Basic Overview of U.S. Nonprofit Financial Management

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Sections of this topic

    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 consider
    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
    .


    For the Category of Financial Management (Nonprofit):

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