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Bookkeeping For Nonprofits: How Is It Different Than For Small Business?

Nonprofit bookkeeper using calculator

Bookkeeping is an essential component of any ongoing enterprise.  It is the meticulous process of recording and organizing financial transactions, and represents the backbone of the financial system for both small businesses and nonprofit organizations.  And while the fundamental principles of bookkeeping remain constant across different entities, the way it’s approached varies a lot based on the nature of the organization.

Introduction

Every company in existence, large or small, for-profit or nonprofit, must keep track of their transactional financial activity.  It’s not an option.  And while many things are the same between commercial and charitable entities, other elements are very different indeed.  In this article, we will delve into the nuances of bookkeeping for nonprofits, highlighting the key differences between them and for-profit small businesses, and the rationale for those differences.

1. Nature and Purpose of the Entity

Small Businesses:

The primary objective of a small business is to make a profit.  Their transactions are largely driven by sales, expenses, investments, and returns.  In essence, their aim is to generate revenue greater than the costs incurred.

Nonprofit Organizations:

On the other hand, nonprofit organizations exist to fulfill a specific mission or purpose rather than earn a profit.  Money coming in is often through donations, grants, or membership dues, or possibly even the sales of goods and services.  That latter category is what we call “program revenue”.  And even though it can resemble commercial sales activity, the key difference is that program revenue MUST be generated by activity that is directly related to the nonprofit’s exempt purpose.  This revenue, whether by gift or by sale is primarily used to fund various activities or programs that align with the nonprofit’s mission.

2. Revenue Recognition

Small Businesses:

Revenue is recognized when a product is sold or a service is rendered. For example, when a customer buys a product, the transaction is recorded as revenue for the business.  That can look different depending on whether the organization uses the accrual or cash method of accounting, but that’s a conversation for another day.

Nonprofit Organizations:

Revenue recognition is more nuanced for nonprofits. They categorize donation and/or grant income as either “with donor restrictions” or “without donor restrictions”. This distinction is essential because certain funds can only be used for specific purposes as designated by the donor. Recognizing these differences ensures that funds are used appropriately and transparently.  Program revenue recognition more closely resembles that of a commercial business, however.

3. Financial Statement Terminology

Small Businesses:

Common financial statements for businesses include the Income Statement (or Profit and Loss Statement), Balance Sheet, and Cash Flow Statement.

Nonprofit Organizations:

For nonprofits, the terminology and presentation are different:

  • The Income Statement is often referred to as the “Statement of Activities.”
  • The Balance Sheet is often referred to as the “Statement of Financial Position.”
  • Instead of an equity section on the Statement of Financial Position (Balance Sheet), nonprofits have “net assets,” which are further categorized based on donor restrictions.
  • The Cash Flow Statement is similar but might have specific line items related to donations or grants.
4. Tracking of Equity vs. Net Assets

Small Businesses:

Owners’ equity represents the ownership interest in the business. It is the residual interest in the assets of the entity after deducting liabilities. This includes capital invested by the owners and retained earnings (or accumulated profits or losses).

Nonprofit Organizations:

Instead of equity, nonprofits have net assets, representing the residual assets after all liabilities are deducted. These are categorized as:

  • Net Assets Without Donor Restrictions: Funds that can be used at the discretion of the organization’s leadership.
  • Net Assets With Donor Restrictions: Funds that are restricted by donors for specific purposes or time frames.
5. Profits vs. Surpluses

Small Businesses:

Small businesses aim to generate profits, which can be reinvested into the business or distributed to owners/shareholders.  Profit is why the owner is in business to begin with.  And the larger the business, the more important this is.  Publicly-traded companies are required by law to consider profit-maximization as a key mandate.

Nonprofit Organizations:

When nonprofits have more revenue than expenses, it results in a surplus, not a profit. This surplus is typically reinvested into the organization to further its mission*.  Unlike commercial businesses, nonprofits do not have shareholders or owners to distribute profits to.

*This is also an area in which we run into weird, pervasive ideas such as the requirement for nonprofits to spend-down (or zero-out) their surplus before the end of their fiscal year.  Nothing could be further from the truth.  Nonprofits that do that inevitably start their new fiscal year with no money!

6. Tax Implications

Small Businesses:

Profits earned by small businesses are subjected to taxes. The exact nature and rate of the tax depend on the business structure (e.g., sole proprietorship, partnership, corporation).

Nonprofit Organizations:

Nonprofits, if they secure tax-exempt status, do not pay taxes on income related to their mission. However, they must adhere to specific guidelines, including filing appropriate returns like the IRS Form 990, which provides a detailed financial overview of the organization’s activities.  Some nonprofits, like private foundations, may pay a small amount of excise tax on investment earnings, but this doesn’t remotely compare with the tax burden commercial businesses face.

7. The Need for Professional Assistance

This is really where we have to collapse the differences between a for-profit business and nonprofit organizations.  When it comes to this topic, the best practice advice is the same for both.

Bookkeeping and accounting are exact sciences that do not lend themselves very well to an amateur effort.  Unless you have someone in your organization who is an expert in bookkeeping, it is critical to enlist the services of a professional.  Both nonprofits and businesses are required by law to keep accurate financial records.  Don’t take chances on a do-it-yourself solution that will cost you in the long run.

Conclusion

While the foundational principles of bookkeeping apply universally, the methodologies and key requirements differ when comparing small businesses and nonprofit organizations. Understanding these differences is essential for anyone involved in financial operations or oversight within these entities.  As such, anyone involved in bookkeeping or financial management for either entity type should be well-versed in the specific standards and practices that apply.

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Greg McRay is the founder and CEO of The Foundation Group. He is registered with the IRS as an Enrolled Agent and specializes in 501(c)(3) and other tax exemption issues.

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