Basic Overview of U.S. Nonprofit Financial Management

© Copyright Carter McNamara, MBA, PhD, Authenticity Consulting, LLC.
Applies to nonprofits unless otherwise noted.

Sections of This Topic Include

Description
Basic Bookkeeping Activities
Financial Statements
Financial Analysis
Financial Reporting

Also see
Related Library Topics

(This information is referenced from the page Basic Guide to U.S. Non-Profit Financial Management)


Description

The following basic overview will give you some overall perspective on the basic processes involved in nonprofit financial management. Key terms to learn are bolded . You'll learn more about the key terms later in subsequent sections when you return to Basic Guide to U.S. Non-Profit Financial Management

The following activities described on this page occur regularly as part of the yearly accounting cycle. The accounting cycle includes bookkeeping, generating financial statements and analyzing information from the statements.

Basic Bookkeeping Activities

Bookkeeping is basically recording various financial transactions. Bookkeeping activities can often by done by someone who's doing basic clerical work in the organization. Often, the board treasurer can help you develop and carry out your bookkeeping system.

Fiscal Policies and Procedures Manual (or Accounting Procedures Manual)

The board develops and authorizes a set of procedures for how the organization manages its finances, including how the following activities are carried out by your organization. The board treasurer usually coordinates the board's responsibility for the manual, including its regular review and update. The board and chief executive should make every effort to ensure compliance to the procedures in the manual.

Type of Accounting System and Recording of Financial Transactions

Accounting starts with basic record keeping (or bookkeeping). When your organization is just getting started, your bookkeeping system will probably be based on what's called a cash-basis accounting system, rather than accrual-basis system. Many organizations, when starting out, use the cash-basis system and a checkbook to track transactions. In the "memo" portion of the checkbook, they note if the amount depicted on the check is an expense or revenue, and where the amount came from or is going to. As your organization grows, you'll begin using ledgers to track transactions, for example, you'll post cash receipts to a cash receipts journal and checks you write to a cash disbursements journal.

As your nonprofit grows and as you begin using the accrual method, you'll likely need more types of journals, for example, a Cash Receipts Journal, Cash Disbursements Journal, Payroll Journal, Accounts Receivable Ledger, Accounts Payable Ledger, Sales Journal, Purchases Journal and General Ledger.

(In an accrual-basis system, you post entries when you earn the money and when you owe it. Small organizations usually do not have the resources to use an accrual-based system. However, financial statements are prepared on an accrual basis. As a compromise, many organizations use the cash-based basis to record entries in journals, but get help to convert to an accrual-based basis to generate financial statements.)

You can do postings using a single-entry or double-entry method. Double-entry works from a basic accounting equation "assets = liabilities + capital". The double-entry method makes sure that your books are always in balance. Every transaction has two journals entries, a debit and a credit. Each transaction effects both sides of the equation.

Each posting might refer to accompanying documents that you keep in a file somewhere. For example, postings about cash receipts might refer to invoices that you sent to a clients which prompted them to write checks to your organization (checks which you posted as cash receipts). For example, postings about cash disbursements might refer to invoices that were sent to your organization which prompted you to write checks (checks which you posted as cash disbursements.) When you make a deposit to the bank, you'll file the bank's deposit receipt in a file.

Manual or Automated Accounting System

Your record keeping system will be based on a manual system (where you make entries and total them by hand) or a computer system. You might even choose to outsource your record keeping system to another business that manages your bookkeeping activities (along with other financial management activities) for you.

Soon you may evolve to using a computer-based system, which greatly automates entry of transactions, updating of ledgers, generation of financial statements and financial analysis (more on these later), and generation of reports needed for filing taxes, etc. The only drawback to using a computer is that you might underestimate the importance of knowing how your accounting processes really work -- that's an advantage of doing the bookkeeping yourself, if only for a few months. You should also generate your own financial statements and financial analysis at least for a couple of months. Having this knowledge and experience helps you develop an instinct for getting the most out of your financial resources.

(We'll talk more about that back in the topic Basic Guide to U.S. Non-Profit Financial Management, after we've reviewed the rest of the information on this page.)

Accounts and Chart of Accounts

You'll post each entry according to the category, or account, of the transaction. Each account will be associated with an account number. These numbers are referenced when developing your financial statements (more on those later). You'll refer to a chart of accounts which will tell you what account number to use when you post an entry. You can design your own chart of accounts, including coming up with your own account numbers. The chart usually have five areas, including assets, liabilities, net assets (or fund balances), revenues, and expenses. The account numbers you come up with should depend on the particular kinds of revenues and expenses you expect to have most frequently.

However, nonprofits have to report account activity according to the classifications functional(or programs) and natural (or supporting). Program transactions are those directly related to providing services to clients, members, etc. Supporting transactions are those in common to all programs, for example, general management costs, etc. It's not always easy to know which transactions belong to which category! We'll also talk more about managing program budgets back in the topic Basic Guide to U.S. Non-Profit Financial Management, after we've reviewed the rest of the information on this page.

Budgets (Financial Forecasting)

You'll have an operating budget (or annual budget), which shows planned revenue and expenses, usually for the coming year. Budget amounts are usually divided into major categories, for example, salaries, benefits, computer equipment, office supplies, etc. You might also have cash budgets, which depicts the cash you expect to receive and pay over the near term, for example a month. You also might have capital budgets, which depict expenses to obtain or develop, and operate or maintain major pieces of equipment, for example, buildings, automobiles, computers, furniture, etc. Development of the budgets is usually driven by the chief executive. In the case of corporations, the board treasurer can take a strong role in developing and presenting the budget to the rest of the board. The board is responsible to authorize the yearly budgets.

You should develop a program budget, that is, a budget for each major service you provide to clients. For example, a transportation program, a child-care program. Many nonprofits have more than one program. It's critical to plan and track financial costs for each program. As much as possible, nonprofits should strive to minimize overhead or administrative costs, that is, costs to support the resources that support the entire organization and all programs, rather than just one program. Examples of administrative costs are rent for a building, office supplies, labor costs for personnel who support the central office or more than one program, insurance, etc. It's wise to develop a program budget that allocates indirect costs to programs. There are several methods to do this. We'll also talk more about these methods back in the topic Basic Guide to U.S. Non-Profit Financial Management, after we've reviewed the rest of the information on this page.

Usually, each month (during trial balancing -- more on that later), you'll update your budget report to include actual revenue and expenses. Then you can compare your planned revenue and expenses to your actual revenue and expenses. This will give you a good idea whether your operating according to plan or not, including where you need to cut down on expenses and build up on revenue.

Petty Cash

You'll have a lot of small, recurring expenses that you'll need to pay right away, for example, to buy a computer power cord, stamps, etc. You'll probably work from a petty cash fund. You might establish this fund by writing a check to your organization, and noting on the check that it goes to the "petty cash" fund. You'll withdraw from the fund by filling out a voucher that describes who took the money, how much, for what and on what date.

Trial Balances

Usually, once a month, you'll do trial balancing. Often, the board treasurer can help with this activity. This activity usually starts by totaling the entries from the journal(s) into a general ledger. (As your business grows, you may use other types of ledgers, too, for example for equipment, payroll, etc.) When using double-entry accounting, you'll add up totals on both sides of the ledger to make sure that total debits equal total credits.

You'll make sure that the individual postings and totals are correct by comparing each to its accompanying documentation. For example, your recording of cash disbursements will be compared to your bank's monthly checking statement that indicates what checks you wrote over the month. Your recording of cash disbursements will also be compared to accompanying invoices and other forms of billing to your organization, to verify there was a need for each check that was written to pay bills.

Internal Controls

You will have various forms of internal controls to ensure the business is following its plans, minimize the likelihood of mistakes, avoid employee thefts, etc. There are a wide range of internal controls. For example, you'll be careful about whom you hire. You might have authorization lists about who can access which areas of the building, types of information, etc.

As mentioned above, you'll carry over totals to various financial reports, including your budget, to see if your financial activities are according to plan or not. To minimize employee theft, the business's mail will be opened by one person who logs in each check that is received. This person will be someone other than the person who deposits the checks to the bank. Disbursements of large amounts, for example, over $500, may require a secondary signature, for example, from the board treasurer.

Another form of financial control is an audit. An audit is a comprehensive analysis, by a professional from outside the organization, of your financial management procedures and activities. The auditor produces a report, with a variety of supplements, that indicates how well your organization is managing its resources. Some nonprofits are required to have audits. It's usually good practice to have an audit, whether you're required to or not.

Financial Statements

In order to know how your organization is doing, you'll do some ongoing financial planning and analysis. In this planning and analysis, you'll likely use your bookkeeping information to produce various financial statements, including a cash flow statement, statement of activities and a statement of financial position.

Your cash flow statement depicts changes in your cash during the year. Your statement of activities (known as the income statement before) depicts the changes in your assets over the past year. This statement is particularly useful to tell you if you are operating with extra money or at a deficit. This gives you a pretty good impression of your rate of revenues and spending. It signals areas of concern, as well. Your statement of financial position depicts the overall value of your organization at a given time (usually at the end of the year), including by reporting your total assets, subtracting your total liabilities and reporting the resulting net assets. Net assets are reported in terms of unrestricted, temporarily restricted and permanently restricted assets. Funders often want to see the statement of financial position. (You'll learn a lot more about financial statements, including examples, later on back in the topic Basic Guide to U.S. Non-Profit Financial Management).

Financial Analysis

By themselves, numbers usually don't mean much. But when you compare them to certain other numbers, you can learn a lot about how your organization is doing. For example, you can compare the planned expenses depicted on your budget to your actual expenses in order to see if your spending is on track.

Another form of comparison is by using ratios. A ratio is a comparison made by mathematically dividing one number by the other. For example, nonprofits are expected to keep administrative costs down in order to make more money available for programs. Dividing a program's expenses by your total expenses indicates the amount of administrative overhead to run your program.

The interpretation of results from various types of comparisons depends on the nature of the nonprofit. For example, an association might expect to spend far less on administrative overhead than would a social services agency during their first year. You'll learn a lot more about financial analysis back in the topic Basic Guide to U.S. Non-Profit Financial Management.

Financial Reporting

The types and frequency of reports depend on the nature of the nonprofit and its situation. For example, if the nonprofit is in some sort of crisis, the board may require frequent reports.

Your board should require regular financial reports at each board meeting. When your organization is just getting started, the chief executive will prepare and present financial reports to the board. However, as the organization develops, a board treasurer will likely take a strong role in helping the chief executive to present financial information to the board. The finance committee, led by the board treasurer, ensures that financial reports are complete and helps present them to other members of the board.

The board may require a statement of financial position and statement of activities at each meeting. They also may request descriptions of finances for each program or of affordability for upcoming, major initiatives. They may request information prior to filing taxes. They will certainly need to see any results from financial audits. You'll learn a more about financial reporting back in the topic Basic Guide to U.S. Non-Profit Financial Management.


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For the Category of Financial Management (Nonprofit):

To round out your knowledge of this Library topic, you may want to review some related topics, available from the link below. Each of the related topics includes free, online resources.

Also, scan the Recommended Books listed below. They have been selected for their relevance and highly practical nature.

Related Library Topics

Recommended Books

Basics and General Information

Budgeting

Bookkeeping and Accounting

Cash Management

Financial Statements, Analysis and Reporting



Basics and General Information

Bookkeeping Basics - Book Cover Bookkeeping Basics -- What Every Nonprofit Bookkeeper Needs to Know
by Debra L. Ruegg and Lisa M. Venkatrathnam, published by Fieldstone Alliance. Explains all aspects of developing and successfully managing systems to track and spend nonprofit finances. This is an easy-to-reference resource that is useful to new or established nonprofits. Today, nonprofits have to be more accountable than ever before about planning, managing and explaining their finances. This accountability now extends beyond just the Board treasurer -- other Board members no longer can expect just one person to handle the finances. This book helps everyone meet their responsibilities about finances!

The following books are recommended because of their highly practical nature and often because they include a wide range of information about this Library topic. To get more information about each book, just click on the image of the book. Also, a "bubble" of information might be displayed. You can click on the title of the book in that bubble to get more information, too.



Budgeting

The following books are recommended because of their highly practical nature and often because they include a wide range of information about this Library topic. To get more information about each book, just click on the image of the book. Also, a "bubble" of information might be displayed. You can click on the title of the book in that bubble to get more information, too.



Bookkeeping and Accounting

Bookkeeping Basics - Book Cover Bookkeeping Basics -- What Every Nonprofit Bookkeeper Needs to Know
by Debra L. Ruegg and Lisa M. Venkatrathnam, published by Fieldstone Alliance. Explains all aspects of developing and successfully managing systems to track and spend nonprofit finances. This is an easy-to-reference resource that is useful to new or established nonprofits. Today, nonprofits have to be more accountable than ever before about planning, managing and explaining their finances. This accountability now extends beyond just the Board treasurer -- other Board members no longer can expect just one person to handle the finances. This book helps everyone meet their responsibilities about finances!

The following book is recommended because of its highly practical nature and often because it includes a wide range of information about this Library topic. To get more information about each book, just click on the image of the book. Also, a "bubble" of information might be displayed. You can click on the title of the book in that bubble to get more information, too.



Cash Management

The following books are recommended because of their highly practical nature and often because they include a wide range of information about this Library topic. To get more information about each book, just click on the image of the book. Also, a "bubble" of information might be displayed. You can click on the title of the book in that bubble to get more information, too.



Financial Statements, Analysis and Reporting

The following books are recommended because of their highly practical nature and often because they include a wide range of information about this Library topic. To get more information about each book, just click on the image of the book. Also, a "bubble" of information might be displayed. You can click on the title of the book in that bubble to get more information, too.



Also See

Organizational Sustainability -- Recommended Books

Taxation (Nonprofit) -- Recommended Books

Strategic Planning -- Recommended Books

Social Entrepreneurship (Nonprofit) -- Recommended Books

Capacity Building (Nonprofit) -- Recommended Books

Fundraising -- Recommended Books

Program Management -- Recommended Books




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