Nonprofit Fund Accounting vs. For-Profit Accounting: How Do They Differ?

6 min read

March 19th, 2024

In both the nonprofit and for-profit sectors, financial management is essential to success. You can’t run a profitable business or a viable nonprofit without a good bookkeeping and accounting system designed to support financial health and operations.

 

While there are some similarities between nonprofit and for-profit financial management, the back-office goals, needs, and requirements of nonprofit organizations and for-profit entities differ significantly.

These differences necessitate significant differences in the accounting methods and processes recommended for each sector.

Nonprofit vs. Business Accounting: 7 Key Differences

The following are some of the main differences between accounting in a nonprofit profit organization and accounting in a for-profit entity.

1. Financial Reports

The basic financial reports that nonprofits and for-profits are required to generate and use are different. The core financial reports in a for-profit business include:

• Balance Sheet
• Income Statement (Profit and Loss Statement)
• Statement of Cash Flow

In a nonprofit organization, the comparable financial reports include:

• Statement of Financial Position
• Statement of Activities
• Statement of Cash Flows

While the reports provide similar information, they are present differently in nonprofit organizations than they are in for-profit businesses. Nonprofit financial statements also usually include additional information and disclosures about the allocation of funds to improve transparency and demonstrate how funds are used to support the mission.

Read More: Financial Reports vs. Management Reports: What’s the Difference?

2. Purpose and Focus

The purpose and focus of accounting in nonprofits and for-profits differ significantly. In a business, the ultimate goal is to generate profits for the business, its owners, and shareholders, and the accounting system is oriented around this purpose.

In a nonprofit, the goal is to carry out and expand the organization’s mission. As a result, the finances must be mission-oriented. Additionally, nonprofits must also focus on accountability (in how they use the money they receive) and financial transparency. So, the accounting system and reporting practices must be designed in a sound and transparent manner to achieve these purposes.

3. Performance Metrics

Since the goals differ in a business and nonprofit, the metrics by which you can measure performance will also differ. In profit-focused businesses, the most commonly measured metrics are related to profitability and financial performance such as profit margins, revenue growth, and return on investment.

In nonprofits, success is measured by how well the mission is achieved and how efficiently the organization raises money. So, nonprofit performance metrics are more closely related to donors, community impact, and beneficiary outcomes. For example, metrics to measure might include individuals served per dollar, fundraising ROI, donor retention rate, cost per dollar raised, and program efficiency.

4. Tax Filing and Compliance

In a successful business, the back office focuses on tracking performance metrics and providing valuable actionable insights that business leaders can use to improve operations and maximize profits. For-profit back offices must also exist to ensure proper tax planning, tax filing, and regulatory compliance.

In nonprofit organizations, the tax and compliance responsibilities of the back office are fairly different. Nonprofits are tax-exempt, so they do not need to tax plan the way a for-profit business would. Instead, they must plan on filing an annual report (IRS Form 990) to maintain their tax-exempt status.

Additionally, nonprofits must ensure their financial records and reports are compliant with all local, state, and federal rules and regulations, in addition to maintaining compliance with any grant requirements that must be satisfied.

5. Auditing

When a business undergoes an audit, it’s because the IRS is making sure the business pays its fair share in taxes. Nonprofit audits, however, occur for different reasons because they don’t pay taxes.

Nonprofits don’t necessarily have to undergo auditing, except in special circumstances such as:

• The nonprofit’s bylaws require auditing.
• The nonprofit’s state requires auditing.
• The nonprofit receives more than $750,000 in federal funding within a year.
• The nonprofit’s funding grantors require auditing.

Sometimes, also, nonprofit organizations decide to hire third-party auditors to audit their organizations for the purpose of increasing transparency, ensuring accountability, shoring up internal controls, and demonstrating responsible use of funds.

6. Revenue Sources

Businesses typically have one primary source of revenue, sales of products and/or services. Nonprofits, on the other hand, are healthiest when they have several sources of funds such as individual donors, corporate sponsors, and grants from foundations and the local, state, and federal government.

As a result, revenue recognition and tracking is much more complicated in nonprofit organizations than it is in for-profit businesses. While businesses need to track revenue sources to ensure proper reporting and financial metrics, nonprofits must track revenue sources to ensure proper recording, recognition, use, and reporting for internal information and compliance purposes.

Read More: The Pros & Cons of Outsourced Accounting Services

7. Restricted vs. Unrestricted Funds

Businesses, unless they use business grants, typically do not need to worry about restricted and unrestricted categories of funds. In the nonprofit world, however, this separation of revenue based on type is common practice and necessary in just about every organization.

Nonprofits often receive earmarked donations that are given for a specific purpose. They also operate with funds from several different grants that typically come with their own stipulations, which dictate how much of a particular award can be used for overhead expenses and how much must go directly toward the mission.

This complex soup of fund categories necessitates its own, unique accounting method called nonprofit fund accounting. While businesses can use a version of fund accounting to improve their budgeting and savings-oriented goal-setting, the method is most applicable to the nonprofit sector.

Accounting in a Nonprofit: Understanding the Nonprofit Fund Accounting Method

Nonprofits face their own set of unique financial management challenges, and the fund accounting principles are specifically designed to support a nonprofit organization’s back-office needs and goals.

Nonprofit fund accounting supports financial transparency, responsible use, and accountability with respect to the complicated and varied revenue sources in nonprofit organizations. Instead of having one big bucket of revenue and a long list of expenses, the fund accounting method devices an organization’s revenue into separate funds (smaller “buckets”) and parses out its expenses between the funds based on each fund category’s rules and requirements for use.

As a result, nonprofits operate with several sets of books. These separate books and budgets can be consolidated to create a global picture, but the ultimate purpose of these separate sets of records is to help nonprofit leaders keep track of their restricted and unrestricted funds. This accounting method helps to ensure the right money is spent on the right expenses to maximize ROI, ensure the optimal use of restricted and unrestricted funds, and maintain compliance.

Level Up Your Nonprofit: Establish Fund Accounting Best Practices With Outsourced Financial Management

Most nonprofit leaders don’t want to be focused on the money management aspect of their organizations, but raising money, using it well, and maintaining proper records of all these financial activities is vital to an organization’s success, compliance, and reputation.

Outsourced accounting is a perfect solution for nonprofit organizations that want to save money on the management of their back offices while improving operations and maximizing mission impact. A team of outsourced accounting professionals with experience in the nonprofit sector can help your organization apply advanced management tools and technology to automate your back-office processes, simplify fund accounting, and ensure compliance — all while freeing you up to focus on what you care about most, your mission!