Nonprofit organizations play a vital role in addressing social, environmental, and cultural issues, often relying on donations, grants, and funding to operate. With this responsibility comes the necessity for financial transparency and accountability.
Financial reporting for nonprofits not only fulfills regulatory requirements but also helps build trust among donors, stakeholders, and the community.
However, unlike for-profit entities, nonprofits face unique financial reporting requirements that ensure funds are managed ethically and efficiently to further their mission.
In this guide, we’ll break down the essential financial reporting requirements for nonprofits, detailing what documents need to be prepared, compliance standards to be met, and best practices for effective reporting.
Nonprofit Resources
The Charity Charge resource hub is dedicated to providing tips, tools, and information to help your nonprofit create and grow a modern organization. Learn more
The Importance of Financial Reporting for Nonprofits
Financial transparency is the foundation of nonprofit success. Regular, accurate financial reporting allows nonprofits to:
- Build Credibility and Trust: Potential donors and grantors want to know their contributions are being used responsibly. Transparent financial reporting builds credibility with these supporters.
- Ensure Legal Compliance: Nonprofits must meet specific legal requirements, particularly for tax-exempt status under IRS regulations.
- Evaluate Financial Health and Performance: Financial statements reveal whether the organization is meeting its financial goals and has the resources to continue its mission.
- Attract More Funding: Clear, detailed financial reporting often attracts additional funding by showcasing prudent financial management and program effectiveness.
Key Financial Statements for Nonprofits
Nonprofits are required to produce several specific financial statements that differ slightly from those used in for-profit accounting. The core financial statements include:
Statement of Financial Position (Balance Sheet)
The Statement of Financial Position provides an overview of the organization’s assets, liabilities, and net assets at a particular point in time. For nonprofits, net assets are categorized as either with donor restrictions or without donor restrictions—a critical distinction that affects how funds can be used.
- Assets: Cash, investments, property, and other resources owned by the organization.
- Liabilities: Debts and obligations, such as accounts payable and loans.
- Net Assets: The difference between assets and liabilities, showing the organization’s overall financial position.
Statement of Activities (Income Statement)
The Statement of Activities summarizes the organization’s revenues, expenses, and changes in net assets over a specific period. It shows where funds are coming from and how they are being spent, which helps illustrate the organization’s financial health and mission effectiveness.
- Revenue: Includes donations, grants, program fees, and other income sources.
- Expenses: Categorized by program, management, and fundraising expenses.
- Net Assets Change: Demonstrates increases or decreases in net assets due to the organization’s operations.
Statement of Cash Flows
This statement provides a detailed view of cash inflows and outflows, organized by operating, investing, and financing activities. For nonprofits, this statement is essential for monitoring liquidity and cash reserves.
- Operating Activities: Daily income and expenses related to programs and services.
- Investing Activities: Purchases or sales of long-term assets, such as property or equipment.
- Financing Activities: Cash from donations earmarked for capital improvements or debt repayments.
Statement of Functional Expenses
The Statement of Functional Expenses is unique to nonprofits and required for organizations filing Form 990. This statement breaks down expenses by their functional purpose (program services, management, and fundraising) to provide a clearer picture of where funds are allocated.
- Program Services: Costs directly related to the organization’s mission.
- Management and General: Overhead and administrative expenses.
- Fundraising: Expenses involved in raising funds, such as marketing and donor relations.
IRS Form 990: Annual Filing Requirement
Nonprofits in the United States are generally required to file an annual information return, known as Form 990, with the IRS. Form 990 provides a comprehensive overview of the organization’s financial activities and is essential for maintaining tax-exempt status.
- Form 990: For organizations with gross receipts of $200,000 or assets over $500,000.
- Form 990-EZ: For smaller organizations with gross receipts under $200,000 and assets below $500,000.
- Form 990-N (e-Postcard): For very small organizations with gross receipts of $50,000 or less.
Filing Form 990 includes providing details on the organization’s mission, programs, governance, and executive compensation. Failure to file Form 990 for three consecutive years results in automatic loss of tax-exempt status.
Generally Accepted Accounting Principles (GAAP) for Nonprofits
Nonprofit organizations must adhere to Generally Accepted Accounting Principles (GAAP) when preparing financial statements. GAAP provides consistency in financial reporting, making it easier for stakeholders to understand and compare financial information.
Key GAAP Principles for Nonprofits
- Accrual Basis Accounting: Revenues and expenses are recognized when they are earned or incurred, not when cash is exchanged.
- Net Asset Classifications: Funds are classified based on restrictions (with or without donor restrictions), affecting how they can be used.
- Revenue Recognition: Contributions are recognized based on donor stipulations, which can impact when funds are recorded as revenue.
Importance of Independent Audits for Nonprofits
Many nonprofits undergo independent audits to provide an unbiased examination of their financial statements. While not always required, audits are often necessary for larger organizations or those that receive government grants.
Benefits of an Independent Audit
- Increases Accountability: Shows donors and grantors that the organization is managing funds responsibly.
- Enhances Financial Transparency: Provides credibility to financial statements.
- Ensures Compliance: Audits check for compliance with GAAP and IRS requirements.
Best Practices for Nonprofit Financial Reporting
Following best practices in financial reporting not only ensures compliance but also strengthens the organization’s operations and impact.
- Maintain Accurate Records: Regularly update financial records to avoid errors and omissions.
- Categorize Donations Properly: Track donations based on restrictions to avoid misuse of funds.
- Use Accounting Software: Many nonprofits use accounting software designed for nonprofit organizations, which simplifies reporting and compliance.
- Regular Financial Reviews: Periodically review financial statements with the board and executive team to stay aligned with financial goals.
- Prepare an Annual Report: Summarize financial information in an accessible annual report to share with donors and stakeholders, emphasizing transparency.
Common Challenges in Nonprofit Financial Reporting
Despite best intentions, nonprofits often face challenges in financial reporting, such as:
- Limited Resources: Many nonprofits operate on lean budgets and may lack staff with financial expertise.
- Complexity of Compliance: Staying compliant with changing regulations can be challenging.
- Restricted Funds: Managing donor-restricted funds requires careful tracking and accurate reporting.
FAQs
What is the purpose of financial reporting for nonprofits?
Financial reporting provides transparency, helps fulfill legal obligations, builds donor trust, and evaluates financial health.
Do all nonprofits have to file Form 990?
Yes, most nonprofits must file some version of Form 990, based on their size. Failure to file can result in the loss of tax-exempt status.
What is the Statement of Functional Expenses?
This statement breaks down expenses by purpose—programs, management, and fundraising—providing insight into fund allocation.
Why are independent audits important for nonprofits?
Audits ensure financial accuracy, compliance, and transparency, often required by larger donors or government grantors.
What are net assets with donor restrictions?
These are funds restricted by donors for specific uses or time periods, requiring careful management to fulfill donor intent.
Can a nonprofit lose its tax-exempt status?
Yes, a nonprofit can lose tax-exempt status for failing to meet IRS filing requirements, among other compliance failures.
