We all hear the term “nonprofit” used to describe everything from a hospital that raises money for disease research to a food pantry to an elementary school’s PTA. So what makes something classifiable as a nonprofit?

The IRS designates nonprofit charities as 501(c)(3) organizations, which makes them exempt from paying federal taxes. According to the IRS website, a 501(c)(3) nonprofit is an organization that is not organized or operated for the benefit of private interests, and none of its earnings can go into the pocket of any private shareholder or individual. 501(c)(3) nonprofits also are eligible to raise money with contributions being tax-deductible for the donor.

Examples of nonprofits are civic and social organizations, community food services, and community housing services, just to name a few.

Why accounting processes are unique for nonprofit entities

The differences between a nonprofit organization and a for-profit corporation go much further, however. For-profit companies have a product or service they sell in order to generate revenue. They also have a number of typical costs associated with running their business: payroll, rent, insurance, for instance. Any profits left over after those bills get paid go to either the owner(s) or the shareholders. Their revenues and expenses are more “free flowing” in the sense that a for-profit can use the money on any legal activity.

Nonprofits have a very different business model. First off, unlike a for-profit company, nonprofits often have disparate streams of revenue, each “bucket” having its own guidelines, associated expenses, and requirements.

Second, whereas a for-profit has obligations to turn a profit for shareholders/stakeholders, a nonprofit’s obligations typically are to various types of donors – grant-givers and others who give money – as well as to whatever charitable cause they support. The money they generate is tied to these obligations, with donations going into specific funds. (Think of making a donation and designating it for “hurricane relief,” as an example.)

Let’s take, for instance, an art museum that has five main streams of income:

  • Donors who give money so the museum can have nice art
  • Grants that provide funds for a specific purpose (for example, allowing low-income children to enter the museum free of charge)
  • Admission ticket sales
  • Memberships for people who want to “join” and get certain perks in return
  • Fundraising events (such as charitable dinners, auctions, etc.)

Each one of these revenue streams has expenses associated with it that are independent of and irrelevant to the other buckets. For this reason, there has to be a way to keep monies for each stream separate. And that process is called fund accounting.

The history and purpose of nonprofit fund accounting

There is an outstanding article that was published in the Harvard Business Review (HBR) many years ago that explains the history and importance of nonprofit fund accounting. The concept of fund accounting can be traced back to the 13th century and the Magna Carta, which asserted the rights of the English lords (their legislature) over the monarchy (the equivalent of our executive branch). More recently, however, “fund accounting systems were devised to help trustees fulfill their legal obligation to use each of the institution’s various funds according to its guidelines,” the HBR article explains.

The article describes a nonprofit’s funds as being “like a collection of cookie jars in which resources for various purposes are stored.” Those “jars” include:

  • Current funds, which is for current operating expenses (similar to working capital); these can either be designed or unrestricted
  • Plant funds, which are the nonprofit’s fixed assets
  • Endowment funds, which is money used for generating income, the principal of which cannot be spent, but its income can be used for designated purposes
  • Special purpose funds, which is money used for a specific objective or goal

Each fund’s balance sheet accounts for the source of the money (liabilities owed and capital generated), as well as any investments the money is in. Fund accounting statements provide three key pieces of information on the nonprofit’s resources:

  • The purpose of the fund’s monies
  • Any legal limits on the dollars’ use specified by the donors
  • Any determinations made by the nonprofit’s board on the money’s use

Our new partnership for nonprofit financial data

As you can see, in addition to their unique “business model,” nonprofits also have their own distinctive set of accounting practices. If you are working with nonprofit clients and prospects, it’s important to understand these key differences. And the Industry Intelligence on Vertical IQ now can help you even more in this endeavor.

In the past, Vertical IQ got its financial statistics in a fairly cookie cutter format. The financial data for nonprofit industries looked much like the data on for-profit industries. We knew that nonprofits’ behind-the-scenes accounting was much more complex than it appeared in our analytics, so we sought out a solution to address this because we knew that’s not how organizations like schools, museums, social charities, etc., view the world.

Many nonprofits release their financial information publicly, and it just so happens a company called Candid has become the leader in keeping track of the aggregate data from these organizations so you can benchmark the various types of nonprofits. They truly are the best in this niche! So, we collaborated with Candid to license their data and incorporate it into our applicable Industry Profiles.

You can read more about our collaboration with Candid here.

A boon for those working with nonprofits

Vertical IQ customers will discover a number of key benefits of having this nonprofit fund accounting data on our site.

First, it gives Vertical IQ users the knowledge to look at a nonprofit’s financial situation through a more specialized lens, enabling them to become a better advisor to their customer. For example if you were to call on a museum and talk about an income statement in traditional terms, you would show a lack of preparation and understanding of how a nonprofit operates. Compare that to a Vertical IQ user who does their homework, reviews the Candid data, and discusses issues around the museum’s fund accounting. You instantly build credibility by speaking their language, and you become a better advisor to that museum.

Next, these niche insights enable you to suggest more tailored products or services that benefit your nonprofit client or prospect because you will know how your solutions specifically fit that type of organization. For example, would your product or service benefit them in their fundraising, their membership drives, their grantmaking, or perhaps something else? To be even more specific for bankers, would this nonprofit potentially need separate checking accounts for each fund?

Finally, this insightful data allows you to be an indispensable advisor to your nonprofit clients to improve their financial situation through improved attention to accounting details. This can be especially valuable for small nonprofits that have limited human resources at their disposal. After all, it’s hard to suggest financial and accounting improvements if you don’t even understand how they are keeping records!

>>Join Vertical IQ and Lerman Strategies for a joint webinar, “Grow and Retain Business with In-Depth Industry Expertise,” on Tuesday, September 20, 2022 at 1:00 PM EST. This webinar will focus on the role industry specialization plays in differentiating your accounting firm, growing your business, and retaining the very best clients. Louis Biscotti, national leader of Marcum’s Food and Beverage Services group, will also be joining us. Click here to register!

>>To learn more about how Vertical IQ can help you help your nonprofit clients and prospects, or to request a demo, contact us today!

Image credit: Rodnae Productions via Pexels

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