spent in alignment with the organization’s mission.

The core activities of nonprofit accounting include:

1. Planning: Creating budgets and financial forecasts to allocate resources effectively
2. Recording: Tracking financial transactions accurately, from donations to expenses
3. Reporting: Preparing financial statements that reflect the organization’s financial health and support compliance with regulations

Additionally, nonprofits are required to comply with various regulations, such as maintaining accurate financial records for IRS Form 990 and following GAAP (Generally Accepted Accounting Principles) to ensure transparency and legal compliance.

Here's what makes it unique: the use of fund accounting, which tracks resources across different funds, ensures that donations and grants are spent exactly as designated. For example, a donation given for a specific program must be tracked separately from general funds to demonstrate compliance with the donor's intent.

Nonprofit accounting vs. for-profit accounting

Understanding the differences between nonprofit and for-profit accounting is essential because these distinctions directly impact the type of accounting systems and software an organization needs. 

Nonprofits focus on accountability, while for-profits aim to generate profit for owners or shareholders. This affects everything from financial statements to reporting practices.

These differences underscore why nonprofit organizations cannot rely on standard for-profit accounting software. The fund accounting method is a key differentiator, ensuring funds are tracked and allocated according to donor intentions and legal requirements.

Nonprofit accounting vs. bookkeeping

The terms accounting and bookkeeping are often used interchangeably, but understanding the distinction is essential. Knowing the difference clarifies which roles and skills are needed within your finance and nonprofit accounting team, as well as how to evaluate the right software for your needs.

This distinction is crucial when deciding which roles to hire for your nonprofit’s finance team and selecting the right software for the job. Bookkeepers focus on operational tasks, while accountants handle strategic financial decisions that require specialized software to manage effectively.

Now that you understand the difference between accounting and bookkeeping, let's dive into the most critical concept that sets nonprofit accounting apart: fund accounting.

Understanding Fund Accounting

Fund accounting is a key aspect of nonprofit accounting. Unlike for-profit businesses, where funds are pooled for general use, fund accounting ensures that financial resources are tracked and spent according to their specific purpose. This system helps maintain donor accountability and ensures legal compliance, particularly when dealing with restricted funds.

In contrast, for-profit businesses generally use a single-account system, where all funds are pooled for generating profits and distributing them to shareholders. There are no legal requirements to track funds separately, as the primary goal is profit, not accountability to donors.

Practical examples: 

• If a donor gives $50,000 for a scholarship program, those funds must be tracked separately to ensure they are used exclusively for scholarships, not for general operations or other initiatives. This is not only a best practice but often required by law under IRS regulations.
• In a capital campaign, funds raised for renovating a facility must remain restricted for that purpose. Misusing any portion could lead to penalties or loss of tax-exempt status. Fund accounting prevents such errors by clearly separating restricted and unrestricted funds.

Standard accounting software, typically designed for for-profits or small businesses, doesn’t support fund accounting because it isn’t built to track restricted funds. As nonprofits grow and manage multiple restricted funds, these systems can struggle to provide accurate tracking and reporting.

For example, attempting to manage several restricted funds using traditional software can be confusing. Nonprofits may struggle to determine whether funds are being spent according to donor restrictions, making compliance more difficult and increasing the risk of errors during reporting.

The three categories of funds

Understanding the three categories of funds is essential for effective nonprofit management. These categories directly impact your financial statements and are also crucial for filing Form 990. Nonprofit organizations must track and report funds according to whether they are unrestricted, temporarily restricted, or permanently restricted. Each category has specific rules that guide how the funds can be used.

1. Unrestricted funds

Unrestricted funds are the most flexible type of funds a nonprofit can have. These funds can be used for any purpose the organization deems necessary, including covering overhead costs and emergencies.

Common sources include:

• General donations
• Membership dues
• Earned income from programs or services

These funds provide the flexibility to support the nonprofit's day-to-day operations, making them highly valuable for maintaining business continuity.

2. Temporarily restricted funds

Temporarily restricted funds are donations or grants that must be used for a specific purpose or within a certain timeframe. These restrictions are lifted once the conditions specified by the donor are met.

Common sources include:

• Program grants
• Capital campaigns
• Multi-year pledge
  
  

Example:
A foundation awards a $100,000 grant to be spent over two years on youth programming. These funds are temporarily restricted until the two-year period expires or the program goal is achieved. Restrictions can either be purpose-based (specific use) or time-based (specific time period).

3. Permanently restricted funds

Permanently restricted funds are donations where the principal amount is preserved forever, and only the investment earnings can be used. These funds are often managed in long-term endowments.

Common sources include:

• Endowments
• Memorial funds
• Scholarship funds

Example:
A donor contributes $1 million to a scholarship fund. The principal remains untouched, while the nonprofit can use the 4-6% annual return (about $40,000-$60,000 per year) for scholarships. This is like a trust fund, where the principal is never spent, and only the earnings are used.

Now that you understand the three categories of funds, let’s dive into the key financial statements nonprofits must prepare to stay compliant and transparent.

Fund accounting best practices

Fund accounting is a powerful tool for nonprofit financial management, but using it effectively requires following key best practices. Here are some concrete tips to help your organization avoid common pitfalls:

1. Don’t create too many funds
   Having too many funds can lead to overwhelming complexity. Keep it simple by grouping similar restricted funds together when possible, to make financial management more manageable and less prone to errors.
2. Use a single cash account when possible
   Funds are accounting designations, not separate bank accounts. By using a single cash account and tracking fund balances separately, you can simplify cash flow management without complicating your bank reconciliations.
3. Document donor intent clearly
   Ensure that you have clear, written policies that outline how funds should be used. This protects your organization from misunderstandings and ensures compliance with donor requirements.
4. Review fund balances regularly
   Regular reviews of fund balances are essential to catch any discrepancies early. By monitoring balances frequently, you can address issues before they affect your financial reporting.
5. Reconcile funds monthly
   Monthly reconciliations of fund balances are crucial for maintaining accurate financial records. Ensure that all transactions are correctly allocated to the appropriate funds, and make any adjustments as needed.

Flowchart depicting the flow of funds from donation to impact

Fund accounting provides the framework for organizing your finances. But the real value comes from how you report on those funds. Let's examine the four essential financial statements that transform your fund data into actionable insights.

4 Essential Nonprofit Financial Statements

Four nonprofit financial statements

Nonprofit financial statements serve as a vital tool for ensuring the organization is on track to fulfill its mission while staying compliant with legal and regulatory requirements. These statements are not just boxes to check for auditors or grantmakers; they provide critical insights into the organization’s financial health and sustainability.

Financial statements are required by several stakeholders, including:

• IRS for tax-exempt status and Form 990 reporting
• Grantmakers to assess nonprofit financial health
• Board members for decision-making
• Auditors for compliance review
• Donors to ensure funds are used appropriately

While for-profit companies prepare three financial statements, nonprofit organizations are required to prepare four:

• Statement of Financial Position (Balance Sheet)
• Statement of Activities (Income Statement)
• Statement of Cash Flows
• Statement of Functional Expenses

Each statement serves a specific function, providing unique insights into an organization’s financial performance and capacity to manage resources effectively.

Let’s look at the first one.

1. Statement of Financial Position (Balance Sheet)

The Statement of Financial Position (often called the balance sheet in for-profit accounting) is a "snapshot" of a nonprofit's financial situation at a given point in time. It shows the nonprofit’s assets, liabilities, and net assets, providing insights into whether the organization has enough resources to meet its obligations and continue operations.

What it shows

The Statement of Financial Position breaks down into three major sections:

Assets:
Assets represent everything the nonprofit owns and can use to carry out its mission. Common asset types include:

• Cash
• Receivables
• Property and equipment
• Inventory
• Prepaid expenses
  

Liabilities:

Liabilities are what the nonprofit owes and must pay off. This section includes:

• Payables (amounts owed to suppliers)
• Accrued expenses (wages, taxes)
• Deferred revenue (funds received before earned)
• Debt (loans or bonds issued)

Net assets:
Net assets represent the difference between assets and liabilities and reflect the organization’s financial standing. Unlike for-profits, nonprofit organizations don’t use the term "equity"; they track net assets, divided by their level of restriction:

• Unrestricted: These funds can be used for any purpose.
• Temporarily restricted: These funds must be used for a specific purpose or within a set timeframe.
• Permanently restricted: The principal is preserved, and only the income generated can be spent.

Key formula

Assets - Liabilities = Net Assets

Example

Here’s a simple example using fictional numbers to demonstrate how the Statement of Financial Position works:

• Total assets: $500,000
• Total liabilities: $200,000
• Net assets: $300,000 (this is the difference between assets and liabilities)

Now let’s break down the $300,000 net assets:

• Unrestricted net assets: $150,000
• Temporarily restricted net assets: $100,000
• Permanently restricted net assets: $50,000

This means the nonprofit has a solid base of unrestricted assets to cover operational costs, while $100,000 is temporarily restricted for a specific program, and $50,000 is permanently restricted, likely invested for future growth.

Why it matters

This statement is essential because it helps answer the following questions:

• Can we pay our bills?
• Do we have adequate reserves?
• What is our financial sustainability?

Understanding the Statement of Financial Position allows nonprofit leaders, donors, and grantmakers to assess whether the nonprofit is managing its funds effectively and can meet its obligations.

2.Statement of Activities (Income Statement)

The Statement of Activities (also known as the income statement) is a critical tool for assessing a nonprofit’s financial performance over a specified period. Unlike for-profit income statements, which focus on profits or losses, the Statement of Activities tracks changes in net assets—the increase or decrease in resources over time—demonstrating how well the organization is fulfilling its mission with the resources available.

What it shows

The Statement of Activities shows how revenue is earned and how expenses are spent, ultimately leading to changes in net assets. It consists of two main sections:

Revenue categories:
Nonprofits receive income from various sources, which can be divided into the following common categories:

• Contributions and donations
• Government grants
• Foundation grants
• Corporate sponsorships
• Membership dues
• Program service fees
• Special events (net)
• Investment income
• In-kind donations

These sources of revenue are critical to nonprofits' sustainability, as they directly fund programmatic activities.

Expense categories:
Nonprofits report expenses by two main approaches:

• By function: This refers to how resources are spent across different areas, including:
  • Program services (activities directly related to the organization’s mission)
  • Management and general (administrative overhead)
  • Fundraising (donor cultivation and solicitation activities)

• By nature: This approach categorizes expenses by their type, such as:
  
  
  • Salaries and benefits
  • Supplies
  • Occupancy
  • Professional fees
  • Depreciation

Key formula

Revenue - Expenses = Change in Net Assets

Restriction breakdown

Nonprofits must show revenue separately for restricted and unrestricted funds. This helps donors, grantmakers, and auditors understand how funds are being allocated and ensures accountability.

• Unrestricted funds: Can be used for any purpose
• Restricted funds: Must be used for specific programs, projects, or time period

Example

Let’s look at an example:

• Total revenue: $1,200,000
  • Unrestricted: $900,000
  • Temporarily restricted: $300,000

• Total expenses: $1,100,000
  • Program services: $750,000
  • Management and general: $200,000
  • Fundraising: $150,000

• Change in net assets
  • Total revenue: $1,200,000
  • Total expenses: $1,100,000
  • Change in net assets = $1,200,000 - $1,100,000 = $100,000

This example shows a $100,000 surplus. The revenue breakdown helps assess which types of funding (unrestricted vs. restricted) contribute to the overall change in net assets, while the expense breakdown provides insights into how efficiently the nonprofit is using its resources.

Why it matters

This statement is the "report card" for nonprofits, showing whether they are operating within their means. It reveals if the organization has a surplus or deficit, offering a clear picture of its financial health.

For board members and donors, this statement is crucial for making informed decisions on funding, budgeting, and evaluating the effectiveness of programs. If a nonprofit consistently runs deficits, it may be unsustainable in the long term.

Now that we've covered the Statement of Activities, let's move on to cash flow management, which is critical for nonprofits to understand how money flows in and out of their organization.

3. Statement of Cash Flows

The Statement of Cash Flows reveals the cash movement in and out of a nonprofit over a specific period, distinguishing between cash flow from operating, investing, and financing activities.

Unlike the Statement of Activities, which uses accrual accounting (recognizing revenue when earned and expenses when incurred), the Statement of Cash Flows tracks the actual movement of cash. This is essential for nonprofits, as even profitable organizations can fail due to cash flow problems.

The three categories of cash flow

The Statement of Cash Flows is divided into three categories: operating, investing, and financing activities. Here's what each category includes:

1. Operating activities

These are cash flows directly related to the nonprofit's mission and day-to-day operations. Common activities include:

• Cash received from donations, grants, and program fees
• Payments made to employees and vendors
• Interest and dividends received

2. Investing activities 

These activities involve the purchase or sale of long-term assets. Examples include:

• Purchase or sale of property and equipment
• Investments in stocks, bonds, or other financial instruments
• Loans made or received

3. Financing activities

This category tracks cash flow related to funding and debt management. Examples include:

• Proceeds from issuing debt (loans or bonds)
• Repayments of debt
• Restrictions lifted (funds no longer restricted by time or purpose)

Direct vs. indirect method

Nonprofits can prepare the Statement of Cash Flows using two methods:

• Direct method: Lists all cash inflows and outflows directly, providing a detailed view of cash movements
• Indirect method: Starts with net income and adjusts for changes in non-cash transactions (e.g., depreciation). The Financial Accounting Standards Board (FASB) prefers the direct method, but the indirect method is more commonly used due to its simplicity.

Key insight

A key insight from the Statement of Cash Flows is the timing gap between revenue recognition and cash receipt. For example, a nonprofit might have $100,000 in receivables (revenue recognized) but no cash to pay bills yet. This shows that profitability does not necessarily mean a nonprofit has the liquidity to meet its obligations.

Why it matters

The Statement of Cash Flows is essential for understanding whether a nonprofit has enough cash to sustain its operations and fulfill its mission. This statement reveals cash flow patterns, helping organizations anticipate seasonal fluctuations (e.g., summer donation slump) and plan reserves accordingly. Nonprofits can better prepare for cash shortages or surpluses, preventing financial crises and ensuring continuous service delivery.

Best practice

For better forecasting and to avoid surprises, it's recommended that nonprofits prepare a monthly Statement of Cash Flows using a 13-month rolling view. This allows the organization to analyze trends and anticipate any cash flow issues well in advance, offering a longer perspective on financial health and liquidity.

With cash flow management in place, we now turn our attention to the Statement of Functional Expenses, which provides the most detailed view of how your nonprofit allocates its resources across different areas.

4. Statement of Functional Expenses

The Statement of Functional Expenses is unique to nonprofits and provides the most detailed breakdown of how resources are allocated across different activities. 

This statement is required for Form 990 Part IX and is often scrutinized by charity rating agencies, as it reveals how efficiently a nonprofit is using its funds. It categorizes expenses based on their function (why the money is spent) and their nature (what the money is spent on). This dual classification provides transparency and accountability to donors, board members, and regulators.

What it shows

The Statement of Functional Expenses is a matrix that shows expenses by function and nature.

By function (why the money is spent):

• Program services: Direct activities related to the nonprofit’s mission (e.g., educational programs, community services)
• Management & general: Administrative costs that support the nonprofit’s infrastructure (e.g., finance, HR, governance)
• Fundraising: Costs incurred to solicit donations and maintain donor relationships (e.g., grant writing, donor events, and communications)

By nature (what the money is spent on):

• Salaries and benefits
• Supplies
• Occupancy (e.g., rent, utilities)
• Professional fees (e.g., accounting, legal)
• Depreciation

This dual approach allows nonprofits to clearly show how funds are being used in relation to their mission, as well as to cover the operational and fundraising costs that keep the organization running.

The three functional categories

1. Program services:

Program services represent the nonprofit’s direct mission activities. They include anything that directly serves the community or fulfills the organization’s core purpose. 

For example, a food bank may list its expenses related to food distribution under program services. Donors expect their contributions to go directly toward these activities.

2. Management & general:

This category includes overhead costs that support the nonprofit but are not directly tied to mission programs. These can include:

1. 1. Finance and accounting
   2. Human resources
   3. Information technology
   4. Board governance
   5. Facilities management

While necessary, management and general expenses are often scrutinized, as excessive overhead can raise concerns among donors about how efficiently their funds are being used.

3. Fundraising:

Fundraising expenses include any costs related to soliciting donations and engaging donors. This could include:

• Grant writing
• Donor communications
• Fundraising events (e.g., auctions, galas)

It’s important to note that direct event costs (such as the costs of food and venue) should not be included here. These are often listed separately under program services if they directly benefit the mission.

The 65/35 "rule"

Nonprofits are often advised to follow the 65/35 rule, which suggests that at least 65% of expenses should go toward program services, and 35% (or less) can be allocated toward overhead costs like management, general, and fundraising.

This is not a hard-and-fast law but serves as a guideline to ensure that most of the nonprofit’s spending is aligned with its mission. Charity watchdogs, like Charity Navigator and GuideStar, often use this rule to assess nonprofits’ financial health and operational efficiency.

Cost allocation

Many nonprofit costs benefit multiple functions, so it’s essential to have a reasonable methodology for allocating those costs across program services, management, and fundraising. For example, the Executive Director’s salary may be split across all three categories, depending on how much time they spend on each function.

Example:
If the Executive Director spends 50% of their time on programs, 30% on management, and 20% on fundraising, their $120,000 salary would be allocated as follows:

• $60,000 to program services
• $36,000 to management & general
• $24,000 to fundraising

Having a consistent, documented method for allocating shared costs is essential for transparency and compliance. It ensures that your financial reports are accurate and defensible if questioned by auditors, regulators, or donors.

Form 990 connection

The Statement of Functional Expenses feeds directly into Form 990 Part IX, which is a key document for maintaining tax-exempt status and reporting to the IRS. Accuracy is critical, as discrepancies can raise red flags for auditors or grantmakers and potentially jeopardize your nonprofit’s funding or tax-exempt status.

Now that you understand this statement, let’s dive into the compliance landscape, where we’ll explore the regulations and accounting principles that govern nonprofit financial reporting.

Accounting Standards and Compliance

Compliance with accounting standards is essential for nonprofits to maintain their legal and financial integrity. Failing to meet these standards can result in penalties, loss of tax-exempt status, and forfeited grants.

Nonprofits enjoy tax benefits, but these come with strict obligations around financial transparency and fund usage. Nonprofits must follow GAAP and IRS Form 990 filing requirements to ensure consistency, accountability, and donor trust.

Key standards include using fund accounting, properly reporting restricted funds, and providing transparent financial statements. Noncompliance can lead to fines, revoked tax-exempt status, or lost funding, making compliance foundational to the nonprofit's success and sustainability.

GAAP for nonprofits

GAAP is a set of accounting rules and standards that nonprofits must follow to ensure consistency, transparency, and accuracy in their financial documentation. These standards are set by the Financial Accounting Standards Board (FASB).

Nonprofits are required to follow GAAP for several reasons:

• External audits require adherence to GAAP to ensure transparency and accountability.
• Most grants require GAAP compliance to ensure proper fund management.
• Sophisticated donors expect GAAP to ensure their contributions are properly allocated.
• GAAP ensures consistency and comparability across nonprofit organizations, making it easier to understand financial statements.
• Following GAAP builds stakeholder credibility, reassuring donors, auditors, and regulators.
• It is the industry standard, widely accepted and recognized across the sector.

Nonprofits must follow the following core principles of GAAP:

• Accrual accounting: Recognizing revenues and expenses when earned or incurred, not when cash changes hands
• Proper fund classification: Classifying funds as unrestricted, temporarily restricted, or permanently restricted
• Revenue recognition standards: Properly recognizing revenue when earned, rather than when received
• Expense allocation methodologies: Accurately assigning expenses to appropriate categories (program, management, fundraising)
• Net asset classification: Classifying net assets based on restrictions imposed by donors or external agencies

Exception: Very small nonprofits (those with under $500K in revenue) may use a modified cash-basis method, which simplifies accounting but limits their ability to apply for grants or undergo formal audits. Most nonprofits, however, should follow GAAP to ensure eligibility for funding and regulatory compliance.

FASB ASC 958

FASB ASC 958 provides nonprofit-specific accounting guidance, detailing how to report revenue, classify net assets, and present financial statements.

Key changes between 2016-2018 simplified net asset classification, reducing it from three categories to two: net assets without donor restrictions and net assets with donor restrictions. 

Other updates improved transparency around fund restrictions, liquidity disclosure, and endowment reporting. These changes help nonprofits present more accurate and relevant financial data, ensuring compliance with current standards and making statements auditor-friendly, grantmaker-approved, and suitable for rating agencies, boosting professionalism and credibility with external stakeholders.

IRS Form 990

IRS Form 990 is an annual information return required for maintaining 501(c)(3) status (tax-exempt status). It provides the IRS, donors, grantmakers, and the public with a detailed snapshot of a nonprofit's financial activities, governance, and accomplishments.

Form 990 must be filed by nonprofits based on their annual revenue or total assets:

• Full Form 990: For organizations with more than $200K in revenue or more than $500K in assets
• Form 990-EZ: For organizations with $50K to $200K in revenue
• Form 990-N (e-Postcard): For organizations with less than $50K in revenue
• Form 990-PF: Required for private foundations, regardless of size

Form 990 is a comprehensive document that includes several key sections:

• Mission and governance
• Program accomplishments
• Financial statements
• Key employee compensation
• Related party transactions
• Functional expense breakdown (how resources are allocated between programs, management, and fundraising)

The Form 990 is due on the 15th day of the 5th month after the end of your fiscal year. For a calendar-year organization, that means May 15. Late penalties start at $20 per day and increase for significant delays.

Form 990 is publicly available and can be accessed on platforms like GuideStar and Charity Navigator. This transparency allows donors to review the organization’s financial health before contributing. It’s critical for nonprofits to ensure accuracy and presentation, as discrepancies can affect donor trust and funding opportunities.

State-level compliance

Most states require nonprofits to register for charitable solicitation, even if based out of state. Failing to register can limit fundraising and harm donor trust. Annual reporting requirements vary; some states accept Form 990, while others need state-specific forms or audited financials. 

Deadlines and fees differ, and noncompliance can result in fines, legal action, or loss of fundraising ability, leading to reputational damage. Nonprofits must stay on top of each state's rules to avoid these risks.

Common compliance challenges (and solutions) in nonprofit accounting

1. Missing deadlines

Nonprofits often face multiple overlapping deadlines for financial reporting, tax filings, and state registrations.

Solution: Use an annual compliance calendar, set 60-day advance reminders, and consider outsourcing to ensure deadlines are met consistently.

2. Inadequate documentation

Nonprofits may struggle to support fund allocations or prove donor intent during audits. 

Solution: Establish document retention policies, require detailed gift letters, and maintain written allocation methodologies to support financial decisions.

3. Misclassifying net assets

Confusion arises around when restrictions on funds lift, leading to misclassification of net assets.

Solution: Develop written gift acceptance policies, conduct quarterly reviews, and consult with auditors to ensure accurate net asset classification.

4. Inaccurate functional expenses

Allocating expenses arbitrarily without a defined methodology leads to inaccurate reporting.

Solution: Implement reasonable allocation methods, keep documented methodologies, and apply them consistently to ensure accurate functional expense reporting.

Meeting compliance requirements is the floor, not the ceiling. Truly effective nonprofit accounting goes beyond checking boxes to implementing practices that drive strategic decision-making and operational excellence. Let’s explore those best practices.

Nonprofit Accounting Best Practices

While compliance is essential to meeting legal requirements, best practices are the strategic actions that allow a nonprofit to not only survive but thrive. These nonprofit accounting best practices support the financial health of the organization, enhance donor trust, and ensure long-term sustainability. In this section, we’ll outline actionable steps to improve your nonprofit’s financial management and ensure the resources are allocated effectively.

Best practice 1: establish strong internal controls

Internal controls are essential for preventing fraud, minimizing errors, and boosting donor confidence. Strong controls safeguard your nonprofit’s assets and ensure funds are spent in accordance with donor intent.

Key controls to implement:

• Segregation of duties: Assign different individuals to authorize, record, and reconcile financial transactions to reduce the risk of fraud.
• Dual signatures on checks: Require two signatures for checks over a set threshold to ensure oversight.
• Monthly bank reconciliation: Someone not involved in deposits should reconcile bank statements each month.
• Access controls: Limit financial system access to only those who need it to protect sensitive data.
• Board treasurer reviews: Regularly have a board treasurer review financial reports for accuracy.
• Physical security: Store checks and cash in locked drawers to prevent unauthorized access.
• Password protection: Use strong passwords for accounting systems to prevent breaches.

If you lack staff to fully segregate duties, involve a board member to conduct secondary reviews.

Best practice 2: create realistic, strategic budgets

A budget should be a strategic planning tool, not just a compliance document. It ensures resources are allocated effectively to meet the nonprofit’s mission.

Budget best practices:

• Use historical data (3-5 years) to guide projections, making data-driven decisions.
• Build in a contingency of 5-10% to cover unexpected costs.
• Align with strategic priorities to make sure funds are allocated where they’re most needed.
• Involve program leaders in the budget discussion to reflect real-world needs.
• Create multiple scenarios (best, worst, likely) to prepare for various outcomes.
• Track monthly variances to monitor budget vs. actual spending.

Common mistake to avoid:
Avoid overly optimistic budgets that create a false sense of security. Be realistic about income and expenses to ensure the nonprofit isn’t overextending.

Best practice 3: monitor cash flow proactively

"Revenue is vanity, profit is sanity, but cash is reality” is a saying for a reason.

Actions to take:

• Generate 13-week rolling projections to forecast short-term cash needs and avoid liquidity issues.
• Identify seasonal patterns in donations and program fees to anticipate cash gaps.
• Maintain three-six months of cash reserves to buffer against economic fluctuations.
• Establish a line of credit before it’s needed to cover short-term cash shortfalls.
• Accelerate receivables collection to improve cash flow and avoid payment delays.
• Time major expenses to coincide with peak cash inflows to avoid dipping into reserves.

Best practice 4: understand and optimize overhead

Rather than focusing on reducing overhead to the bare minimum, ask: "What investment maximizes impact?" Spending on essential infrastructure, like hiring a qualified finance director, can significantly enhance growth and funding opportunities.

The 65/35 rule, for example, suggests that 65% of expenses should go toward program services, and 35% to overhead. This is a guideline, not a hard rule. The ratio varies depending on mission type, organizational size, and growth stage.

Additionally, don’t hide overhead costs. Be transparent and explain how investments, such as a qualified finance director or software, help secure long-term financial growth and fundraising success.

Best practice 5: maintain detailed documentation

Proper documentation is essential for audits, proving compliance, and enabling strategic financial analysis. Well-organized records also help justify financial decisions during audits and support transparent decision-making.

What to document:

• Donor correspondence, especially related to fund restrictions
• Board minutes that reflect financial decisions
• Expense allocation methodologies for transparency
• Grant agreements and related reporting requirements
• Vendor contracts above a certain threshold for audit purposes
• Asset purchases and depreciation schedules for accurate planning
• Related party transactions for IRS compliance

Retention policy:
There is no universal regulation or guideline for document retention that applies to all nonprofits. Each organization must research its specific state laws and retain only the documents relevant to its activities. Since state laws vary regarding retention requirements and nonprofits generate different types of documents, it's important to understand your obligations. However, there are key documents that all charitable nonprofits should keep permanently, along with others that should be saved for a set period of time by most organizations. Form 1023 and incorporation documents, for example, should be kept permanently.

Best practice 6: use purpose-built software for nonprofit accounting

Generic software often lacks features like fund accounting, functional expense allocation, and nonprofit-specific reporting. Nonprofits need tools that track restricted funds, manage grants, and comply with IRS Form 990.

Required features:

• Multi-dimensional chart of accounts for tracking diverse funding sources
• Automated fund accounting for easy tracking of restricted and unrestricted funds
• Built-in Form 990 reporting for compliance with IRS regulations
• Grant tracking for monitoring restricted funds
• Donor management integration for streamlined contributions
• Audit trail functionality to maintain transparency
• Role-based access to ensure data security

Some popular options include Sage Intacct, NetSuite, and QuickBooks Online. Limelight, for example, integrates smoothly with all of these software, enabling nonprofits to enhance their financial management without disrupting existing workflows.

Best practice 7: conduct regular financial reviews

These best practices all point to a fundamental truth: effective financial management requires more than accurate recordkeeping. It requires strategic planning and forecasting. Let’s explore how modern nonprofits approach budgeting and financial planning.

Nonprofit Budgeting and Financial Planning

Effective nonprofit budgeting and financial planning go beyond simply meeting compliance requirements. While financial statements provide a snapshot of past performance, budgets are forward-looking tools that shape an organization’s future. They help nonprofits strategically allocate resources, anticipate challenges, and drive impact.

Budgeting should be an ongoing strategic process, not just an annual exercise. By regularly revisiting and adjusting the budget, nonprofits can stay agile and responsive to changing circumstances. Here are seven key reasons why budgets matter beyond compliance:

• Guide resource allocation by aligning funds with strategic priorities
• Identify funding gaps early to ensure no critical programs go underfunded
• Enable scenario planning to test how different variables affect financial health
• Create program accountability by linking budgets directly to program goals
• Support grant applications by presenting clear, realistic financial projections
• Drive strategic priority conversations across leadership teams, ensuring alignment with the nonprofit’s mission

Effective financial planning empowers nonprofits to make data-driven decisions, optimize resources, and keep their mission on track.

The pain of traditional spreadsheet budgeting

1. Version control chaos: Imagine the frustration of dealing with multiple files—“Budget_Final_v7_ACTUAL_FINAL.xlsx”, “Budget_v2_draft.xlsx”—and constant email threads trying to figure out which version is the most up-to-date. With multiple people working on separate files, someone’s changes inevitably overwrite someone else’s, leading to chaos and confusion.
2. Manual data consolidation: The hours spent copying and pasting data from the accounting system into spreadsheets, reformatting to fit budget templates, and double-checking for alignment are not only tedious. They’re prone to error. One misaligned row or incorrect formula can throw off the entire analysis. By the time the process is complete, the data is already outdated, making it impossible to make timely decisions.
3. Limited collaboration: When program directors can’t access or input directly into the budget, finance teams become the bottleneck. The email back-and-forth slows things down, and finance ends up translating every request into a spreadsheet. This lack of collaboration leads to inefficiencies and delays, preventing teams from acting quickly in response to changing needs.
4. Static forecasts: By the time Q1’s actuals are consolidated and reviewed, Q2 is halfway over. Rolling forecasts are supposed to provide an up-to-date picture of financial health, but without real-time updates, they quickly become stale. Finance teams struggle to keep up with the pace of the organization, resulting in inaccurate projections and missed opportunities.
5. No scenario planning: Want to assess the impact of a 20% drop in grant revenue? In traditional spreadsheets, it means rebuilding formulas across dozens of linked files, if you can even remember how they’re connected. These time-consuming manual adjustments can take hours or even days, preventing teams from making informed decisions about potential risks.

The modern approach to nonprofit budgeting

Modern Excel-free, FP&A platforms like Limelight solve the inefficiencies of traditional spreadsheet budgeting by integrating real-time data, enhancing collaboration, and automating forecasting to drive strategic decisions.

What modern platforms enable:

• Connected to source data: Automatically integrates with your accounting system, eliminating the need for manual exports or copy-paste, ensuring real-time data accuracy across all financial reports
• Collaborative planning: Program leaders can input directly into the budgeting process, while validation rules ensure consistency. This allows finance teams to focus on reviews, not data entry.
• Continuous forecasting: With rolling forecasts that auto-update, you always have an up-to-date 12-month view. This eliminates the need for time-consuming rebuilds and keeps your financial plans current.
• Instant scenario modeling: Easily toggle between multiple financial scenarios (optimistic, conservative, contingency). Unlike traditional methods, this takes minutes, not hours, allowing fast decision-making.
• Real-time reporting: Monitor budget vs. actual by program, fund, or grant with a few clicks. Drill down from summary to transaction level instantly for deeper insights.
• Complete audit trail: Track every change made in the system with a timestamp and user identification. This version history ensures full transparency and accountability for all financial decisions.

A comparison: traditional vs. modern approaches

Building on the challenges we’ve outlined, modern FP&A platforms address these issues by streamlining budgeting, improving collaboration, and enabling real-time, scenario-based decision-making, all while connecting historical accounting data to strategic planning.

How Limelight Enhances Your Nonprofit Accounting System

Limelight FP&A for nonprofit accounting

Remember the late nights spent by the CFO trying to reconcile multiple versions of the budget spreadsheet? The confusion between “Budget_Final_v7_ACTUAL_FINAL.xlsx” and endless email threads just to ensure everyone was working on the right version? It’s frustrating to spend 40-50% of your time on manual consolidation and spreadsheet maintenance, all while feeling disconnected from the real-time data needed for strategic decision-making.

The Limelight advantage for nonprofits

Limelight provides a modern FP&A layer purpose-built for nonprofits that have outgrown spreadsheets and manual processes. By seamlessly integrating with your existing accounting system, Limelight empowers your team to plan, forecast, and manage resources with efficiency and accuracy, helping you make informed, data-driven decisions.

1. Seamless integration with leading ERPs

 Limelight’s integrations

Limelight integrates bi-directionally with leading ERPs like Sage Intacct, NetSuite, Microsoft Dynamics, and QuickBooks Online, automatically pulling actual data from your ERP and sending budgets and forecasts back into the system. This ensures a single source of truth across all financial data.

Practical impact:

• No manual exports of data, ensuring accuracy
• Real-time or scheduled updates keep financials current
• Fund dimensions map directly, simplifying fund tracking
• Historical data imports automatically, preserving your existing financial history
• Single source of truth eliminates data discrepancies
  
  

What this solves:
By automating data integration, Limelight eliminates the version control chaos and manual consolidation that nonprofits often face. You no longer have to worry about outdated or inaccurate data, making financial decision-making faster and more reliable.

2. Purpose-built for nonprofit accounting

Limelight understands the complexity of nonprofit financials. It allows for multi-dimensional budgeting, tracking various categories such as funds, programs, grants, departments, and locations, all within a single platform. This structure mirrors your accounting system, ensuring consistency.

Limelight’s pre-built templates for nonprofits

Limelight’s platform comes with nonprofit-specific templates for:

• Program-based budgeting
• Headcount planning with loaded costs
• Grant tracking and draw-downs
• Cash flow by fund
• Functional expense allocation

What this solves:
Instead of building complex Excel formulas from scratch, Limelight offers proven templates designed specifically for nonprofit requirements. This speeds up budgeting, reduces errors, and ensures that your planning aligns with industry best practices.

3. Collaborative planning

Limelight enables collaborative planning, allowing program directors and department heads to participate directly in the budgeting process. No Excel expertise required. This eliminates the need for finance teams to be bottlenecks.

How it works:

• Finance sets up templates with validation rules.
• Program leaders input directly via a user-friendly web interface.
• Built-in approval routing ensures smooth sign-offs.
• Comments track decisions for transparency, while the audit trail shows changes.

What this solves:

Limelight eliminates email back-and-forth and manual data entry bottlenecks, allowing finance teams to facilitate collaboration directly. This leads to faster decision-making and more accurate, inclusive budgets.

4. Intelligent FP&A with Limelight AI

Limelight AI landing pages

Limelight AI acts as an intelligent FP&A assistant, helping finance teams turn complex data into actionable insights. Ask questions about budget variances, program expenses, or headcount trends, and Limelight AI delivers clear, context-rich answers, without digging through spreadsheets or building custom reports.

Why choose Limelight AI for your nonprofit accounting:

• AI insights: Automatically analyzes your financial data to highlight trends, detect anomalies, and explain variances, giving you a complete picture of resource allocation
• AI assistant: Serves as a finance co-pilot, providing instant answers to questions like “Why did program expenses increase this quarter?” or “How did grant revenue change?”
• AI forecaster: Generates forecasts that incorporate historical data and market intelligence, producing multiple what-if scenarios to plan for program growth, funding changes, or seasonal fluctuations

With Limelight AI, nonprofits can accelerate analysis, improve accuracy, and focus on strategic decision-making, transforming hours of manual work into instant, actionable insights.

Nonprofit Accounting as a Driver of Strategic Growth

Effective nonprofit accounting goes beyond compliance. It requires strategic planning, accurate fund tracking, and clear insights into how resources are allocated. From understanding fund accounting and preparing the four essential financial statements to implementing best practices like internal controls, cash flow monitoring, and collaborative budgeting, nonprofits can strengthen financial health while building donor trust.

Modern FP&A platforms, such as Limelight, enhance nonprofit accounting by integrating with existing systems, automating routine tasks, and providing real-time, scenario-based insights. This allows finance teams to spend less time on manual work and more time on mission-driven decision-making, ensuring the organization can grow sustainably and maximize its impact. Find out how nonprofits are using an FP&A like Limelight to plan and grow strategically.

FAQs

1. What is nonprofit accounting and how does it differ from for-profit accounting?

Nonprofit accounting focuses on tracking funds used to support the mission, rather than generating profit. Unlike for-profits, which distribute profits to shareholders, nonprofits must ensure funds are used for their intended purpose, adhering to fund accounting. Nonprofits also prepare four financial statements compared to three in for-profit accounting.

This distinction ensures financial transparency and accountability to donors, regulators, and the IRS.

2. What is fund accounting for nonprofits?

Fund accounting is a system used by nonprofits to separate resources into different categories or "funds" based on restrictions placed by donors or the organization itself. Funds are typically categorized as unrestricted, temporarily restricted, or permanently restricted.

This system allows nonprofits to track how funds are used in compliance with donor intentions and regulatory requirements. It ensures financial accountability, especially for grants or donations with specific terms.

3. What is IRS Form 990 and who needs to file it?

IRS Form 990 is an annual information return required for most tax-exempt nonprofits. It provides the IRS, donors, and the public with insights into a nonprofit's finances, operations, and governance. Nonprofits with gross receipts over $200,000 or assets exceeding $500,000 must file the full Form 990.

Form 990 is a critical document for maintaining 501(c)(3) status and demonstrating transparency to donors and grantmakers.

4. What is GAAP and why does it matter for nonprofits?

GAAP is a set of standards used to prepare and report financial statements. Nonprofits must follow GAAP to ensure consistency, transparency, and comparability in their financial reports.

By adhering to GAAP, nonprofits enhance credibility with donors, grantmakers, and auditors, and ensure compliance with IRS regulations. It helps to clearly track restricted vs. unrestricted funds, properly classify net assets, and demonstrate sound financial stewardship.

5. How do nonprofits track restricted vs. unrestricted funds?

Nonprofits track restricted and unrestricted funds using fund accounting. Restricted funds are donor-designated for a specific purpose or timeframe and cannot be used for general operations. Unrestricted funds, on the other hand, can be used freely by the organization for any purpose.

Fund accounting helps segregate these funds into separate categories, ensuring compliance with donor restrictions and proper reporting for regulatory bodies like the IRS.

6. Do nonprofits need accounting software, or can they use spreadsheets?

While small nonprofits may rely on spreadsheets initially, growing organizations benefit from nonprofit-specific accounting software for features like fund accounting, grant tracking, and compliance reporting.

Modern FP&A solutions, such as Limelight, integrate with systems like Sage Intacct, NetSuite, and QuickBooks Online to automate reporting, track budgets in real-time, and enable scenario-based forecasting. By combining accounting software with FP&A tools, nonprofits can reduce errors, save time, and focus on big-picture financial planning rather than manual data entry.