What separates nonprofits from for-profit businesses? Nonprofits and for-profits each have a different criteria for determining their bottom line.
For for-profit businesses, the focus is on profitability, whereas nonprofits focus on accountability to build trust and increase funding. The bottom line for a nonprofit is to fulfill its mission. To achieve this, nonprofits must raise money and be accountable to funding sources. Where for-profit businesses have one bottom line, nonprofits have two bottom lines. One is to fulfill their stated mission and the other is having the funding to support their mission.
Key Differences Between Nonprofit and For-Profit Businesses
Compared to for-profits, nonprofits are held to different standards and are required to separate revenue sources into categories or funds. This practice helps nonprofits demonstrate accountability, not profitability. Fund accounting identifies revenue sources in order to provide transparency for the organization. By using fund accounting methods, a nonprofit can generate financial statements that show how funding is being spent and prove the revenue is being used for its specific purpose.
When implemented properly, fund accounting can identify key areas of strength and weakness. Think of it this way — each fund represents a separate company within your organization, with its own self-balancing set of books to track assets, liabilities, revenue, expense and fund balances or net assets.
Impact of New FASB Regulations
New FASB regulations go into effect in December 2017 that will affect the presentation of financial statements. The new rules simplify the treatment of net assets in financial statements by focusing on the existence or absence of donor imposed restrictions, as opposed to the types of restrictions (i.e., temporarily restricted vs. permanently restricted). The classification of temporarily restricted versus unrestricted assets has long been an area of confusion. Under the new rules the Statement of Financial Position will only have two classes of “Net Assets”: net assets with donor restrictions, and net assets without donor restrictions.
“The new rules simplify the treatment of net assets in financial statements by focusing on the existence or absence of donor imposed restrictions, as opposed to the types of restrictions (i.e., temporarily restricted vs. permanently restricted).”
Net Assets without Donor Restrictions: There are no restrictions placed on this type of fund. The nonprofit can use the revenue as it sees fit. Restricted gifts, or gifts with strings attached, fall into two categories known as the gift instrument, which is the document that determines how the donated funds will be used. This could be an award letter from a foundation or a letter from an individual donor.
Net Assets with Donor Restrictions: These funds never expire. However, there is a catch. Only the income earned by the assets can be used. The original gift must be kept intact forever or for a designated period of time. For example, a permanently restricted fund may go into an endowment that supports a particular activity or the organization in general.
How Subcategories Identify Funds for Specific Purposes
Subcategories help nonprofits identify funds for specific purposes. An example of this includes Board Designated Funds. These are a subcategory of net assets without donor restrictions established when the board takes a portion of the fund and uses it for a specific purpose.
Lets say your nonprofit creates a Fixed Asset Fund to track all buildings, furniture, fixtures and equipment. In this case, the board might want to separate the assets from the from the net assets without restrictions. By doing this, the fund now clearly shows the activity of how the funds are being used for the current program. The decision to do this is purely optional by the board.
Basics of Fund Accounting
Fund accounting focuses on accountability and proper stewardship. Nonprofits must demonstrate compliance and adhere to specific government regulations and requirements. More importantly, by using fund accounting methods, nonprofits can manage revenue received by funding sources and monitor the restrictions associated with the revenue. Separating funding into specific funds help prevent the misuse of revenue. Each fund has its own revenue and expense report; excess efficiency calculation and its own balance sheet.
A fund accounting system groups funds into either net assets without donor restrictions and net assets with donor restrictions. Nonprofits use this to satisfy GAAP and FASB 116/117 requirements and generate reports that break down net assets on the IRS Form 990.
Fund Accounting Rules
When it comes to donations, the donor has the right to decide whether they want restrictions or non restrictions placed on their donation. They are entitled to request their wishes by letter or through and agreement with the nonprofit. As for grants from foundations, these typically have restrictions for a specific program or purpose. Very often these restrictions are specified in the documentation for the grant award.
Nonprofits must be transparent when soliciting donations from donors. When soliciting donations by email or direct mail, they may ask for donations without restrictions. This request must be clearly stated on the donation form or in the gift acknowledgement. Exceptions to this include capital campaigns, a building fund or scholarship fund.
“When it comes to donations, the donor has the right to decide whether they want restrictions or non restrictions placed on their donation.”
Making requests like this come into play when donors specify their donations be used for a specific purpose only to discover their gift was used in an unrestricted way. Nonprofits can prevent this from happening if they give donors a choice of designation at the time of the donation. If the donor specifies the donation be used for a specific purpose and the nonprofit does not comply then the donor can demand a refund and legal action and report the charity.
Nonprofits must maintain a clean image in the public eye in order to keep their nonprofit status. By implementing fund accounting, a nonprofit can comply with regulations and become more accountable, transparent and sustainable.
Joseph Scarano is the CEO of Araize, Inc., developers of cloud-based FastFund Online Nonprofit accounting, fundraising and payroll software solutions to help your nonprofit become more transparent, accountable and sustainable.