A Practical Guide to Not-for-Profit Financial Management

Not-for-profit financial management is notoriously difficult, thanks to limited resources, unpredictable sources of funds, unclear forecasts, fund restrictions, complex compliance requirements, and the ever-glaring need to align with the mission despite challenges.

As nonprofit leaders, you must devise smart and practical financial management strategies to overcome these and many other challenges. 

In today's practical guide, we'll discuss how you can use modern financial management software for nonprofit organizations to simplify various processes. 

For example, as financial management software designed specifically for nonprofits, Martus can help with solutions such as fund-based accounting, monthly reforecasting, collaborative budgeting, and transparent reporting. 

Schedule a consultation with our team to see how Martus can empower your team through actionable financial management practices. 

How Not-for-Profit Financial Management Works

Sound not-for-profit financial management requires you to source, plan, monitor, and report finances in a way that supports your organization’s mission, ensures compliance, and maintains stakeholders’ trust. 

Unlike a for-profit company, a nonprofit must balance its budget to fulfill its goals and make a sustainable impact rather than generate a profit. 

Here's the basic framework for how financial management works in a nonprofit and how it differs from a for-profit institution:

1. Focus on the Mission

A not-for-profit makes all its financial decisions based on its mission and goals. You must allocate resources to programs and services that directly support the mission, making it easy to measure success by impact rather than income, like in a for-profit. 

The mission-first budgeting process involves forecasting expected income and allocating expenses to categories such as program services, administrative costs, and fundraising. 

2. Observing Donor Restrictions and Categorizing Funds

Many nonprofits deal with restricted donations as donors specify how they want the money to be used. For example, a donor may require you to specifically allocate their money to a scholarship program. 

Besides categorizing such funds as restricted donations, you can also have other categories, like unrestricted donations. Restricted donations are further split into temporarily restricted funds and permanently restricted funds. 

You can account for every fund separately through fund accounting, which tracks how you allocate and spend restricted or unrestricted monetary resources. 

You can use unrestricted funds at your own discretion, usually to cover operating expenses like salaries and rent. Temporarily restricted funds typically apply to time-limited programs or specific grant cycles. 

You must strictly stick to donor intent, unlike a for-profit organization, which generally uses its revenue however it decides. 

3. Grants and Grant Cycles

Many nonprofit organizations rely on grants from corporations, foundations, and governments. Grants usually come in annual or multi-year cycles and require formal application, grant reporting, and renewal procedures. 

You must track how you spend the grant income within its specified time and terms using separate grant accounts. 

For example, if you receive a two-year grant to operate a scholarship program for short courses, you must track it separately. Any unused funds should go back to the grantor. You can also retain and reallocate them with the grantor's permission. 

The Importance of Nonprofit Financial Planning

Here's why planning and managing your nonprofit's finances better matters:

1. Increasing Your Adaptability: Proper not-for-profit financial management makes it easy to adapt to changing circumstances. For example, since revenues are unpredictable, you can revise your budgets in real time to reflect changes in funds. Reforecasting helps you update and adjust forecasts throughout the fiscal year to make strategic decisions as situations change. 
2. Promoting Long-Term Sustainability: Because revenue and grant timing are unpredictable, you may have to deal with delayed grant payments, seasonal funding shortfalls, and restricted funds that cover daily operations. Diversifying funding sources and building a reserve fund for emergencies and lean times can help sustain your programs and operations in the long term. 
3. Ensuring Compliance: By following nonprofit accounting best practices and IRS regulations, you can ensure compliance with donor, grantor, and government requirements. For instance, fund accounting helps you track expenses by grant or donor requirements to ensure you comply, gain their trust, and secure their continued support. 
4. Expanding Bandwidth: You may face limited bandwidth, which means a lack of capacity in terms of time, staff, and even monetary resources. Managing resources well helps you overcome time, staff, and financial limitations. For example, allocating enough money to staff salaries ensures you attract enough talent so your workers don't have to play multiple roles. Role multiplicity overwhelms workers and reduces their ability to pursue new funding opportunities that may arise. 

Financial Roles and Responsibilities in NFP Organizations

Depending on the size and maturity of your nonprofit organization, you can expect financial roles and responsibilities such as:

1. Executive Director: As the senior-most staff member, the executive director ensures your organization delivers its mission as per the strategic direction set by the board. They can manage finances, staff, and programs alongside other leaders. They also help with fundraising and other means of finding financial resources. 
2. Chief Financial Officer (CFO): The CFO works with executive leaders and focuses on providing guidance and leadership in financial strategy. They report directly to the executive director and help with budgeting, forecasting, managing grants, developing fiscal policies, and setting financial goals. 
3. Finance Director: The finance director manages daily financial activities, including budgeting, forecasting, accounting, and reporting. They guide and lead the financial team to ensure accountability and transparency in financial matters. They report to the CFO, where one is available, or the executive director. They may also liaise with the board's financial committee. 
4. Program Lead: The program lead or director oversees how the organization creates programs and manages them to support your goals and mission. They help develop and oversee program budgets as well as participate in resource allocation to ensure all programs are financially healthy and sustainable. They work closely with the finance team to ensure financial practices like reporting are consistent. 
5. Board of Directors: The board fulfills the fiduciary duty of ensuring your organization is financially viable and uses its resources properly. They oversee the general financial health of the organization and ensure your internal controls are operational. They also approve budgets, establish and update financial policies, and help set strategic goals. 

It's important that all departments collaborate to secure the organization’s financial health. 

For example, the program lead should communicate program-related financial information to program participants and the financial department. 

Where nonprofit roles are blurred or unclear, especially in small organizations, you may struggle with reduced efficiency, increased team conflict and stress, and decreased ability to achieve your mission. 

Key Actions for Not-for-Profit Financial Management

Effective financial management requires structure, adaptability, and alignment with the mission. 

Here are practical steps to help you manage resources strategically and transparently while staying ready for changes. 

1. Building Forecast-Ready Budgets

You need to develop comprehensive budgets for programs and the overall organization, indicating your expected revenues and expenses. 

Use fund and expense tracking tools to identify areas for cost savings and increasing revenue. 

Your budgets should be forecast-ready, meaning they are designed for regular updating and revision based on actual performance and changing situations. 

The idea is to eliminate the issues of traditional static budgets, so you can make informed decisions and adjust your finances as needed. 

Let's check out some important actions at this stage:

• Clearly label your restricted and unrestricted funds.
• Make conservative revenue estimates and realistic expenses.
• Review your budget-to-actuals every month to identify variances. 
• Use rolling budget forecasts that you can update monthly, quarterly, or mid-year. 
• Model what-ifs or scenarios, such as, What if we get a new but restricted $100,000 grant?

2. Assign User Roles

You should assign clear user roles and responsibilities so that every staff member and leader aligns with your mission and objectives. 

You can assign the roles we discussed earlier, such as the program lead, CFO, and finance director. 

Segregating duties is important as an internal control measure to ensure that no individual can single-handedly complete a financial transaction. 

For instance, a program manager can manage their own program budget, but the financial team and the board review it before the funds are disbursed. 

Consider the actions below at this stage:

• Define the roles and responsibilities for budget makers, finance directors, executive leaders, and more. 
• Separate duties, such as the person who approves payments isn't the one who also makes the checks. 
• Develop review and approval systems for grants, donations, and expenses.
• Set up dual sign-offs for large expenses. 

3. Align Financial Data with Program Impact

Ensure your not-for-profit financial reporting shows not only the money you've spent but also the missions and impacts you've accomplished. 

You'll want to consider actions like the ones below:

• Tag expenses by funder, grant, or program in your accounting system. 
• Have the program and finance teams collaborate in monthly check-ins. 
• Use real-time dashboards that show your functional expenses alongside relevant impact metrics. 
• Match your financial reports with program outcomes, such as the dollars you’ve spent on every nurse in a nurse scholarship program. 

4. Use Fund Accounting to Track Restrictions

As part of your nonprofit accounting, use the fund accounting feature in your accounting tool to track restricted and unrestricted funds separately. 

Consider these actions:

• Reconcile grant spending with funder reports regularly.
• Set up separate fund categories in your accounting software. 
• Record grants and donations by the type of restriction or the lack thereof. 
• Send notices to your program leads when they have nearly exhausted restricted funds. 

5. Monitor Cash Flow and Liquidity Monthly

Check how cash flows in and out of the organization to ensure you are ahead of pitfalls such as delayed grant payments. 

Here's what to do at this stage:

• Create a fiscal-year-long cash flow forecast with the anticipated expenses and revenues.
• Have at least 3-6 months of operating and program reserves if possible. 
• Consider the timing for grant receivables and reimbursements. 
• Monitor upcoming low-cash periods to plan early. 

6. Conduct Financial Reviews

Have regular financial reviews and analyses with the leaders and the board to keep everyone accountable and aligned. 

You can meet monthly with leadership and quarterly with the board's finance committee, depending on how your organization operates. 

You can do the following in this step:

• Review your budget vs. actuals every month with the leaders.
• Provide summary reports or dashboards rather than just spreadsheets to the board. 
• Discuss your explanations for the variances and whether you need to reforecast. 
• Connect these discussions with the mission's impact, not just the numbers. 

7. Prepare for Grant Reporting and Audits Year-Round

You'll want to be grant- and audit-ready all the time, rather than during deadlines only. 

You can do the following:

• Get your documents regarding restricted funds, time-bound grants, and program expenditure in order. 
• Update your nonprofit chart of accounts to reflect funder requirements, donation tracking, restricted funds, and grant tracking. 
• Maintain digital records of contracts, receipts, and reimbursement requests. 
• Have internal mini-audits or mock grant reviews semiannually to ensure you are always ready for funder questions, site visits, or even surprise audits. 

8. Automate and Streamline as Necessary 

Use nonprofit budgeting and financial management software to streamline how you manage your nonprofit finances. 

With dedicated not-for-profit financial software like Martus, you can simplify the process through our automation and modern budgeting, forecasting, and reporting tools. 

Here are some activities to complete for this step:

• Integrate your accounting software with your financial management software, grant systems, payroll, and donor CRM. 
• Automate expense tracking, invoice approvals, payroll, and other activities. 
• Set automated alerts for grant deadlines and budget limits. 

9. Report Transparently

Communicate your financial health with donors, grantors, the public, and other stakeholders to gain their trust and support. 

You can:

• Prepare and publish fiscal year reports with detailed financial highlights and impact metrics. 
• Share simple financial summaries with potential funders during fundraising campaigns. 
• Be open about the challenges you face and how you plan to (or usually) address them. 

These steps can help you build a financially sound, transparent, accountable, and impact-driven organization that funders trust. 

How to Improve Not-for-Profit Financial Reporting and Transparency

Let's build up further on improving reporting transparency in this section. 

You'll want to improve critical aspects like functional expense reporting and grant-specific reporting. You must do this despite pain points such as manual data importation, lack of dashboard visibility, and the complexity of compliance requirements. 

For grant reporting, you need to show grantors how you used their grant. Make time-bound reports (quarterly, semiannually, or annually) to prove that you used funds as per the restrictions. 

Your Statement of Functional Expenses should be consistent and accurate, with expenses properly classified based on their nature and function.

To improve financial reporting and transparency, you can:

• Maintain comprehensive audit trails to remain compliant and audit-ready. 
• Present reports clearly and understandably in plain language and without industry jargon. 
• Embrace timeliness to show your general preparedness for audits, reporting, and oversight. 
• Embrace fund accounting to track multiple funds in real time while complying with donor and grant regulations. 
• Embrace role-based access to budgets and reports to prevent accidental edits while encouraging shared ownership. 
• Use real-time reporting dashboards in not-for-profit financial tools to create customizable reports that show your key performance indicators. 
• Use financial software with dimensional tagging capabilities by fund, grant, or restrictions to filter your not-for-profit financials for reports and simplify audit preparation and grant compliance. 

Common Hurdles and How to Stay Ahead of Them

Your financial management journey won't be all about upsides. You can encounter common pitfalls such as:

1. Budget Silos Between Programs and Finance

You are likely to struggle with limited coordination and communication between program staff and the financial team. 

The disconnect can cause confusion and stress, leading to missed opportunities, inefficient allocation of resources, and financial decisions that lack full program context. 

Lack of coordination and transparency can erode your credibility with donors and make it harder to secure future funding.  

To deal with this, you can promote open communication and collaboration and provide financial literacy training to program staff. 

2. Inability to Reforecast Easily

If you can't reforecast efficiently and effectively, you'll struggle to adapt to changing situations, such as unexpected financial shortfalls. 

You'll need specialized expertise and software with forecasting functionalities to help you reforecast regularly, especially monthly, to capture budget vs. actuals realities. 

3. Difficulty Preparing Clean Financial Statements for the Board

Complexities in compliance requirements, restricted funds, and fund accounting can make it difficult to generate accurate and transparent financial statements for your not-for-profit organization. 

If your not-for-profit financials are inaccurate or late, your credibility with the board can erode. You also reduce the board's ability to make informed decisions. 

You can ensure clean reporting by using a robust accounting system, offering staff financial literacy training, segregating duties, embracing collaboration, and working with professional accountants. 

Leveraging Nonprofit Financial Software

The good news is that you can overcome these and other hurdles with the right not-for-profit financial software, including accounting tools and budgeting, forecasting, and reporting software. 

The features and capabilities of these tools can streamline your financial management. For example:

• Role-based access helps prevent errors because multiple users work together, making it easier to spot and correct mistakes early. End-users can't make accidental or intentional edits to your approved workflows. 

• Pre-built templates save time because they reduce the time you spend on formatting budgets, reports, or forecasts. 

• User dashboards promote financial visibility through the real-time tracking of funds and restrictions. 

Martus fits the bill as a dedicated tool for not-for-profit financial management. 

Built with nonprofits in mind, Martus integrates with your accounting software for automatic data pulls. It also supports nonprofit collaborative budgeting, timely reporting, and data-informed forecasting. 

You can use Martus for its end-user lock controls, real-time dashboards, and the ability to cut the time you spend managing finances by 50% compared to traditional tools like spreadsheets. 

Schedule a demo today to see Martus in action. 

Frequently Asked Questions (FAQs)

Have additional questions about not-for-profit financial management? We've got the answers. 

What Are the Key Financial Statements for Not-for-Profit Organizations?

The key financial statements for not-for-profit organizations are:

• Statement of Financial Position, which shows your financial health at a specific point by capturing your assets, liabilities, and net assets. It indicates your financial stability and sustainability. 

• Statement of Activities, which shows your revenues and expenses and the changes in net assets over a specific time. It's important when filing Form 990. 

• Statement of Cash Flows, which tracks cash coming in and going out over a certain period to help assess your liquidity and ability to meet your obligations. 

• Statement of Functional Expenses, which shows your program services and supporting activities based on nature and purpose to explain how you are using your resources to fulfill your mission. 

Your accounting software can help you collect all the data you need to generate accurate financial statements. 

Do Not-for-Profits Need to Follow Specific Accounting Standards?

Not-for-profits must follow Generally Accepted Accounting Principles (GAAP), a set of accounting standards, practices, and rules established by the FASB to guide organizations in preparing and presenting financial statements. 

It's also wise to follow the recommendations of the American Institute of Certified Public Accountants (AICPA). 

While it doesn't issue accounting standards that directly apply to not-for-profits, the AICPA supports them by offering audit and accounting guides, best practice publications, and training resources. 

For example, you can refer to the AICPA’s Not-For-Profit Entities Audit and Accounting Guide to learn more about nonprofit auditing and how to prepare your financial statements. 

Your accounting software tool can follow various accounting standards, such as accrual accounting, to streamline compliance. 

How Do You Track Restricted vs. Unrestricted Funds in a Not-for-Profit?

You can track restricted and unrestricted funds using accounting software that supports fund accounting, the specialized type of accounting for monitoring different types of funds and restrictions. 

You can track Net Assets Without Donor Restrictions and Net Assets With Donor Restrictions, which can be restricted temporarily or permanently. 

You'll find the ability to track revenues and expenses using dimensional tags in your accounting software helpful in determining the release of donor-imposed restrictions to keep your program leads alerted in time. 

Conclusion

By building a successful not-for-profit financial management system, you can have smart actions, processes, and decisions that lead to better mission outcomes. 

You can maximize your impact if you focus on informed budgeting, accounting, forecasting, and reporting with the input of both financial and non-financial teams. 

To achieve this, you need to use nonprofit-specific financial software to simplify the process. 

For example, Martus can simplify budgeting, forecasting, and reporting through collaboration, real-time dashboards, analytical tools, and pre-built reports. 

Connect with us today to learn more about Martus and how it can help you improve your nonprofit financial management.