Nonprofit organizations are subject to a unique accounting and reporting requirement that requires the reporting of expenses according to the purpose for which they are incurred. This process, referred to as functional expense allocation, is one of the more challenging areas of preparing a nonprofit organization’s financial statements.

During the July 8, 2020 Kids Chance National Conference webinar, Vicki Burkhart, Executive Director, Kids’ Chance of America, discussed how nonprofits allocate general, program, and fundraising expenses.

Key Take-Aways

Boards of Directors Fiduciary Responsibility‍

Nonprofit boards of directors have fiduciary responsibility for their nonprofit organizations. This means more than simply compiling a budget or signing off on taxes. Accepting fiduciary responsibility means integrating financial thinking, including the stewardship of assets, into every aspect of board governance. As a board member, if you don’t know the financial information of your organization by heart, if you’re not steeped in the numbers and understand their importance, if you can’t answer simple questions such as:

• What is your annual budget?
• What are your current sources of income?
• What are your largest expenses?
• Do you have a reserve fund?

‍Budgeting

‍Your annual budget should be completed before the fiscal year begins and include projected income and expenses from your program, scholarship, and fundraising committees and any area that would require budget dollars. A budget will include both income projections and expense projections. Realize, that at budgeting time, these are projections – ballpark numbers typically based on the prior year’s figures.

‍Form 990

‍Even though tax-exempt nonprofits do not pay federal taxes, they do have to file an information form with the IRS, which is the IRS Form 990. Having to file the 990 ensures nonprofits conduct their businesses in a way that is consistent with their public responsibilities.

The 990, which must be made public, also provides an easy way for donors and other people interested in supporting a particular cause to find and evaluate the best charities to support. In a way, the 990 can be a public relations tool for a charity when care is taken to fill it out correctly and carefully.

‍State Audits

‍In general, state governments are the primary demanders of audited financial statements and do so based on income levels. For example, nonprofits based in California must file audited financial statements if their gross receipts exceed $2 million. For Georgia, gross receipts must surpass $1 million. Some states do not require audited financials at any level, while other states require them at levels as low as $100,000 in contributions. Nonprofits should confirm the requirements relevant to their particular state.

‍Federal and Other Audits

‍The federal government does mandate audited financials for those nonprofits that receive more than $500,000 in grants or awards from federal agencies in a given fiscal year. Audits are only required for that year. However, if a nonprofit consistently surpasses the $500,000 annually, it must obtain annual audits. In addition, nonprofits that receive large funding amounts from a single source, including private foundations, may be required by that source to provide audited financials. Or, if you are interested in submitting grants to large private and public foundations, they often require at least three years of audited financials.

‍Finance Reports

‍The two most used finance reports for board review are the Balance Sheet and the Profit/Loss (P&L) Statement. A nonprofit’s balance sheet compares current assets (cash in the bank plus any assets that will become cash in the next year) to current liabilities (everything that must be paid within the year, including bills, salaries, and scholarships). A P&L statement lets you know how you are progressing against your budget projections. Other reports might include a transaction/check register, bank statements and reconciliations, income/expense detail, and individual fundraising project reports.

‍Reserve or Contingency Funds

‍A contingency fund is simply a reserve fund set aside to handle unexpected debts that are outside the range of the usual operating budget. Contingency funds protect the organization against possible loss in the event of an emergency situation. They can also be used to take advantage of an opportunity or new initiative that needs funding that may not have been included in the budget. Healthy organizations must have enough money to cover typical (and budgeted) expenses for three to six months.

‍Investment Funds

‍This is typically an amount of funds deemed “extra” that can be placed in longer term investment accounts for faster growth due to higher interest. These funds would be for cash that is not needed in the day-to-day.

‍Endowment Funds

‍An endowment fund is generally utilized for specific needs or to further an organization’s operating process. Financial endowments are typically structured so the principal amount invested remains intact, while investment income is available for immediate funding for use to keep a nonprofit operating efficiently. Most large endowments are structured so a portion of the principal is released for use only after a period of time. Endowments also may be given with specific uses stated by the donor, further complicating disbursements. Endowment funds are typically funded entirely by donations that are deductible for the donors. Almost all large endowment funds are professionally managed with clear investment goals.

‍Restricted Funds

‍A restricted fund is a reserve account that contains money that can only be used for specific purposes. Restricted funds provide reassurance to donors that their contributions are used in a manner they have chosen. Caution should be taken to ensure that funds, even restricted funds, are able to be used in support of the organization’s mission.

‍Records RetentionThe Sarbanes-Oxley Act (SOX) is directed at improving corporate transparency and accountability. For nonprofits, key among the SOX provisions are document retention practices — yet the law doesn't provide explicit document retention schedules.

Following these best practices in nonprofit financial management should protect your organization from financial risk.

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