Archives for July 2014

The Differences between For-Profit and Not-For-Profit Accounting

When dealing with not-for-profit accounting and for-profit accounting there are many similarities. For example, the tracking and reporting of income and expenses, and payroll taxes, but there are some very important differences that make nonprofit organizations different from the general for-profit businesses.

The most notable difference is the functional expenses that the IRS requires nonprofits to report. Functional expenses include itemized expenses across management (general and administrative), fundraising, and program areas. The necessity to report these particular forms of expenses comes from the nonprofit’s need to push its resources towards the mission of the organization.

So what does this mean for not-for-profit accounting? It means that there has to be an established system that defines how you will allocate expenses across the functional areas and into the specific programs. An example of this would be if the administrative function takes up 20% of the office space, then you assign 20% of an expense such as paper to the administrative functional area.

To help determine how much a program or activity actually cost the nonprofit organizations can use a cost allocation plan. This plan when accurately done can give a clearer picture of the organization’s finances. Several acceptable methods can be used to determine the organizations finances. Two of these are applying direct/indirect costs, and allocations based on percentage of payroll or physical space used (like the example above). A combination of these is also acceptable, but to determine which is best for your organization consult an accountant.

Nonprofits also have to track revenue in the form of contributions. This included unrestricted and restricted funds, donated goods, in-kind contributions, pledges, etc. There also has to be a standard value placed on donated services. This is necessary to record donated services   such as volunteer time in the organizations financial statements.

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Basic Reports for Nonprofit Organizations

Like many organizations and businesses, there are specific reports that nonprofit organizations have to provide when reporting about their organization. These report not only help determine the financial health of the organization, but many are also required by funders when applying for grants. The reports also convey important financial information to the board of trustees and the government.

The following are the basic financial reports that nonprofit organizations should include:

  • Statement of Financial Position: This is also referred to as a balance sheet. This summarizes the assets, liabilities and net assets of the organization at a specific date. It is like taking a picture of the organization at that particular period.
  • Statement of Activity: This is the income and expense statement. It shows an overview of the financial activity over a period in time. This statement will also show income with the expenses taken out, which will result in a profit or a loss.
  • Statement of Cash Flow: This statement summarizes the resources that are available to the organization during the reporting period and how the resources were used. This is one of the most useful reports because it shows the income coming and the expenses going out. A statement that shows projected cash flow can also be helpful to the board in determining if there will be any shortfalls or overages for the budget period.
  • Statement of Functional Expenses: This report is for all expenses related to the program services and supporting services. Expenses for each program and shown divided into the various programs. The expenses under the supporting services are usually divided into two sections, the management and the general expenses, and fundraising expenses.

There are other report that can be used such as government information returns, payroll tax returns, reports to founders, management reports, budget monitoring reports, and analysis of statements and investment reports. The report that your nonprofit needs is determined on an individual basis. Remember nothing replaces a qualified accountant that can take care of all the needs of the nonprofit.

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Preparing a Budget for a Nonprofit

For any organization, profit or nonprofit, it is important to establish a operational budget. The operational budget is the foundation for your work and how it will be carried out over the next year or even several years. You will be able to establish benchmarks for your organization, gauge the financial health from year to year, and determine what the organization’s priorities should be.

When developing your budget keep in mind the following:

  • Establish the budget period. Is it one year or multiple years? Determine how many years your budget needs to cover. If it needs to be more than a year at a time establish the intervals and reasoning for the multiple year budget.
  • Analyze financial performance and program achievements from the prior year. This gives you the opportunity to adjust your focus for programs that are doing well or other that may need a boost.
  • Set program and organizational goals. Once you determine what the performance was for last year, you can project what the performance should be for the coming budget period.
  • Estimate expenses. Every expense should be analyzed including fixed costs such as tax, rent, utilities, etc. and variable costs that fluctuate based on number of clients and environmental factors, and incremental expenses that only occur when a particular action is taken. The variable costs are the most challenging to predict, but they can be based on the last budgetary period or on a short/long range plan established by the organization.
  • Estimate anticipated revenue. Base what revenue off last budgetary period and then adjust for an increase or decrease based on prediction for the upcoming period.
  • Plan for needed cash flow and develop cash reserves. It is important to have the necessary cash for the day-to-day operation of the organization. Having a healthy cash flow and cash reserves can be beneficial for more than emergencies.
  • Adjust to align expenses and revenue. Make any adjustment necessary to maintain a positive budget and healthy cash flow for the organization.

When your budget is established, it is easy to see how the money flows through the organization and areas where refinement is necessary. The most important part to keep in mind is how much money you will raise. It is easy to say you will raise a lot of money, but it is important to be realistic when setting your goals and projections.

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Audits for Not-For-Profit Organizations

This is the time of year audits are conducted  in full force, but not all audits involve the IRS. Most audits are a review of procedures, internal and external management reviews, etc. Many time federal and state governments require a yearly audit for all businesses, whether for profit or not-for-profit. The federal government requires organizations receiving federal funds of more than $500,000 a year to go through a single audit, which is a yearly audit covering and entire year of the program in question.

If it is determined that your business needs an audit, then it is important that a licensed independent certified public accountant prepares it. The accountant will know that proper forms and procedures that the audit will need, and the requirements for the federal and state government.

Once the auditors determine what is required and beneficial then they can prepare to look into you organization. Auditors will examine many procedures during an audit, but you can expect them to look at:

  • Bank reconciliations
  • Selected restricted donations (To ensure that they are handled properly)
  • Grant letters
  • Physical assets
  • Journals
  • Ledgers
  • Board Minutes

Once they have examined everything then they will formulate a report on the accuracy of the financial reports.

If your company undergoes an audit, the board of directors should establish an audit committee that is responsible for selecting the auditor, reviewing the auditor’s outputs, and meeting with the auditor for the pre- and post-audit to address any issues or questions. This committee typically has ongoing responsibilities for the organization that includes the overall financial over-sight and internal financial controls.

Audits do not have to be a scary thing for companies to go through. It is important to review the internal controls and procedures that run the day-to-day part of the organization. It is important that everything runs smoothly, and audit will help with this process.

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