Best Accounting Practices for Nonprofits - Top Tips

Accounting isn't the most glamorous activity for nonprofits, but it's key to running your organization smoothly.

Whether for routine financial management or compliance, accounting is one of the backbones keeping your organization’s finances in control. 

The trouble is that understanding and scrutinizing a nonprofit’s finances can be overwhelming. But it doesn't have to be. 

In this guide, we'll explore the best accounting practices for nonprofits to help cater to all your accounting needs and maintain good financial health in the long run.

TL;DR - Best Accounting Practices for Nonprofits

Let's start with a quick overview of the accounting practices we'll cover:

1. Understanding nonprofit accounting principles and standards 
2. Implementing robust internal controls 
3. Conducting regular internal audits 
4. Understanding nonprofit tax regulations
5. Working with a professional nonprofit bookkeeper 
6. Building a professional accounting team 
7. Using nonprofit accounting software 
8. Using dedicated nonprofit financial management software

Applying these best accounting practices for nonprofits can be taxing, especially when it comes to choosing the best accounting software and dependable financial management software for your organization.

Martus is the best bet as tailored financial management software for nonprofits looking to optimize accountability, transparency, collaboration, and efficiency in financial planning. 

Martus connects with existing accounting tools to amplify accounting functionalities and streamline financial management through cloud-based budgeting, reporting, and even forecasting. 

Request a detailed demo to see Martus in action and discover how it can transform your financial management. 

Key Differences Between Nonprofit and For-Profit Accounting Practices?

While nonprofit and for-profit accounting are similar in many ways, they differ in the following four critical areas because of the unique nature of nonprofits. 

1. Fund Accounting: Nonprofit fund accounting is a specialized form of accounting that tracks income and expenses depending on donor or grant restrictions. A for-profit organization doesn't have these restrictions, which makes accounting for revenue easier. 
2. Focus on Transparency and Accountability: Nonprofits focus more on transparency and accountability than profitability. Their leaders are accountable to board members, regulatory authorities, donors, and the public. Rather than focusing on profit creation and sharing, a nonprofit focuses on net assets and how they are used in its programs and activities. 
3. Unique Financial Statements: Nonprofits compile financial statements with unique names and procedures. For example, expenses are reported in the Statement of Functional Expenses, which requires special knowledge of nonprofit accounting. 
4. Special IRS Filing Requirements: Unlike for-profit businesses, nonprofit organizations are typically tax-exempt. The Internal Revenue Service (IRS) requires nonprofits to follow good accounting practices and special tax filing through Form 990. 

Why Good Accounting Practices Matter for Nonprofits?

Nonprofits must stick to good accounting practices to enjoy benefits such as:

• IRS Compliance and Maintaining Tax-Exempt Status: Proper accounting using Generally Accepted Accounting Principles (GAAP) helps you comply with IRS regulations to maintain tax-exempt status through proper Form 990 filing. 

• Compliance with Donor Restrictions: Donors usually restrict the use of their funds to specific programs. Accounting for charities helps you manage funds as per donor requirements to avoid legal repercussions or harm to your charity's reputation. 

• Informed Decision-Making: Accurate financial data provides the information you need to decide on operations, investments, and programs. You can identify trends, opportunities, and challenges that may affect your financial health and respond accordingly. 

How to Set Up a Strong Accounting System for Nonprofits

Setting up a sound nonprofit accounting system requires combining bookkeeping, accounting software, and dedicated nonprofit financial management software. 

1. Hiring a Bookkeeper

Find a professional bookkeeper with experience in nonprofit systems to help you with basic data entry, making bank deposits, processing payroll, writing checks, and managing invoices. 

2. Finding the Right Accounting Tool

You'll also need to find the right nonprofit accounting software to help with budgeting, tax filing, preparing financial statements, maintaining GAAP compliance, and managing donations and grants. 

We recommend Sage Intacct, our main API-based integration, as the best accounting tool for multi-entity nonprofits looking for detailed cash flow management, financial reporting, and project costing. 

3. Finding Dedicated Nonprofit Financial Management Software 

You'll need the right software for nonprofit financial management. Martus is a holistic cloud-based financial management tool that helps nonprofits with:

• Unlimited nonprofit budgeting
• Robust internal controls to minimize errors 
• Integration with accounting software for timely and accurate preparation of financial statements
• Fund and expense management
• Detailed financial reporting
• Cash flow forecasting

Martus also supports financial forecasting, a valuable addition to the capabilities of the accounting software it integrates with.

Financial forecasting also complements the budgeting and reporting capabilities you get with Martus.

Book a discovery call today to find out more about Martus and how it can streamline your nonprofit accounting processes. 

How to Choose the Right Accounting Tools and Technology

To choose the right accounting tools and technology, here are some major aspects to consider:

• Assessing Your Needs: Identify your organization's unique needs and challenges. For example, you might need a tool for more in-depth financial reports. Create a list of the most important functionalities you want the tool to have. 

• Setting a Realistic Budget: Understand how much you’ll be able to spend on software costs such as staff training, implementation, maintenance, and potential customizations. Ensure the budget aligns with your needs and the expected benefits. 

• Researching Available Options: Research the available tools and technology, considering both API- and file-based platforms. Shortlist vendors with good customer reviews and experience working with nonprofits. 

• Requesting Demos and Trials: Ask to test the software yourself to see if it will be a good fit for your organization. Focus on ease of use and practicality.  

• Evaluating the Features: Check each tool's features against your list of needs to ensure they apply to nonprofits, such as grant management, budgeting, reporting, and donor management. 

• Making an Informed Decision: Decide on the most appropriate tool and technology system based on the above aspects and your evaluation. Choose the one that best meets your organization’s goals, budget, and long-term objectives. 

Best Accounting Practices for Nonprofits

Let's now discuss the best practices in detail:

1. Understanding Nonprofit Accounting Principles and Standards 

You must stay abreast of the current guiding principles and accounting standards for nonprofit organizations. 

The Financial Accounting Standards Board (FASB) sets and updates the best nonprofit accounting principles, including GAAP. 

For a nonprofit, ensure you keep up with FASB’s guidelines, such as:

• Summary of Statement No. 117 and Accounting Standards Update (ASU) No. 2016-14, which detail how not-for-profit entities should present their financial statements. 
• ASU 2018-08, which ensures more standardized reporting of restricted and unrestricted grants. 

2. Implementing Robust Internal Controls 

Internal controls are necessary to prevent fraud, promote responsible collaboration, and reduce errors. Design thorough internal policies and controls that you update regularly. 

Some common internal measures include:

• Role-based permissions and lock systems to ensure only the intended person receives information and acts on it accordingly. 
• A code of ethics to show your employees, donors, board of directors, and the public the values your organization embodies. 
• Segregation of duties, which means assigning different financial responsibilities to different people to create a system of checks and balances that protects the organization from fraud and errors. 
• Hierarchical approval processes to manage expenses and other financial transactions across different employees. 

3. Conducting Regular Internal Audits 

You'll want to conduct internal audits to ensure that all accounting meets the organization’s standards and GAAP. 

The audit results are helpful in decision-making, external audits, securing government funding, and establishing trust and credibility with donors. 

4. Understanding Nonprofit Tax Regulations 

Stay current with the IRS’s accounting, tax, and reporting requirements for nonprofits to maintain compliance and your organization's tax-exempt status. 

For example, you must file Form 990 correctly, keep accurate charitable contributions documents or records, and be ready for audits if needed. 

5. Working with a Professional Nonprofit Bookkeeper 

Rather than using inexperienced volunteers or staff who lack accountancy training, work with an experienced nonprofit bookkeeper.

Good bookkeeping is the basis of good accounting, and you'll need a bookkeeper who understands aspects such as:

• Restrictions (or lack of) on grants or donations, and how these funds should be used
• How to document transactions in the nonprofit chart of accounts
• Maintaining a clean nonprofit general ledger

6. Building a Professional Accounting Team 

It's a great idea to have someone responsible for accounting, such as the chief financial officer. You can also have a whole accounting team, depending on the size and complexity of your charity. 

Certified Public Accountants are ideal, but you must focus on the person's understanding of GAAP and the ability to produce accurate financial reports routinely. 

You can outsource the service if you don't have the proper budget to hire an in-house accountant or team. 

7. Using Nonprofit Accounting Software 

Your accountant or accounting team can produce better results with the right nonprofit accounting software. 

Choose software specifically designed to address the unique challenges nonprofits face, such as restricted vs unrestricted fund accounting and strict regulatory compliance requirements. 

8. Using Dedicated Nonprofit Financial Management Software 

Your accounting system won't be complete without nonprofit-focused financial management software. Look for a cloud-based tool that supports budgeting, reporting, collaboration, and better financial visibility. 

You can use Martus to streamline your accounting process through real-time budgeting and reporting, data-driven insights, and integrations with accounting tools to centralize control. 

Book a consultation today to learn more about streamlining nonprofit financial management with Martus. 

Common Mistakes to Avoid in Nonprofit Accounting

Even as you work with professional bookkeepers and accountants, you must avoid these common nonprofit accounting mistakes:

• Lack of Internal Controls: Failure to enact internal controls exposes your organization to errors, fraud, potential external audits, and reputational damage. 
• Poor Record-Keeping: Inaccurate and incomplete records, both on the bookkeeping and accounting ends, can lead to financial misstatements and compliance issues. Ensure detailed records of all transactions and activities, including your accounting procedures. 
• Ignoring Revenue Recognition Standards: Recognizing revenue incorrectly can result in incorrect Statement of Activities, which may trigger audits or budget vs actuals reporting problems. 
• Misinterpreting Donor Restrictions: Misinterpreting donor requirements can lead to improper recognition of incomes and restricted net assets, which skews the report on the true nature of your resources. Ensure robust tracking and reporting processes for restricted and unrestricted funds and clear communication with donors to understand their terms.

Frequently Asked Questions (FAQs) 

Here are answers to questions we often get concerning nonprofit best accounting practices. 

What Are the Key Components of Nonprofit Accounting?

Nonprofit accounting is a special type of accounting that includes components such as fund accounting, budget management, legal and regulatory compliance, donor management, and financial reporting. 

How Often Should a Nonprofit Review Its Financial Reports?

A nonprofit should ideally review its financial reports monthly to proactively monitor financial trends, identify potential issues, and compare budgets with actuals. 

Most nonprofits review their financial reports based on how often the board meets, which is usually monthly or quarterly. Some may meet more often, depending on the size, needs, bylaws, and maturity of the organization. 

Do All Nonprofits Need to Follow GAAP?

It's highly recommended that every nonprofit, especially large organizations, follow GAAP to ensure accuracy and consistency in financial management. 

Using GAAP maintains compliance with donor and IRS requirements and builds the credibility, trust, and transparency necessary for continued donor support. 

What Is the Role of an Accountant for Non-Profit Organizations?

An accountant for nonprofit organizations professionally helps with financial management. 

Their tasks include ensuring compliance, applying accounting principles and standards, maintaining an up-to-date net assets schedule, and preparing financial statements. 

They may also advise the board on making appropriate financial decisions. 

Conclusion

Best accounting practices for nonprofits ensure you stay compliant with governmental and donor requirements, maintain tax-exempt status, and continue receiving support from your benefactors. 

For these benefits to happen, you must have a robust accounting system that includes bookkeeping, accounting professionals and software, and nonprofit-oriented financial management software. 

You need the right financial management tool if you already have bookkeeping and accounting software. 

Martus is your best option, given its extensive budgeting and reporting functionality and focus on collaboration, transparency, accountability, and mission alignment. 

Besides, you can also enjoy forecasting capabilities, which augment all your accounting processes and results. 

Book a demo to see Martus in action today.