You've seen this before or perhaps even experienced it at your charity: You are all passionate about change through service to humanity. However, most of the team members feel completely lost when it comes to nonprofit finance.
You aren't alone. Most leaders in the nonprofit sector understand how challenging it can be, from time-consuming manual spreadsheets and budget delays to difficulty collaborating across departments.
We've got your back. In today's guide, we’ll discuss the core principles of nonprofit finance, best practices, and more to help you remain focused on your mission without being sidetracked by financial stewardship challenges.
Martus Solutions offers nonprofit financial management software with cloud-based budgeting, forecasting, and reporting capabilities to streamline financial administration.
We help organizations transform financial management by eliminating complexity, spreadsheet errors, and manual data entry.
Martus cuts the time you spend managing finances by 50%, saving your team time that they can dedicate to other strategic and mission-focused activities.
Gain financial clarity and make smarter decisions with Martus—schedule a consultation with us today to get started.
What Is Nonprofit Finance?
Nonprofit finance is the practice of procuring and managing financial resources to support a nonprofit organization.
The practice comprises the processes an organization applies to secure and manage resources to support its intended purpose and mission.
Nonprofit finance revolves around:
- Nonprofit Financing: Your charity can use different methods to raise funds to operate and achieve its target missions. The sources can be diverse, but are usually donations, grants, and earned income.
- Alignment with Your Mission: Your organization’s financial decisions must directly support its mission and maximize the target effect.
- Stewardship of Funds: Every organization must use its funds ethically, in accordance with the expectations of the donors, the law, and the public.
- Financial Management Practices: You can apply various practices to manage your finances, including bookkeeping, budgeting, accounting, reporting, and forecasting.
Key Differences Between For-Profit and Nonprofit Finance
In this section, we'll discuss how finance for nonprofits differs from finance for for-profit institutions.
1. Tracking Restricted vs. Unrestricted Funds
Nonprofits must adhere to donor and grantor requirements, such as restrictions on how they should use the funds. Some funds come with no restrictions.
The nonprofit must differentiate between and separately track restricted and unrestricted funds to comply with donor or grantor requirements and the law.
For-profits lack this distinction and focus mainly on maximizing profits for shareholders and the owners. They are mostly concerned with the effect of revenue and expenses on profits.
For-profits have no clearly defined restrictions or non-restrictions because all revenue is generally seen as available for general operations and profit generation.
2. Managing Grants
Nonprofits focus on advancing a mission and being accountable to funders, which requires careful grant handling and transparent reporting.
A for-profit organization may receive a grant, but it focuses on how it affects the bottom line and return on investment.
Rather than the fund accounting system nonprofits use to manage restricted and unrestricted grants and donations, for-profit organizations use integrated accounting.
The grant is incorporated in the overall financial statements, focusing on how it impacts profitability and/or overall financial health.
Grantors require the nonprofit to report on the grant's usage, but for-profit reporting is usually less detailed and not focused on mission fulfillment, if it's required at all.
3. Purpose and Mission
As mentioned, for-profits focus on maximizing profits, while nonprofits concentrate on fulfilling their mission.
Nonprofits must meet board and donor expectations in managing resources. Their reports emphasize stability, transparency, long-term sustainability, and accountability to stakeholders.
Traditional finance management tools like spreadsheets and legacy software are not suitable for nonprofits because of their unique structure and focus on transparency and accountability.
The tools lack fund accounting functionalities and can't handle the required unique nonprofit financials.
How Nonprofit Finances Work
Nonprofit finance involves managing revenues, expenses, and net assets to support the mission while being accountable to donors and other stakeholders.
The practice requires fund accounting, budgeting, forecasting, and financial reporting. We'll look at these aspects in greater detail in one of the next sections.
Funds can come from streams such as donations, grants, and earned income.
Donations and grants can be from individuals, corporations, foundations, or the government, with or without restrictions.
Earned income can be from activities directly supporting or relating to your mission, such as interest and dividends, offering paid services, selling merchandise, or renting space.
Budgeting is necessary to track and manage funds based on different nonprofit budget categories. You can allocate funds from revenues such as grants, corporate philanthropy, and contributions to administrative, program, fundraising, and unexpected expenses.
Exceptional budgeting and financial management for nonprofit organizations requires balancing short-term operational needs and long-term sustainability.
Short-term budgeting and cash flow management help assign resources to daily operations and programs within the fiscal year to meet immediate needs, such as staff salaries and program costs.
You can achieve long-term sustainability through better net assets management, diversifying revenue sources, reserving funds for a rainy day, strategic planning, and investing excess funds or assets to earn interest and dividends for future programs.
Why Financial Management in Nonprofits Is Critical
Here's why proper management of finances matters for nonprofits:
- Preventing Reactive Planning: When you handle your finances appropriately, you cultivate a proactive approach to anticipate potential issues and apply corrective measures early. You can achieve better resource allocation, scenario planning, risk management, and financial resilience.
- Improving Real-Time Visibility: The process of managing your finances helps you see your revenues, expenses, budgets, and actuals in real time, which can improve operational efficiency. Accurate, up-to-date financial data can also help you make informed decisions, enhance transparency, and improve compliance.
- Eliminating Data Silos: Good management of finances promotes integrating and centralizing data for a unified and accurate understanding of your organization’s financial health. With centralized data, collaboration is easier since you can communicate seamlessly and share data between departments for better decision-making.
- Increased Audit Readiness: You can relieve audit pressure because financial administration promotes using better internal controls, ensuring accurate and transparent reporting, and compliance with accounting standards and IRS regulations.
Martus helps ease these challenges. As a cloud-based budgeting, reporting, and forecasting tool purposely built for nonprofits, Martus streamlines financial management for both financial and non-financial teams.
For example, Martus integrates with your existing accounting software for real-time insights and compliance with accounting standards. This helps reduce the chances of audits and prepares your organization for both internal and external reviews.
Book a demo to see how Martus can help you overcome complexity, spreadsheet errors, manual data entry, and veering off your mission.
Breaking Down Essential Nonprofit Financial Statements
We’ve mentioned that nonprofits have unique financials that require specialized handling.
The four special nonprofit financials include:
- Statement of Financial Position: Similar to the balance sheet for for-profits, the Statement of Financial Position shows a nonprofit's financial health at a specific point. It shows the assets, liabilities, and net assets (the difference between assets and liabilities). The statement tells whether you have enough resources to cover your mission and sustain operations.
- Statement of Activities: This financial statement is similar to the for-profit income statement and summarises a nonprofit’s revenues, expenses, and changes in net assets over a specific period, usually a fiscal year. It tells how efficiently the organization is generating revenue and managing expenses to achieve its mission.
- Statement of Cash Flows: Similar to the Cash Flow Statement for for-profits institutions, this statement tracks how cash moves in and out of a nonprofit over a specific period. The statement includes operational activities, investments, and financing activities related to repaying or receiving resources. It tells you if the organization has enough money on hand to fund its obligations and operations.
- Statement of Functional Expenses: This specialized statement groups expenses by functions such as programs and fundraising, and natural classes like salaries and utilities. It shows how you allocate resources across various activities to promote transparency and accountability.
Core Components of Healthy Nonprofit Finances
A healthy nonprofit financial ecosystem involves the major elements below.
1. Nonprofit Financing
We’ve already discussed financing as a way for nonprofits to get funding. The diverse income streams and restrictions necessitate fund accounting and the use of nonprofit accounting software.
2. Nonprofit Bookkeeping
You'll want to practice good bookkeeping because it forms the basis for exceptional accounting.
For example, it's the source of the nonprofit Chart of Accounts, the organized system that records, groups, and tracks financial transactions into categories like assets, liabilities, revenues, expenses, and net assets.
Bookkeeping supports effective financial governance and transparency to build trust with grantors, donors, and the public.
3. Nonprofit Budgeting
Budgeting for nonprofits involves creating expenditure plans that align with an organization’s strategic goals and mission.
Through collaborative budgeting, you can make an overall budget or program budgets with input from relevant stakeholders, eliminating the lack of visibility through real-time updates.
Budgeting supports strategic reporting, accountability, and forecasting.
4. Nonprofit Accounting
Accounting for nonprofits is critical to an organization’s financial sustainability. It's how your organization manages its finances by properly recording, tracking, and summarizing financial transactions.
Nonprofit accounting improves reporting through accurate statements, maintains donor trust, and promotes compliance with legal and regulatory requirements.
For example, effective accounting helps you protect and preserve your organization’s tax-exempt status through proper Form 990 filing.
5. Nonprofit Forecasting
Financial forecasting for nonprofits involves simulating and planning for various monetary scenarios to promote clarity in decision-making, accuracy in managing finances, and situational adaptability.
Forecasting also involves cash flow forecasting, which offers insights into your financial liquidity.
6. Financial Reporting
Nonprofit financial reporting involves preparing and understanding financial statements like the Statement of Activities.
Reporting promotes financial visibility, transparency, accountability, and trust from donors. It also includes budget-to-actuals reporting, which assesses budget performance and helps shape future budgeting decisions.
Common Nonprofit Finance Challenges
You might face these common challenges when dealing with finance for nonprofit organizations:
- Erratic Manual Budget Workflows: Manual budgeting is time-consuming and inefficient due to poor collaboration. Lack of automation leads to inaccuracies, which can cause accountability issues. You also have limited visibility and control, making it difficult to track budgets, identify potential issues, and make timely decisions.
- Inability to Forecast Mid-Year: Not being able to forecast mid-year makes it harder to plan, manage cash flows, maintain consistent funding, and adjust to scenarios. The inability can be because revenue is unpredictable due to changes in economic conditions, policies, or donor behavior.
- Lack of Robust Access Controls in Shared Worksheets: Without proper access controls, you may grapple with compliance issues and security risks, such as leaked donor information through unauthorized access. Version control issues, accidental overwrites, and confusion about the most recent information can make collaboration trickier.
- Difficulty Producing Clean Reports: You may not always have the proper financial systems or expertise to produce clear financial reports for grants and board oversight.
You can overcome these challenges with specialized nonprofit management software, which helps with better donor management, flexible budgeting, and access controls.
Proven Practices for Better Nonprofit Finances
Let's check out some tried and tested ways to manage your finances better.
- Reforecasting Every Month: Reforecasting every month can improve financial health. You can update budgets based on actual performance and situational changes. You'll find it easier to make more informed decisions, seize opportunities, adapt to changes, and align better with your mission.
- Implement User-Level Budget Permissions: You can apply access controls with user-based permissions to promote efficiency, accountability, and transparency. They allow you to control access to specific information to ensure users focus on relevant data without being overwhelmed by irrelevant details.
- Make Budgets Based on Programs: Proper program budgeting allows you to focus on program outcomes and align resources with your goals. Linking expenses to various program results promotes transparency, accountability, and mission alignment. You'll need clear programs and objectives, metrics for tracking progress, and multi-expert input.
Modern software systems make these easier to adopt through collaborative budgeting, financial forecasting, unlimited budgets, and user-based controls.
Unlocking Efficiency with Nonprofit Financial Software
Talking of modern software systems, you can use Martus to improve your nonprofit financial stewardship processes in the following ways:
- Saving Time Through Automation: Martus automates various tasks to save time, such as importing accounting data from your accounting tool. For example, our efficient, collaborative budget solutions can boost your budgeting speed by 50% over traditional spreadsheets.
- Real-Time Collaboration Across Departments: Martus promotes real-time cross-department collaboration, unlike spreadsheets, which are disconnected and unsuitable for working concurrently.
- Clear Audit Trails and Role-Based Access: Martus includes lock controls that ensure end-users can't accidentally change completed and approved worksheets. During the process, you can see who made changes and when. Martus's robust security measures ensure role-based access controls to protect sensitive information from breaches.
- Data Accuracy: Unlike spreadsheets that are prone to errors, Martus ensures accurate data through automation, multi-expert collaboration, process transparency, and Integrations with Accounting software for smooth data flow.
Streamline your nonprofit financial management with Martus—consult with us today to get started.
Frequently Asked Questions (FAQs)
Here are answers to common questions on nonprofit finances.
What Are Internal Controls in Nonprofit Finance?
Internal controls refer to the policies, procedures, measures, or systems your organization implements to protect its information, ensure accurate reporting, and promote legal and regulatory compliance.
Common internal controls include segregation of duties, thorough documentation, and regular review of financial transactions and records. For instance, Martus provides lock controls that prevent end users from making changes to completed and approved worksheets.
How Often Should a Nonprofit Review Its Budget?
You can review your budget monthly, quarterly, semiannually, or annually. The frequency depends on when your board meets, the size of the organization, and your needs.
For instance, reviewing budget performance at the end of the fiscal year can help inform the following year's budget.
What Metrics Should Nonprofits Track to Evaluate Financial Health?
You can track the metrics below to evaluate your nonprofit's financial health:
- Percentage of revenue spent on administrative costs (administrative cost ratio)
- Percentage of revenue spent on programs (program expenses ratio)
- Operating surplus or deficit (net assets vs total expenses)
- Cash flow from operations
- Fundraising efficiency
- Donor retention rate
- And more.
Conclusion
Managing nonprofit finances properly can help you overcome budget delays, difficulties collaborating across departments, and manual processes.
To achieve this, you'll need dedicated nonprofit financial management software with budgeting, forecasting, and reporting functionalities. It should also connect seamlessly with your existing accounting tools for easy data importation.
As dedicated financial administration software for nonprofits, Martus streamlines budgeting, reporting, and forecasting to ensure you remain true to your mission.
Martus helps you save time through automation, simplifying tasks like importing data from your accounting software.
You can use Martus to produce multiple budgets, clean reports for your board and donors, and accurate financial projections throughout the fiscal year.
Join our weekly Coffee Break Demo to discover how other nonprofits are gaining real-time insights and saving time with Martus.