Accounting for Charities - Essential Guide for Non-Profits

As a nonprofit professional, your strengths are likely fundraising, managing volunteers, and working with beneficiaries. While these capabilities are critical to sustaining your charity’s mission, proper accounting keeps things running smoothly. 

Accounting for charities ensures transparency and accountability, which can mean continued support from benefactors. 

In today's guide, we’ll explore the meaning of nonprofit accounting, its importance, how it differs from for-profit accounting, and how to set up a reliable accounting system. 

Your accounting system should have two key types of tools working in tandem: accounting software and dedicated nonprofit budgeting, forecasting, and reporting software. 

Martus fits the bill nicely as a tailored nonprofit financial management software that enables you to manage budgets, project financial situations, and produce detailed board- and donor-ready reports. 

Martus integrates with popular accounting software, like Sage Intacct, to complete the accounting system, enabling you to accurately manage and report on your finances. 

Book a free discovery call today to discover how Martus can streamline your budgeting and accounting processes. 

What Is Nonprofit Accounting?

Nonprofit accounting is the unique process that charities use to plan, record, and report their finances. 

While it's a specialized form of accounting, the practice is based on nonprofit bookkeeping, which entails:

• Recording transactions 
• Maintaining organized financial records
• Managing accounts receivable and payable 
• Allocating resources
• Making bank deposits
• Processing payroll
• Writing checks 
• And more. 

Accounting is more complicated than bookkeeping and requires accounting for tasks such as:

• Budgeting
• Filing tax forms 
• Managing grants and donations
• Maintaining Generally Accepted Accounting Principles (GAAP) compliance
• Preparing nonprofit financial statements
• Preparing for internal or external audits
• Among others. 

Nonprofit accounting focuses on fund accounting, which involves tracking revenues and expenses across different programs or activities. 

Not-for-profit fund accounting separates monetary resources into different dedicated funds based on their intended use and donor restrictions. 

For example, if a certain donation is specifically meant to fund a school feeding program, you use the money and account for it specifically under that school feeding fund. 

If there are no donor restrictions, you can add the money to the organization’s annual fund and spend it on projects, overhead, or other appropriate expenses. 

Why Accounting Matters in Nonprofit Organizations?

Proper accounting is important to nonprofits for several reasons:

1. Complying with Grantor Usage and Reporting Requirements: Grantors and donors usually have specific requirements not only for how you use funds but also how you report on your finances. They may require specific reporting information, format, or frequency. Strong accounting practices enable you to meet these requirements, ensuring transparency and building trust with grantors. 
2. Streamlining Board Reporting and Oversight: Nonprofit board reports don't have to be bland. Well-prepared reports help the board fulfill its oversight duty, which includes identifying potential issues, monitoring budget adherence, and making informed financial and organizational decisions.
3. Maintaining Audit Readiness: Following best accounting practices for nonprofits ensures you have the accurate, up-to-date, and relevant records or documents required by auditors to ensure you meet your charity's mission and donor intent. Compliance reduces the risk of IRS audits and potential penalties. Accounting also ensures real-time audit readiness by focusing on proper financial management throughout the fiscal year or grant term rather than just before an audit. 
4. Ensuring Transparency in Financial Management: Through accounting, you cultivate transparency because it ensures your organization is accountable to its donors, board members, and the public. Your financial statements show how you use the funds you receive, and this transparency builds trust and encourages continued support. 
5. Ensuring Mission Alignment: Accounting helps your charity align its financial management strategy with its mission. Fund accounting ensures you use funds for their intended purpose, while mission-driven budgeting ensures you focus on maximizing the impact of every dollar spent on projects or initiatives. 

Key Differences Between For-Profit and Nonprofit Accounting

As a specialized form of accounting, nonprofit accounting differs from for-profit accounting in ways such as:

• Fund Accounting: Nonprofits use fund accounting to track monetary resources from different sources, like grants and donations, based on their intended use and donor-imposed restrictions. For-profits institutions typically do not have expenditures imposed by external stakeholders. Fund accounting can complicate the process due to the need for specialized record-keeping, restriction compliance, and the administrative burden of managing multiple funds. 
• Accountability and Transparency: Charitable organizations focus on how they use their resources to achieve a mission, while for-profit organizations report on profits for shareholders or owners. A nonprofit views the difference between revenue and expenses as the net assets available for future use, while a for-profit views this difference as income to be distributed to shareholders. 
• Meeting Regulatory Requirements: To maintain tax-exempt status, your nonprofit must ensure financial integrity and compliance with certain state or federal regulations, such as filing IRS Form 990. 
• Unique Expenses Reporting: As a nonprofit, you must report expenditures by function (programs and supporting activities) and by nature (expense line). To meet this need, you set up a separate financial statement called the Statement of Functional Expenses. Like other nonprofit financial statements, this document requires special accounting expertise. 
• Titles for Financial Statements: Both nonprofits and for-profits have some similar financial statements, but they have different reporting names and specific requirements for how you present them. In a nonprofit, the balance sheet changes to the Statement of Position. The cash flow statement changes to the Statement of Cash Flows, and the income statement to the Statement of Activities. These documents also require special accounting expertise and experience. 

How to Set Up a Reliable Accounting System for Charities

When accounting for charities, you'll need to create separate funds or accounts for various programs. 

You establish various nonprofit budget categories with expenses and revenues using the chart of accounts, usually called the nonprofit chart of funds. 

Because of the added complexity of accounting for donations and grants that may cover multiple categories, you need an accounting system tailored to the unique nonprofit needs of keeping accounting records and generating specialized reports. 

When choosing an accounting system for nonprofit organizations, you must ask yourself two key questions:

• Can the system support multi-program budgeting?
• Does it allow role-based permissions?

This is where Martus comes in, and here's how it helps:

• Collaborative Multi-Program Budgeting: Martus is a nonprofit-focused, cloud-based budgeting, forecasting, and reporting solution that allows you to create and manage unlimited budgets collaboratively. As a nonprofit budgeting software, Martus’s budgeting capabilities go beyond multiple budgets. Each budget can have an unlimited number of lines!
• Seamless Integration with Accounting Software: Martus integrates with over 25 API-based accounting software to automate workflows and unlock real-time insights. For example, our primary Sage Intacct integration has helped over 650 organizations reduce errors, save time, and gain financial clarity. Through the integration, you get real-time bottom-up budgeting, forecasting and what-if analysis, controlled access, pre-built reporting, and personnel budgeting. 
• Freeing Up Your Team: Martus streamlines budgeting and helps you cut your budgeting time by 50% by eliminating reliance on traditional spreadsheets. Your team’s time and expertise is freed up to focus on other activities. 
• Role-Based Permissions for Extra Security: Through Martus's lock control feature, you can lock a worksheet once it's completed so that the end-user doesn't make any accidental changes. 
• Ready-to-Use Reports: Martus's nonprofit reporting solutions allow you to create ready-to-use reports that cover crucial areas like budgeting performance, expense tracking, and revenue analysis. You can prepare income statements, monthly budget-to-expenses comparisons, multi-year budget-to-actuals, and fiscal year forecast reports. 
• Financial Forecasting as a Bonus to Accounting: While financial forecasting isn't part of accounting, Martus goes further and lets you use the data and insights from your nonprofit accounting to forecast financial scenarios. You can predict your future performance based on current financial data and trends. Martus lets you forecast cash flows, revenues, and expenses to make informed decisions regarding your finances, programs, and overall organization. 

Trusted and used by over 850 organizations worldwide, Martus is the best nonprofit financial management software for aligning your financial strategy with your mission while maintaining accountability and transparency. 

Schedule a free discovery call to learn more about how Martus can revolutionize nonprofit accounting and how your organization plans for the future. 

How to Stay Compliant with 501(c)(3) Accounting Rules

If your charity qualifies as a federal tax-exempt entity, you must file with the Internal Revenue Service (IRS) yearly to confirm that you comply with the 501(c)(3) rule.

Let's check out how you can comply with the rule to maintain your exemption from federal income tax. 

1. Handling IRS Form 990

Form 990 is a filing requirement for federal tax-exempt organizations. You should file with the IRS if you receive over $200,000 in revenue or own over $500,000 in assets. 

To comply with Form 990 requirements, you must do the following:

• Choose and complete the right Form 990, depending on your organization’s designation and size. Form 990-N is for small organizations, Form 990-EZ for mid-sized organizations, and the full Form 990 for large organizations. If you are a private foundation of any size, you should use Form 990-PF.
• Use your financial statements as the source of information for the form.
• Submit the completed form on time to avoid penalties. (File by the 15th day of the 5th month after your fiscal year ends.)
• Confirm with your nonprofit tax accountant if you are exempt from filing Form 990, as some religious and political organizations are. 

2. Audit Preparedness

Here's how to ensure you are ready for an audit if needed under 501(c)(3):

• Understand and follow requirements like filing Form 990 and any state-specific regulations, such as the independent audits required by some states. For example, you may have to fulfill the single audit requirement if you receive $750,000 or more in federal funds. 
• Understand the IRS charity and nonprofit audit process.
• Keep proper records for all transactions and pre-audit meeting minutes. 
• Complete regular internal audits to identify potential weaknesses, especially regarding compliance, and address them proactively before an independent or IRS audit. 
• Provide the auditor with accurate, updated, and organized financial documents and statements.
• Ensure proper internal controls documentation, including role-based responsibilities and authorizations. 
• Review past audits, if any, to improve financial management and compliance. 

3. Grant Funding and Reporting Requirements

Your grantors or state might require grant accounting for not-for-profit organizations to ensure you comply with grant-specific requirements to continue receiving the necessary funding.

Your accountant can help you ensure tax-compliant fund accounting for your not-for-profit accounts, including grants. 

Accounting for Charities Mistakes to Avoid

Whether you handle your accounting in-house or outsource it, you should be aware of the typical nonprofit accounting mistakes below. 

• Overusing and Overloading Spreadsheets: If your organization has outgrown spreadsheets, continued use slows you down and exposes you to more accounting errors, especially when you overload them with too much information. Unlike spreadsheets, Martus is built for modern budgeting and helps eliminate mistakes through real-time updates, automation, scalability and flexibility, speed, and collaborative effort. 

• Lack of Forecasting: We’ve mentioned that forecasting isn't part of accounting, but not using the insights and historical data from accounting to make future projections is a big fail. Forecasting helps with future decision-making to streamline and align your financial management and strategy with your mission. Martus enables you to project accurate financial trends based on your accounting through automation and data-driven insights. 

• Poor Visibility into Funds: Nonprofits require real-time visibility into funds and financial data to make sound decisions. If you can't access multiple budgets, income sources, and resource allocation details in real-time, it's time to switch to a better nonprofit accounting software. 

• Unclear Roles: Assigning clear roles and responsibilities is a crucial internal control mechanism for nonprofits. Failure to segregate cash management and accounting duties can lead to fraud and too many corrective actions. You can have a dedicated accountant or use Martus in your accounting ecosystem. 

Book your free consultation today and discover how Martus can help you avoid common nonprofit accounting pitfalls.

Frequently Asked Questions (FAQs) 

Here are answers to questions we get often from nonprofit professionals regarding accounting software for their organizations. 

How Does Nonprofit Accounting Differ From Traditional Accounting?

One key difference between nonprofit accounting and traditional accounting is that the former focuses on accountability, transparency, and mission alignment rather than maximizing profits. 

Nonprofits rely on fund accounting to categorize and track funds based on intended application and donor restrictions. 

The objective is to show donors, grantors, and the public that the organization is accountable and sticks to its mission objectives. 

Can I Use Free Accounting Software for a Small Charity?

You can use free accounting software for nonprofits if you run a small charity. Such software offers essential features like basic accounting, expense tracking, and reporting. 

As your organization grows, you need to shift to a paid system to enjoy advanced capabilities like Martus's budgeting, forecasting, reporting, and multiple integrations with top accounting software for charities. 

What Should I Look for in an Accountant for Non Profit Organization?

When looking for an accountant for your nonprofit, you should consider these attributes:

• Commitment to mission-focused work. 
• Proof of a four-year degree in accounting.
• Certified Public Accountant (CPA) license.
• Strict adherence to accounting standards for nonprofit organizations, including GAAP. 
• Strong understanding of nonprofit accounting best practices, including fund accounting, budgeting, and reporting. 
• Demonstrable experience with common accounting software like Sage Intacct, Xero, and Microsoft Business Central. 
• Experience with nonprofit financial management software such as Martus.

Outsourcing your accounting saves money and time compared to using an in-house team. 

Conclusion

You may not have the required experience and expertise to complete accounting for your charity accurately, but using the right resources can help you ensure compliance with public and benefactor expectations. 

A reliable accounting system will require accounting software and nonprofit-focused financial management software. 

You may already have the right accounting software, meaning you are now looking for the best nonprofit financial management tool. 

Martus is a reliable cloud-based tool for nonprofits to manage their finances through advanced budgeting, forecasting, and reporting. 

Through Martus’s many integrations with accounting software, you can enjoy seamless financial management that promotes transparency, accountability, and alignment with your mission’s objectives. 

Gain financial clarity and make smarter decisions with Martus from today.