In this blog post, we will explore the top 5 accounting problems we see in delivering accounting services to nonprofit organizations.
Accounting departments, to some extent, for small for-profit businesses are a “nice to have.” When a for-profit entity has a robust accounting function it will help the decision-makers in the business to make more effective decisions and drive revenue growth. In other words, a full accounting function in a small for-profit business (< $5M in annual revenue for the purpose of this discussion) is almost a nice-to-have.
Contrast that with a small nonprofit (again, <$5M in annual revenue) where a robust accounting solution is basically a need to have. Nonprofit accounting is about compliance, first, and driving the organization forward second. If your nonprofit is non-compliant, you can lose your nonprofit status, receive fines and penalties and possibly even face civil penalties.
1) Your nonprofit isn’t using accrual accounting
Most small businesses and small nonprofits use cash-based accounting. Cash based accounting is easy to implement and maintain and it’s easy to understand. Under cash-based accounting, transactions are recorded when cash moves. In theory, cash-based accounting is not very complicated.
Accrual accounting is much more complex and much more difficult to implement and maintain. Under accrual-based accounting, transactions are recorded as they occur, whether or not cash also moves.
Here’s an example of the difference: Let’s say you pay hourly employees every two weeks with a one week lag. Employees earn wages through 12/31 and then you’ll pay them for the two weeks of wages on 1/7. Under accrual accounting, you will recognize the expense in the current year. Under cash accounting, you will recognize the expense next year on your employees’ next payday. The same principle can apply month to month, not just across years.
Here are five situations in which you’ll need to maintain accrual-based financial statements:
- Your nonprofit’s bylaws require an audit. Audited financials must comply with Generally Accepted Accounting Principles (GAAP) to be audited under Generally Accepted Auditing Standards (GAAS). Audited financials must be presented on an accrual basis.
- Your nonprofit is going to apply for grant funding. Most grantors will require audited financials to be considered for funding.
- You want to show management, the board of directors and donors the economic reality of your nonprofit. See the above example. Management and donors can and should know the accrued liabilities and assets of the nonprofit to make informed decisions.
- Your nonprofit expends more than $750,000 in federal funds. This will trigger a single audit.
- Some states require an audit. As we now know, audits require accrual-based financial statements.
2) Your nonprofit isn’t effectively tracking donors
Donor tracking is important for three reasons:
- You need to provide letters to donors. These letters will tell the donor, and more importantly the donor’s tax accountant, how much they donated during the course of the year.
- Having an accurate list of donors may help your nonprofit raise funds in the future. You’ll know who is most likely to donate again.
- If there is a restriction placed on the donation, you must use the money according to that restriction.
Your accounting system and financial app ecosystem need to be setup correctly to track this information. Having this information handy at a moment’s notice can greatly impact your organization’s ability to function effectively.
Wouldn’t it be awesome if your accounting software contained the same information as your donor database? Automation of information workflows in this area can help ensure timeliness and accuracy across applications.
3) Your nonprofit isn’t effectively tracking restrictions
Donors and grantors may require your nonprofit to spend the dollars it receives in certain areas. You will need to have an accurate accounting of which dollars were spent and for what purpose. This information may need to be reported to the grantor, auditor, and in the event a donor asks.
What happens if your nonprofit fails to comply?
You will need to verify donor funds were spent the way the donor intended. Furthermore, many donors will use websites such as Guidestar to research nonprofits before donating. Non-compliance in this area can lead to legal action against your nonprofit’s board of directors and management.
4) Your nonprofit isn’t paying attention to Unrelated Business Income
Unrelated Business Income is tricky business and relates to Unrelated Business Income Tax. What is Unrelated Business Income Tax (UBIT)?
Per IRS Publication 538: Tax on Unrelated Business Income of Exempt Organizations
“Unrelated business income is the income from a trade or business regularly conducted by an exempt organization and not substantially related to the performance by the organization of its exempt purpose or function. Use by the organization, of the profits derived from this activity, does not, alone, make the activity substantially related to the performance by the organization of its exempt purpose or function.”https://www.irs.gov/pub/irs-pdf/p598.pdf
In other words, your nonprofit that pays no tax could potentially pay tax in some circumstances. Having a thorough understanding of UBIT and working with a financial professional to monitor how it might apply to your organization is a good idea.
5) Your nonprofit isn’t using a cloud-based system
It’s no secret that we love cloud-based accounting.
Cloud-based accounting allows for a lot of benefits, such as:
- To some extent, it’s possible to outsource your data security to a third party. For instance, would you rather be liable for the QuickBooks Desktop file on your bookkeeper’s laptop, or would you rather Intuit (multi-billion dollar company, maker of QuickBooks Online) take care of it?
- Cloud-based systems allow for easier data connectivity. Data connectivity is what allows for the automation of crucial accounting functions. The ability to stitch together workflows with software like Make (formerly Integromat) let us automate donor letters, for instance.
- Data connectivity allows for things such as cloud-based financial reporting. Cloud-based reporting is accessible on-demand by your key decision-makers.
In summary, nonprofits face a lot of challenges with their accounting and finance function. Accounting and finance for a nonprofit are mostly concerned with compliance. Management decisions are a secondary consideration for nonprofits. The reverse is true for for-profit businesses, especially small businesses. With both types of organizations it’s crucial to have a robust accounting and finance function. An experienced finance team will be there to provide invaluable advice and guidance along the way.
The top 5 accounting problems for nonprofit organizations are all manageable. However, it takes a diligent and dedicated management team to do so.