Understanding accounting for non-profits
Let’s first begin with a quick demonstration of the difference between for-profit and nonprofit accounting.
In its simplest form, for-profit accounting operates under the principles of profit and loss, whereas a nonprofit operates under the principles of social welfare.
That means that the nonprofit fund serves two functions. It needs to serve the primary function of the organization, and secondly, it needs to provide the necessary funding to continue supporting the mission in future operations.
Accounting for nonprofits needs to focus on the financial aspects of the nonprofit.
Fund accounting specifically focuses on accountability and stewardship as two examples of ledgers, also known as funds. These provide nonprofit organizations with the ability to separate resources into multiple accounts helping to identify where donations and resources come from and how they are being used.
As you might expect, retaining detailed records while bookkeeping is of prime importance as nonprofits operate with a number of tax exemptions and it is important to ensure that all funds—donations or grants—are being used only for permitted purposes.
How a balance sheet works
As you are most likely aware already, a balance sheet is a company’s financial statement and it will include things like assets, liabilities, equity capital, and total debt.
A balance sheet is commonly be made up of two sections, with one side for assets and the other liabilities. The assets are resources or things that a company owns, and liabilities are the debts or obligations of a company. As the name would suggest, the figures should balance out as assets equalling liabilities plus equity.
A balance sheet will need to be calculated regularly—after every quarter, six months, or a year—because it is effectively a snapshot of the company’s financial position at a specified time.
The balance sheet for a for-profit company would also include important information like shareholder equity. The amount of revenue that a company would receive and the amount shareholders would hold is an important defining characteristic of what a company owns and owes.
For nonprofits though, there are no shareholders and therefore this part of the balance sheet is effectively replaced by net assets.
Given the distinct organizational structure differences between for-profit and nonprofit organizations, the information presented on the statement is very different which is why a nonprofit will instead use a statement of financial position to record its assets.
What is a statement of financial position?
In the nonprofit world, there is actually no such thing as a balance sheet. Instead, it is known as a Statement of Financial Position.
What this does is provide an overview of what the nonprofit organization is worth. It means that within the net asset section of your statement of financial position, you will see one of two assets: Unrestricted, or restricted net assets.
Unrestricted net assets
These are donations to a nonprofit organization that have no restrictions placed on them by the donor for a specific purpose. Thus, the nonprofit can use the funds for general expenses or any other legitimate purpose.
Unrestricted donations are generally preferred by nonprofits because it affords them maximum flexibility in benefitting the organization. Potential uses for this kind of donation could range from expanding their services to hiring additional staff.
Restricted net assets
Restricted net asset donations are known as “restricted” because the donor has outlined a specific purpose for their use. This means that a nonprofit organization cannot use it for anything other than the stated purpose.
They can be further classified in two ways.
A temporarily restricted net asset will have a specific use set—an expense or project usually—and also a time period set for its use. This also stipulates that in the future, the net asset could have restrictions removed.
A permanently restricted net asset is one that has a specific purpose set and it will maintain the purpose in perpetuity.
Whether a net asset is restricted or not can have benefits for both donors and organizations.
For example, a donor who has strong beliefs about a specific part of an organization’s work can assure that their funding is going towards enacting this rather than it being swallowed up in administrative functions.
Likewise, for some organizations, their administrative team may be in dire need of investment, in which case an unrestricted asset can be a huge help.
Is your nonprofit financially healthy?
This is the real purpose behind a statement of financial position. Much in the same way as a balance sheet is used for for-profit companies, a statement of financial position will allow you to see clearly whether your assets are greater than your liabilities.
It will also allow you to assess the status of your assets to hopefully retain a large surplus that can be used to achieve mission goals in the future.
While the mission is your main goal as a nonprofit, retaining a net asset surplus will enable further growth to sustain the organization for years to come.
As specialists in nonprofit accounting, our team of remotely operating experts is available to help your organization navigate the sometimes confusing world of accounting so that you can focus on your mission goals safe in the knowledge that all of your donations and net assets are in order.