The Basics of Nonprofit Accounting

accounting software for nonprofits

Accounting for nonprofits is similar to financial tracking for a regular business, with a few key differences that fit with the unique needs of charitable organizations, schools, government offices, churches, and other nonprofits. These organizations use four main financial reporting statements: balance sheet, income statement, statement of cash flows, and statement of functional expenses. The income flow is known as fund accounting; payables and receivables are the same for a non-profit as in a regular business.

This is a comprehensive resource on the basics of nonprofit accounting. Having a set of best practices allows your organization to make sure it is hitting its key performance indicators (KPI). The outline here includes the information you need related to nonprofit and fund accounting, from the leading software platforms to accounting best practices and bookkeeping tasks.

At Capital Business Solutions, we are dedicated to helping nonprofit organizations like yours save time, improve productivity, and maintain accurate financial reporting and records with software solutions.

Understanding Nonprofit Accounting

Nonprofit accounting is defined as the process of recording, tracking, and reporting financial positions for not-for-profit organizations. Like commercial accounting, you need to record accounts payable and receivable, complete bank reconciliation tasks, maintain the general ledger, and run reports. At all times it is essential to do so while following GAAP and all national ethical standards and present it to all your stakeholders, including the board of directors, donors, and the IRS so you can maintain your tax-free status.

GAAP stands for Generally Accepted Accounting Principles and are the standardized general principles followed by accountants in all sectors. These standards are instituted by an organization called the Financial Accounting Standards Board (FASB). Other factors such as KPIs are still an important internal indicator of financial health for a nonprofit.

The unique needs of nonprofit organizations lead to the leveraging of a different type of accounting, also known as “fund accounting,” to manage their finances. It entails tracking the amount of cash assigned to different purposes and the usage of that cash for specific projects.

Differences Between For-Profit & Nonprofit Accounting

You know that business accounting practices are different from practices used in nonprofits, but let’s dig a bit deeper with our article, Differences Between For-Profit & Nonprofit Accounting. This article is ideal for accountants and bookkeepers who have made the transition from business to an NPO and would like to know more.

Differences From Regular Accounting

The primary difference between fund accounting and standard commercial accounting is that while standard accounting uses one primary fund for all expenses, nonprofit accounting focuses on tracking its restricted and unrestricted funds (explained further below).

Additionally, for a nonprofit organization, gross receipts replace gross sales. Gross receipts are the amount of money your nonprofit has raised without any expenses being taken out. These sources can be from fundraisers, government grants, or direct donor contributions.

Fund accounting software is available to allow nonprofit organizations to set money into different groups or funds to stay organized, track usage, and make sure the money is spent only on what it is designated for. The latter part is especially important for transparency and maintaining the support of its stakeholders.

Differences Between Government and Nonprofit Accounting

While government agencies and offices are considered nonprofits, they follow very different accounting principles and regulations. Learn more in our article, 3 Major Differences Between Government and Nonprofit Accounting.

Restricted vs. Unrestricted Funds

The various income funds available to a nonprofit are classified according to the intended purpose and outlay.

  • Restricted funds: These are mandated to be spent on certain projects and activities at your organization, either by a donor’s specific request or by a grant.
  • Temporarily restricted funds: Cash for activities at your nonprofit that are mandated until a certain time period, before becoming available for other purposes.
  • Unrestricted funds: Also known as the annual fund. These funds can be spent on whatever aspects of your organization require the greatest need or become time-sensitive.

These restrictions may also apply to the assets line on the Ledger. Restricted assets include donor-imposed conditions and are especially common for large capital expenditures. Unrestricted funds are “released” to the unrestricted fund category when dollars are spent based on operational needs.

Maintaining the General Ledger

Like regular for-profit accounting, nonprofits need to track income and outlays on the general ledger. The transactions are accumulated over the fiscal period, and the totals are maintained and account balances are used as the basis for all reporting activity. Account balances are checked to generate all financial position statements produced throughout the year.

Access to the general ledger should be limited to only a few individuals. Most transactions are posted automatically through receipts and payables modules. All modifications to the accounts should be made by posting a journal entry. This procedure ensures an audit trail will be maintained, and all activity is recorded and monitored. It also shows the totals that are presented in the financial statements and IRS Form 990.

Financial Position/Balance Sheet

The balance sheet is a report that shows a snapshot of your organization’s financial health. It measures the assets, liabilities, and net assets in a single document. Also known as the financial position, it is part of the accounting process and is done as an equation. The simplest mathematical way to write it is: 

Net Assets = Assets – Liabilities

The Net Assets show the total amount of Assets available to a nonprofit after subtracting any Liabilities from the available Assets.

Statement of Functional Expenses

The statement of functional expenses report is used by nonprofits to present the functional classification of expenses in addition to the natural classifications of expenses. Natural expense classifications are what constitutes an organization’s chart of accounts and what is featured on its statement of activities. It further classifies natural expenses into three areas: program, management and general, and fundraising.

Create Budgets for Expenses, Fund Uses

Budgeting for a nonprofit involves making an educated guess as to what finances will look like and a projected cash flow. It requires examining what happened in the previous period, what happened three months ago, and what the same month a year ago looked like; that information can then be tabulated to make sound financial decisions for the months and years ahead. Managing cash flow efficiently and effectively is a must for all nonprofit organizations.

Specifically, a nonprofit budget is a set of planning documents used to predict expenses and allocate funds. When you analyze each aspect of your budget, you will need to understand how the budget is figured out and calculated.

Expected Revenue

This can be calculated using historical figures and two different calculations: the cutoff method and the discount method. It will also include projected revenue through unrestricted funds and grants.

The cutoff method requires you to take each separate revenue stream and multiply it by the probability that you receive the funding. For instance, if you have an 80% chance of receiving a certain grant, you would multiply the grant funding by 0.8. The discount method, on the other hand, requires you to take the entire expected revenue and factor it by your income. For instance, if you expect to receive a total of $500,000 in revenue, but believe you have a 75% chance of achieving that revenue amount, you would enter $375,000 in your budget.

Expense Budget

Your expense budget will divide the entire expenditures for your organization into separate categories. These categories will include but are not limited to fundraising expenses, operational expenses, and program expenses.

accounting software for nonprofts

Statements of Activities and Cash Flow

Nonprofits and for-profit organizations alike must understand their cash flow and provide a statement about how it moves in and out of the organization. These Statement of Activity reports are generated monthly, going back the previous thirteen months. Using this report, nonprofits can categorize the trends that are impacting their revenue and expenses. It can show changes in net assets from the beginning of the year to the end of the year.

For example, if you have $50,000 of restricted assets set aside for a scholarship program, then decide to provide a new $5,000 scholarship, it is not a loss in funds. Rather, it is a use of funds for their intended purpose. These types of expenditures will be reflected in your statement of activities.

Accounting software can be a boon for providing notification of the cash flow situation with its ability to create custom reports tailored to each stakeholder.

Income and Expense Tracking

Income tracking is used for: building a budget with proper cost allocation and tracking a nonprofit’s cash flow. Although financial transactions are recorded in the systems that make the organization’s ledger, recording charitable donations require additional detail. FASB principle 117 requires nonprofits to record charitable contributions as unrestricted or as temporarily or permanently restricted.

A best practice is to limit this function to one or two individuals.

For the expenses, they are tracked in your financial position or there are also software applications that provide a more sophisticated way to manage expenses, and many effective tools can be free and open-source.

Expenses can be categorized as one of two types: Reimbursements to employees for out-of-pocket payments they have made during the course of doing business. Or secondly, payments to service providers or vendors for services or products the organization has purchased.

Donation Tracking

Donations come from individuals or other organizations and need to be tracked as part of the income.

Donations and grants must be tracked the moment they are processed into a nonprofit organization’s ledger. Fund tracking should show exactly where every penny is being moved, spent, or saved according to its correct category.

Volunteer Tracking

Nonprofits also have a vested interest in tracking time and talent contributions from their network of volunteers. At the time of this writing, the value of each volunteer hour on a national scale is $28.54. However, unless the volunteer is providing a specialized skill, such as those you receive from a licensed professional, these hours do not qualify as an in-kind donation.

Tracking volunteer hours is helpful for two main reasons. The volunteer time can be used to create or improve a nonfinancial asset, such as skilled or unskilled volunteers building a new facility for a nonprofit. Secondly, the previously mentioned in-kind donation of time from a specialist can be accounted for in the ledger.

Bank Reconciliation

Bank reconciliation involves linking and verifying your account balance against a source document, such as a bank statement. This is done as part of financial reporting and analysis, and verification is important for transparency.

Donor Management

This process is one of the most important for accounting purposes. It involves organizing a donor’s information, tracking your interactions with them, and maintaining your relationship with them. Because donors form the backbone of your nonprofit work, building meaningful relationships with your donors should be a central focus.

This can be done in several ways to manage expectations on the part of contributors to improve their experiences with your nonprofit, and to garner supportive relationships along a donor’s journey. The donor lifecycle analyzes donors from a holistic perspective, from acquisition to final engagement. By organizing your donors into a spectrum based on the donor lifecycle, you can understand the best way to engage your partners.

Acquiring the right nonprofit donor management software can store donors’ data, identify trends, categorize your donors into lists and segments, and improve the donation experience through fundraising tools and enhanced communication.


For nonprofits, marketing is both a meaningful task and an expense that needs to be accounted for. Raising awareness of a cause is why many nonprofit organizations exist, but building awareness is an operational task that needs tracking as much as cash outlays.

There are two types of nonprofit marketing: outbound and inbound. Outbound, or push marketing, is the process of putting your messaging in front of a potential donor and includes direct advertising like cold-calling, paid advertising, and trade shows. Inbound, or pull marketing, is a more passive method that provides donors with your nonprofit’s information when they are looking for related causes.

Maintaining a donor dataset, either in old-school notebooks or on sophisticated software, is a critical way to achieve success for an organization.

Grant Management

Public and private grants are a key source of income for nonprofits, so a lot of attention needs to be paid to these as well. Grant management involves all the steps and processes organizations must follow to satisfy the requirements of funding that they have been awarded. It usually means following tasks related to documentation, financial tracking, project management, and more.

Application data is to be collected about how to apply and how often it is available. Otherwise, they may miss the opportunity to renew.

Fund Accounting

MIP Cloud accounting software

Fund accounting, as mentioned above, is what separates nonprofit accounting from regular accounting. Tracking different fund types means separating money into various dedicated funds categories according to their intended purpose and whether they are unrestricted.

If your nonprofit is big enough to use the accrual method of accounting—tracking transactions as they are made—then it is big enough to practice fund accounting. Smaller nonprofits might have only one fund, while nonprofits with endowments and donor-restricted funds might have several funds or more.

There are additional types of restrictions on funds that the stakeholders may create.

Endowment Funds

This is a subset of restricted funds. The principal capital of any endowment is permanently restricted, while the income may be restricted to specific programs, such as funding scholarships.

Board-Designated Funds

Board-designated funds are created by moving unrestricted funds into a new category designated by the board of directors for a particular use. These funds resemble restricted funds, but their use is determined solely by the board and not donors. 

For a nonprofit, each fund should have its own accounting ledger, complete with its own assets and liabilities. This may be overly complex, so be careful about setting up too many funds, and you do not necessarily need separate funds for every activity or program.

Generating Reports and Submitting Form 990 to the IRS

Various financial and annual reports are generated and released to the public each year. They may be demanded by the stakeholders in the charter, or perhaps by financial reporting.

Nonprofits should use annual reports to share their accomplishments, their donors and contributors, and give viewers an in-depth look into their organization and the impact they are making.

Tax exempt status organizations must file a return called a Form 990 with the IRS each year to comply with federal regulations. This form has spaces for data on a nonprofit’s finances and activities which is accurate and open to public scrutiny. These details include:

  • Charity assets
  • Total figures for donations and grants received; however, public charities are not required to publicly disclose the personally identifiable information for donors
  • Board and top staff members
  • Whether the charity gives grants

Running Financial Statements

Most nonprofits look at the financial statements on a monthly, quarterly, and annual basis. When doing so, pay special attention to the financial position. It is a best practice to use software systems to run these reports. When you are preparing these financial statements, you will want to check the IRS’ compliance guide for public charities, private foundations, or tax-exempt organizations other than 501(c)(3) public charities and private foundations for what is required.

Accounts Payable and Accounts Receivable

An account payable is an outstanding bill from a vendor that the organization has an obligation to pay. The following examples show in a journal entry format A ledger is created to show when an account payable is created and how the account payable is removed when the check is cut to pay the invoice.

Receivables are monies owed to the organization by another party. Typically, accounts receivable are recorded when services are rendered to earn revenue for the organization or when promises to give are received by the organization.


Although nonprofits often rely on an army of volunteers, and the board of directors may forgo a paycheck, payroll is still necessary. Having full-time staff is a boon for an organization and allows for consistency across business operations. Payroll is therefore calculated as a liability.

Challenges in Nonprofit Accounting

Nonprofits face many challenges due to very strict rules and regulations, so many smaller organizations struggle with complex accounting issues.

Specific Nonprofit Challenges Include

  • Recording donations, processing expenses
  • Preparing and paying invoices and managing payroll
  • Preparing accurate financial reports
  • Modernizing their accounting programs
  • Accounting for grants and tracking donors
  • Filing Form 990 and annual reports
  • Dealing with the Board of Directors
  • Lack of real-time financial visibility
  • Lack of management reporting
  • Slow paper-based processes

Additionally, nonprofits may struggle to maintain a large enough unrestricted fund balance to support operations or deal with an unexpected expense. If too many contributions are restricted, management has less ability to adapt.

Many of these issues can be mitigated with stakeholder involvement, proper written procedures, or the right set of software programs.

Choosing Nonprofit Accounting Software

Working on complex procedures or archaic programs can be both incredibly time-consuming and a distraction to the livelihood of a nonprofit. Therefore, having the right accounting software can both save time and improve your accuracy through the use of digital templates, tools, and other features designed for the specific needs of a nonprofit. No shortage of accounting programs are available, from simple, completely free options that are designed for small groups, like little league sports teams or school programs, to enterprise-level software suites for global organizations.

So how does a nonprofit decide which accounting solution is best? Consider these factors when choosing the right software, whether it is cloud-based or a desktop application. Cost is a major benefit, although donors may provide restricted funds just for operational use. This can be accounted for if the program charges a monthly fee. Also look for nonprofit-specific features, such as donor management, fund accounting, budgeting capabilities, running financial statements, and compliance management.

nonprofit software training

Nonprofit Accounting Training

If you need resources on your existing software, want to provide additional education to members of your team, or need clarity on certain topics, these nonprofit accounting training articles can help you meet your goals.

Choosing the Right Software Platform/MIP Software Training

If you use MIP software, learn whether customized training is right for your organization and if you need one-on-one guidance or would like to set up a more expansive training program for your accounting and bookkeeping team in our article, Why Your Nonprofit Needs Custom MIP Training.

While we mentioned some tips on how to choose the best accounting software for your organization, we wanted to provide a closer look at this topic. For a deeper dive, check out our blog, Is Your Accounting Software Designed Specifically for Nonprofits, in which you’ll learn why the software you choose should be designed for your organization.

We also offer resources for educational institutions seeking the right software in our article, How to Choose Accounting Software for Nonprofit Education Organizations, in which we focus on the unique needs of schools and the specific features you need.

Consider an Accounting Assessment for Your Nonprofit Organization

An accounting assessment of your nonprofit can find inefficiencies, help you reduce out-of-date information, or streamline your database. Find out if you need a fundraising database assessment.

Schedule a Consultation for Nonprofit Accounting Solutions Today

If you need assistance navigating your accounting software, want to find the right platform for your organization, or integrate features that will save time, improve accuracy, and generate detailed reports, we can help. Schedule a consultation with a member of our team today by calling or filling out our contact form to get started.