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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