All About Financial Management in Nonprofits

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    All About Financial Management in Nonprofits

    Guidelines for nonprofit financial management are included in the book Bookkeeping Basics: What Every Nonprofit Bookkeeper Needs to Know .

    © Copyright
    Carter McNamara, MBA, PhD, Authenticity Consulting, LLC.
    Applies to nonprofits unless otherwise noted.

    New nonprofit leaders and managers have to develop at least basic skills in financial management. Expecting others in the organization to manage finances is clearly asking for trouble. Basic skills in financial management start in the critical areas of cash management and bookkeeping, which should be done according to certain financial controls to ensure integrity in the bookkeeping process.

    New leaders and managers should soon go on to learn how to generate financial statements (from bookkeeping journals) and analyze those statements to really understand the financial condition of the business. Financial analysis shows the “reality” of the situation of a business — seen as such, financial management is one of the most important practices in management. This topic will help you understand basic practices in financial management, and build the basic systems and practices needed in a healthy business.

    Sections in This Topic Include

    The following links are to sections included further below in this Web page.

    Basics and Getting Started

    Activities in the Yearly Accounting Cycle

    Planning and Cash Management

    Financial Statements, Analysis and Reporting

    Special Topics

    Also consider
    Related Library Topics

    BASICS AND GETTING STARTED

    Basics of Financial Management

    Reviewing the Basics of Nonprofit Financial Management

    To manage your finances as effectively as possible, you should at least have an understanding of the basic accounting process. To get an overall sense for the recurring financial activities in the typical nonprofit, carefully read the following article.
    Basic Overview of U.S. Nonprofit Financial Management

    Other sites that you might benefit from are:

    Use Fiscal Sponsorship?

    In some cases, you might want to pursue finding a fiscal sponsor. For example, if you’re not sure you want to start a nonprofit, or if your nonprofit may not need to exist for long, then a fiscal sponsor may be useful for you. A fiscal sponsor might oversee your financial management activities until your organization is more developed or terminated. See Fiscal Sponsorship — Is it For You?

    What Type of Bookkeeping System Should You Use?

    Small organizations might use a single-entry bookkeeping system, although some might choose to use a double-entry.
    What Type of Bookkeeping System Should You Use?

    Also, see the cash-basis or accrual-basis in Basic Overview of U.S. Nonprofit Financial Management

    Your Board Treasurer and Board Finance Committee — Critical Resources to Help You Get Started

    An active board treasurer can be the most important resource in the long-term financial health of your nonprofit. As a new nonprofit organization, you must get accounting expertise somehow, if you don’t have strong skills in this area yourself. You (or, ideally your board chair) should get someone on your board with accounting skills to be your treasurer. See

    Getting an Accountant, If Needed

    You might choose to do the basic bookkeeping activities yourself. You should get an accountant initially to help you set up your bookkeeping system, generate financial statements and do some basic financial analysis.

    Buy a Software Package to Automate Your Financial Management?

    There are a number of very useful software packages that will help you automate bookkeeping, generation of financial statement and their analysis. See

    Getting a Bank and Banker

    You’ll need to start a checking account. Probably the best way to find a good bank is to ask for advice and references from other nonprofits, especially other nonprofits that are of the size and nature of yours. If you’re just starting out, you probably don’t have much money. You may be able to get buy with a non-interest-bearing checking out that has no, or minimal, fees. The following link may be useful
    Getting and Using a Banker





    Understanding and Setting Up Your Nonprofit Bookkeeping and
    Accounting

    Now that you have a sense for the overall, recurring activities in nonprofit financial management. Let’s take a closer look at what happens in nonprofit accounting. Accounting is identifying, organizing and reporting financial transactions. It’s useful to understand the basics of accounting before reading the next major section on financial planning — that planning requires some understanding of the accounting process. One of the biggest challenges is knowing how to enter each type of transaction in the journal and ledger. The following links are very useful for this challenge. Before reading them, do read Basics of Nonprofit Financial Management.

    Quick Overviews of Bookkeeping / Accounting

    Bookkeeping and accounting is all about identifying, organizing and reporting your financial transactions. Scan this information to further clarify your understanding of bookkeeping and accounting.

    Critical Issues in Financial Accounting Regulation for Nonprofit Organizations

    Setting Up Your Chart of Accounts

    How to Design a Scalable Chart of Accounts

    Deciding to Use Cash Basis or Accrual Basis for Accounting

    Deciding Which Expenses Are Direct and Indirect (Overhead)

    Cost Analysis to Determine Costs of Activities

    The following series gives you a well-structured overview of how to analyze the financial data, especially to associate costs with the activities in your organization. That information is extremely important if you ever need to cut costs.

    Deciding How Much to Allocate to Fringe Benefits in Payroll Expenses

    What is a fringe benefit rate? | AccountingCoach.com Q&A

    Deciding How Much to Document as Depreciation

    Addressing Financial Controls and Risk Management

    There are certain practices that you should consistently follow to ensure that financial transactions are consistently recorded in an accurate fashion. These controls also help to minimize risk, including employee theft.

    Also consider

    ACTIVITIES IN YEARLY ACCOUNTING CYCLE: Budgeting (Financial
    Forecasting) and Cash Management

    Financial Planning

    Financial planning works from the strategic and business plans to identify what financial resources are needed to obtain and develop the resources to achieve the goals in the two types of plans. Typically, financial planning results in very relevant and realistic budgets — budgets are addressed later on in this topic. So be sure to consider business planning for each of your products and services.

    Budgeting and Managing Budgets

    A budget depicts what you expect to spend (expenses) and earn (revenue) over a time period . They are useful for projecting how much money you’ll need for a major initiative, for example, buying a facility, hiring a new employee, etc. They also help track whether you’re on plan or not. There are yearly (or annual or operating) budgets, cash budgets, capital budgets (for major assets, such as equipment, buildings, etc.) and proposal budgets (for fundraising), etc. The following links are about annual budgets.

    Meaningful Budget Work by the Board

    Managing Program Finances

    Usually, there are two major types of costs to consider: indirect costs and direct costs. Indirect costs are what we sometimes call “administrative” or “overhead” costs, for example, costs to run the central facility. Direct costs are those that fund resources which directly produce services to clients, for example, supplies and materials for books provided to clients.

    Usually, the lower your administrative costs, the more it looks like your resources are going directly to services to clients. In addition, you may have restricted grants (that is, grants that are dedicated for certain programs), which require you to report monies spent on overhead and directly on the program. Therefore, it’s wise to track carefully how much money each of your programs requires to operate and how much revenue it generates, as well. A major challenge is to analyze how much of the indirect costs are associated with each program.

    Also see Basic Guidelines for Nonprofit Program Design and Marketing.

    Managing Cash Flow

    As a new or small nonprofit, your biggest challenge is likely to be managing your cash flow — probably the most important financial statement for a new business is the cash flow statement. The overall purpose of managing your cash flow is to make sure that you have enough cash to pay current bills. Nonprofits can manage cash flow by examining a cash flow statement and cash flow projection.

    Basically, the cash flow statement includes total cash received minus total cash spent. Cash management looks primarily at actual cash transactions. (Note that nonprofits must file a financial statement called Cash Flow Statements or Statements of Cash Flow — this statement is not the same as a cash flow budget.)

    Basics of Cash Flow Management — article specific to nonprofits

    How to Make Cash Flow Projections

    More Basics of Cash Management

    Note that cash management activities, whether nonprofit or for-profits, are essentially the same.

    Basics of Cash Management

    Preparing a Cash Flow Statement

    Preparing Cash Flow Projections and Forecasts

    Managing Your Bank Account

    For a new nonprofit, your check register very likely will be your primary means to record and track cash. Whether yours is a new nonprofit or an established nonprofit, you’ll need to know how to manage your bank account. See

    Credit and Collections

    Matters of credit and collections are similar between for-profit and nonprofit organizations, other than that nonprofits obviously grant free services much more than for-profit organizations. Consequently,
    nonprofits are not nearly as likely to utilize credit and collections procedures.

    Budget Deviation Analysis

    You learned above that a budget depicts what you expect to spend (expenses) and earn (revenue) over a time period. Budget deviation analysis regularly compares what you expected, or planned, to earn and spend with what you actually spent and earned. The budget deviation analysis can help greatly when detecting how well you’re tracking your plans, how much to accurately budget in the future, where there may be upcoming problems in spending, etc. A budget deviation analysis report might include columns with titles:

    Planned for Month

    Actual for Month

    Difference
    (planned minus actual)

    % Deviation
    (Difference x 100)





    ACTIVITIES IN YEARLY ACCOUNTING CYCLE: Financial Statements
    and Analysis

    Financial Statements

    In order to know how your nonprofit 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.

    Statement of Activities (Income Statements)

    These statements include much money you’ve earned (your revenue) and subtracts how much you’ve spent (your expenses), resulting in the total of your unrestricted net assets. The statement of activities includes how much money you’ve earned (your revenue) and subtracts how much you’ve spent (your expenses), resulting in how much you’ve made money (your profits) or lost money (your deficits). Basically, the statement includes total sales minus total expenses. It presents the nature of your overall profit and loss over a period of time. Therefore, the Income Statement gives you a sense for how well the nonprofit is operating.

    Statement of Financial Position (Balance Sheets)

    Whereas the statement of activities depicts the overall status of your profits (or deficits) by looking at income and expenses over a period of time, the balance sheet depicts the overall status of your finances at a fixed point in time. It totals your all your assets and subtracts all your liabilities to compute your overall net worth (or net loss). This statement are referenced particularly when applying for funding.

    Financial Analysis (individual statements, ratios, break-even analysis, etc.)

    Financial analysis can tell you a lot about how your nonprofit is doing. Without this analysis, you may end up staring at a bunch of numbers on budgets, cash flow projections and financial statements. You should set aside at least a few hours every month to do financial analysis. Analysis includes cash flow analysis and budget deviation analysis mentioned above. Analysis also includes balance sheet analysis and state of activities analysis. There are some techniques and tools to help in financial analysis, for example, profit analysis (yes, these can be used even in nonprofits), break-even analysis and ratios analysis that can substantially help to simplify and streamline financial analysis. How you carry out the analysis depends on the nature and needs of you and your business. The following links will help you get a sense for the “territory” of financial analysis.

    General Information

    Financial Planning and Analysis — Ratios

    There are a variety of ratios that can be used to help determine the current and future condition of a nonprofit. The following links provide explanation and procedures for using those ratios. The ratios are produced from numbers on the financial statements. Note that the usefulness of ratios often are from comparing ratios from different time periods in the same nonprofit or from standards for a type of nonprofit, eg, social services, associations, civic organizations, etc.

    The following articles are in reference to for-profits, but the principles behind the ratios also apply to nonprofit organizations.

    Overview of major types of ratios and how they’re computed

    Financial Planning and Analysis — Break-Even Analysis

    The break-even analysis uses information from the statement of activities and cash flow statements to compute how much sales or revenue much be accomplished in order to pay for all of your fixed and variable expenses. Fixed expenses are expenses that you’d have regardless of the level of sales of products or services (eg, sales, rent, insurance, maintenance, etc.). Variable expenses are incurred according to the level of sales of products or services (eg, sales commissions, sales tax, freight to ship products, etc.). Break-even analysis can help you when deciding how much to charge for a service, how much to ask for from donors, etc.

    Financial Reporting

    The types and frequency of reports depend on the nature of the nonprofit and its situation. Banks might want reports to verify financial strength to pay back loans. Foundations, individuals, or other donors may want reports to verify that donations are being spent as expected by the foundation or donor. The Internal Revenue Service will want certain reports when filing yearly tax forms.

    Overview

    Basics of Nonprofit Financial Management

    Annual Reports

    General

    SPECIAL TOPICS

    Cost Cutting

    Also consider
    Organizational Sustainability

    Lease Versus Buy

    Assessments and Audits of Nonprofit Financial Management Practices

    Various Assessments and Indicators

    Audits

    GENERAL RESOURCES

    Sources of Online Assistance and Information

    Resources for Nonprofits

    Software to Help Manage Your Finances

    Software for Nonprofits

    Getting and Using Banking Services

    Getting and Using Accounting Services

    You should carefully consider whether you should hire an outside accountant, or hire your own employee. The IRS pays increasing attention to the hiring of independent contractors.
    Potential Issues in Hiring Consultants (general information and IRS-related issues)

    Have a Treasurer to Help You?

    Fiscal Sponsorship — To Help Get Your Finances Started …

    Miscellaneous Other Resources

    Major Sites of Online Information

    Also consider
    Supersites

    Learn More in the Library’s Blogs Related to Nonprofit Financial Management

    In addition to the articles on this current page, also see the following blogs that have posts related to Nonprofit Financial Management. Scan down the blog’s page to see various posts. Also see the section “Recent Blog Posts” in the sidebar of the blog or click on “next” near the bottom of a post in the blog. The blog also links to numerous free related resources.

    For the Category of Financial Management (Nonprofit):

    To round out your knowledge of this Library topic, you may want to review some related topics, available from the link below. Each of the related topics includes free, online resources.

    Also, scan the Recommended Books listed below. They have been selected for their relevance and highly practical nature.