Whether it’s a church, charity or youth organization, nonprofits exist to improve the quality of life of their constituents. Considering this, these organizations also face a wider variety of input from stakeholders—both upward and downward—which can often lead to additional challenges in accounting and finance.
Challenges Nonprofit Financial Teams Must Overcome
- Manage resources provided by donors and members efficiently
- Act as stewards for those resources, including responsibility for overall performance of the nonprofit organization.
This means they also have to measure whether the nonprofit is using the donated resources effectively and ethically to achieve its mission.
While for-profit accounting generally has one “equity” section, with capital and retained earnings, non-profit accounting must separate this section into “net assets” and must report each category as unrestricted, temporarily restricted and permanently restricted.
Nonprofit accountants must also separate expenses into administrative, fundraising and programs elements thus increasing complexity.
Ethics Issues Specific to Nonprofits
Unethical behavior for nonprofit finance teams span far beyond those of for-profit ones. Examples shared in the AFP article Accounting Challenges for Nonprofit Treasury and Finance include:
- Consulting Beneficiaries (Nonprofit) vs. Consulting Customers (For-Profit): While a for-profit may not necessarily have to consult its customers on every decision (though it is good practice), not consulting beneficiaries in non-profits is considered unethical.
- Cost Minimization Concerns: While cutting costs to maximize stakeholder value makes sense for for-profit companies, spending less to increase surplus is usually not acceptable in nonprofits because the objective is rarely to have more money left but utilize funds to meet the nonprofit’s mission.
- Low Burn Rates Frowned Upon: “Saving” money and having large cash balances for a long-term strategy can make sense for a for-profit company. For nonprofits, doing so can harm the credibility among stakeholders and donors who expect money to go to program impact.
More Scrutiny from All Parties
Whether it’s from government, donors, grantors or volunteers, nonprofits face scrutiny on par with publicly traded organizations. A major portion of this scrutiny goes to expenses.
Breaking Down and Communicating Expenses
Communicating how expenses are accumulated and categorizing these expenses correctly can be done through an allocation process and plan. As highlighted by McKonly and Asbury, expenses are broken down into three categories:
- Program Service Expenses: These are costs related to providing the nonprofit organization’s programs or services in accordance with its defined mission. For established nonprofit organizations, program service expenses generally represent the majority of the overall expense of the organization. The public generally prefers to see a nonprofit organization with the largest allocation to this category.
- Management and General: These are costs related to administering the day-to-day activities of the nonprofit organization. These expenses do not directly relate to the purpose for which the organization exists and typically includes activities such as bookkeeping, management and governance. While important to the operation of the nonprofit, organizations generally try to minimize these as much as possible.
- Fundraising: These are costs of all activities that relate to an appeal for financial support or for a contribution to an organization. Examples of these expenses are the costs of holding a fundraising event, solicitation of contributions, or salary of individuals involved in the fundraising process.
Best Practices in Expense Management and Allocation
The article goes further into providing seven best practices for expense management and a functional allocation plan:
- Document the functional allocation plan in writing. It is important that the methodology for allocating expenses can easily be communicated to the organization’s governance board, the independent auditors and the users of the financial statements. By documenting this plan in writing, it makes it easier to understand and update the plan when needed.
- Identify the type of expense transactions that are directly allocated to one of the functional categories, or that need to be allocated amongst several categories. Further, if there are multiple program service offerings, it is important to identify the type of expense transactions that are directly or indirectly allocated to each program. Accurate cost allocation between programs can be important for grant reporting purposes and for determining the overall success of a particular program.
- Maintain timesheets for individuals whose responsibilities include tasks that fall into more than one functional category or program. The timesheets should approximate the amount of time in a given week (or month) that the individual spends on program type services, administrative services and fundraising services. It is important that the individual maintaining the timesheets understand the definitions of the functional categories and the difference in programs.
- If an allocation of time is not practicable, which is often the case with rent, utilities, and other space related costs, allocating by square-footage is an acceptable alternative.
- Establish a chart of accounts within the accounting system that can help facilitate the allocation process in an efficient manner without providing a burden to management at year-end.
- Remain consistent with the functional and cost allocation plan. Special exceptions to the plan should be minimal.
- Review the allocation methodology at least quarterly. It is not uncommon for the funding stream of nonprofit organizations to change or for there to be a change in the make-up or responsibility of personnel.
How can you ensure the transparency that comes from following these allocation best practices? For starters, you can simplify the timesheet completion and expense reporting process for employees and sometimes volunteers. Nexonia is designed to simplify the organization, allocation and reporting of expenses to stand up to the increased scrutiny you face from all stakeholders.