In this blog post, we will explore some of the differences between nonprofit and for-profit accounting.
It is beneficial to understand some of the areas in nonprofit accounting that differ from those in a for-profit company. The number of differences between the two is many. We will look at 5 of those areas which will provide a general overview of how nonprofit accounting is different.
1. Mission Driven
The focus for nonprofit organizations is fulfilling their mission. A nonprofit wants to provide services and programs to their community for the betterment of society. Not surprisingly, many individuals work for and volunteer for a nonprofit because they believe in the mission. They want to help the organization succeed and make a greater impact to those being served through the mission. Nonprofit organizations want to bring in funding and donors to expand their reach and grow their services. For-profit companies focus on increasing profits and earnings for shareholders. Appreciating that a key indicator for success in a nonprofit is fulfilling the mission is critical. Specifically, this will help guide which financial areas are most important to the nonprofit.
2. Reporting to a Board of Directors
In order to operate as a nonprofit entity, the organization must have a board of directors. The board of directors are people, that are appointed to board positions. The board serves as the governing body for a nonprofit organization. They typically meet monthly or quarterly to discuss the current operations. In addition, the board receives updates on projects, programs, or fundraisers, and hear reports from department managers.
The board also discusses and votes on items needing board approval. Those items may include approval of the current financial report or purchasing a fixed asset. The board approves new or updated policies as well. It is best to have an odd number of board members for voting purposes. The minimum size of a board should be 3 or 5 people. Appointment to the board is not a uniform process and can be unique to each nonprofit. Individuals that are engaged and committed to the mission of the nonprofit are ideal board members. The founders of the nonprofit, someone with a legal background, another with finance experience, and community leaders all can make for great board members.
3. Tax Status
One of the main differences between a nonprofit and for-profit corporation is their tax status. If approved by the IRS, a nonprofit organization is exempt from income taxes. A nonprofit organization must apply for tax-exempt status through the IRS. If the IRS approves the nonprofit as a 501c3 tax-exempt organization, a letter of determination will be issued to the nonprofit.
Annually, nonprofit organizations are required to file a Form 990 tax return. There are different versions of the Form 990. The amount of gross receipts and total assets for the year will determine the Form 990 to use. A Form 990 must be filed to maintain tax-exempt status with the IRS. If a Form 990 isn’t filed for three consecutive years, tax-exempt status will be automatically revoked. It is crucial for the nonprofit to remain in compliance with this reporting requirement to not jeopardize their nonprofit status.
4. Terminology of Statements and Accounts
A nonprofit organization’s financial statements will have statement names and accounts that differ from those of a for-profit company. Below is a table showing some of the terminology differences between nonprofit and for-profit entities.
|Statements of Financial Position
|Statement of Activities
|Stockholder’s Equity/ Retained Earnings
The statements and accounts for a nonprofit organization and for-profit corporations are very similar. However, it is important to know what each statement and account is referring to, to avoid confusion. An inexperienced individual could misinterpret the financial results of a nonprofit organization. Someone could be looking for a balance sheet and an income statement and not realize they will instead see a statement of financial position and a statement of activities. Ensuring that everyone understands the naming convention of the nonprofit financial reports is key.
5. Tracking Grant and Donor Restrictions
Lastly, another difference between nonprofits and for-profits is their source of income. Nonprofit organizations receive grants and donations as a component of their revenue. As the recipient of these types of funds, the nonprofit needs to track every grant and donation. For grants, a nonprofit needs to capture the grantor’s company information, the award amount, and the grant period. The purpose or restriction for the grant is the most important piece and also must be captured and tracked.
Some grants might be for general operations. Those funds could be used for any activity that the nonprofit chooses. However, most grants will be restricted. Restrictions can be time focused, with funds available after a certain time. The grant could also be operationally restricted for a specific program or event. For restricted grants, the expenses allocated to the grant will need to be tracked to show compliance with the restriction/s. Grant tracking will also allow the nonprofit to report grant results to the board of directors and the grantor.
Donations the nonprofit obtains can be restricted or unrestricted funds. With all donations, a thank you letter should be sent to the donor within a reasonable amount of time. At the end of the year, a donor tax letter will need to be sent to individual donors for their personal income tax preparation. A number of items need to be tracked when a nonprofit receives a donation. The name and address of the donor, the amount, and campaign the donation pertains to are all important pieces. It is critical that the restriction/s associated with the donation is also tracked. Documenting this information will allow the nonprofit to use the funds as intended by the donor. The nonprofit will be able to show what each donation was used for and report on it.
There are many differences between nonprofit and for-profit accounting. The focus for nonprofits is fulfilling their mission and creating sustainable community impact. For a nonprofit to thrive, they will need an engaged and well-rounded board of directors. Additionally, a nonprofit needs the ability to obtain and maintain their tax-exempt status. They also need their audience to be aware of the different naming convention of the financial reports. Further, forming strong relationships with grantors and donors is essential. Compiling with grant and donor restrictions will help with these relationships. As well as, reporting on how the grant and donation funds helped the nonprofit provide more, serve more, or help more.
In conclusion, understanding what makes nonprofit accounting different from for-profit accounting is paramount. It allows one to have better insight into how a nonprofit operates and what is most important to them.