A Beginner's Guide to Nonprofit Accounting

Nonprofit accounting is similar to accounting for for-profit businesses, with a few big differences. Learn what you need to know to set up your nonprofit accounting system properly.

We may receive compensation from partners and advertisers whose products appear here. Compensation may impact where products are placed on our site, but editorial opinions, scores, and reviews are independent from, and never influenced by, any advertiser or partner.

While accounting itself can present numerous challenges to the non-accountant business owner, nonprofit accounting can pose an even greater level of confusion.

Of course, all businesses need to deposit funds, track expenses, and pay vendors and employees, but nonprofit organizations also need to track donations (both monetary and in-kind), handle tax receipts and thank you letters, manage volunteer staff, and track funds provided via grants or sponsorships.

That’s where nonprofit or fund accounting comes in. While fund accounting may sound complicated, it simply means that instead of tracking money for a single business or entity, you’re tracking income and expenses using multiple funds.

For instance, when a nonprofit holds a fundraiser, the money received needs to be tracked separately from other funds. So, if a nonprofit has five active programs for which it regularly obtains funding, it will need to track all income and expenses for each of those programs or funds separately.

The same principle applies to grant or endowment funding.

When a nonprofit obtains a grant from a foundation, that money needs to be accounted for in a separate fund, with a report provided to the foundation at the end of the grant term that provides detailed information on how the grant funds were used. Endowments are managed the same way.

While creating multiple fund accounts can certainly be done manually or by using standard accounting software, it’s a more cumbersome process that involves additional data entry, the need to create a specialized chart of accounts, as well as the need to add sub-accounts to your general ledger, making the entire process more confusing.

On the other hand, nonprofit or fund accounting software offers a more flexible chart of accounts structure that is specifically tailored to nonprofit organizations.

Like for-profit businesses, there are different types of nonprofits, each with their own specific needs. For instance, a nonprofit that is funded primarily through private donations needs to track funds much differently than a nonprofit that receives grants on a regular basis.

Here are a few of the things nonprofits need to manage:

  • Funds: If you have numerous sources of income, you need a way to properly account for all of those income sources.
  • Donation management: Many nonprofit organizations are funded primarily by individual donations. Not only do you need a way to track donation amounts, but you also need a way to manage the donors since you need to supply them with thank-you letters or, at the very least, a receipt for their donation.
  • Grant management: While not every nonprofit needs grant management, if you receive grants from foundations, you need a way to manage the funds properly. In fact, proper management of funds is usually a stipulation of any grant a nonprofit receives.
  • Volunteer management: If your nonprofit uses a lot of volunteers, you need a way to manage those volunteers properly.
  • Campaigns: Again, if you run multiple campaigns, you need a way to manage both the campaign itself as well as any funds received from those campaigns.

Nonprofit vs. for-profit entity: What's the difference?

There are numerous ways in which a nonprofit differs from a for-profit business. Here are just a few:

  1. Accountability: While for-profit businesses are accountable to stockholders and investors, they have much more autonomy than a nonprofit, which has to regularly report how the funds received are used and ensure they are used properly. In fact, a nonprofit organization is accountable to anyone who provides funds to the organization — starting with a $10 donor all the way to the foundation that awarded your nonprofit a $100,000 grant.
  2. Taxes: Nonprofit organizations are typically exempt from paying taxes on donations and other funds received, though they are still liable for payroll taxes such as federal and state taxes, as well as Social Security and Medicare taxes.
  3. Different missions: The primary purpose of a nonprofit organization is to provide goods or services needed, while the mission of a for-profit business is to make money for the owners and stockholders.
  4. Profit distribution: While a nonprofit organization is allowed to earn a profit, any profits earned must be reinvested in the work of the organization. Profits earned by a for-profit business are distributed to owners and shareholders, as well as reinvested in the business.
  5. Financial statements: Financial statements are different for for-profit and nonprofit organizations.
Nonprofit Financial Statements For-Profit Financial Statements
Statement of financial position Balance sheet
Statement of activities Income statement
Statement of functional expenses Cash flow statement
Cash flow statement

The cash flow statement is the only financial statement used by both nonprofit organizations and for-profit businesses.

How to set up bookkeeping for your nonprofit

Here is how you can go about setting up your accounting system for your nonprofit.

Step 1: Choose nonprofit software that suits your organization

Doing bookkeeping manually is a tough job, but it’s even tougher if you’re trying to do bookkeeping for a nonprofit organization. While you can use T-accounts to help with your transactions, keeping track of multiple funds, programs, or grants on a spreadsheet is a recipe for disaster.

Spend some time to find a nonprofit accounting software application that fits your needs and your budget. You won’t regret it.

Step 2: Create a nonprofit chart of accounts

Nonprofits need to track both income and expenses in three distinct areas: programs, administrative costs, and fundraising. If you apply for and receive grants or sponsorships, you’ll need to account for those areas as well.

With areas such as fundraising and grants, you’ll also have to account for fund status, such as restricted, unrestricted, and temporarily restricted funds.

If you use nonprofit accounting software, your chart of accounts will include the option to use multiple segments to manage multiple funds, which is a necessity for adequately managing funds, programs, and grants.

For example, in a standard chart of accounts, an expense account would appear as follows:

5000 - Salary Expenses

However, if you wish to track salary expenses for a particular program, your chart of accounts structure would look like this:


The 01 segment indicates the specific fund involved. The 02 segment indicates the specific department, program, or grant, and 5000 is the standard expense account number.

Step 3: Choose cash or accrual accounting

All businesses — nonprofit organizations and for-profit companies — need to use either cash or accrual accounting in their bookkeeping. Here’s the difference.

  • Cash accounting: If you use cash accounting, you’ll record transactions when money is actually exchanged, recording revenue when your customer pays and recording expenses when they are paid.
  • Accrual accounting: Accrual accounting recognizes revenue and expenses when they are incurred. For instance, when you invoice a customer, the invoice is recorded as revenue, regardless of whether the customer has paid the invoice. The same goes for expenses, which are recorded when they occur, not when they’re paid.

Step 4: Familiarize yourself with nonprofit financial statements

There are four nonprofit financial statements that are typically used.

  1. Statement of financial position: The statement of financial position is similar to a balance sheet. It displays assets, liabilities, and net assets, which details restricted, temporarily restricted, and unrestricted assets. Net assets take the place of owner’s equity for a nonprofit since a nonprofit does not have an owner or investors.
  2. Statement of activities: The statement of activities shows any changes in net assets over a specified period of time. The statement of activities is similar to an income statement, but it includes current and prior-year totals as well as budgeted totals and budget variances. An explanation of any changes should always accompany the statement of activities.
  3. Statement of functional expenses: The statement of functional expenses reports on each individual program offered by the nonprofit, along with administrative/overhead expenses and fundraising expenses. The statement of functional expenses can also be used when preparing your Form 990.
  4. Cash flow statement: The cash flow statement is the only report that is used in both for-profit businesses and nonprofit organizations. The cash flow statement identifies and reports on cash received from operating and investment activities as well as cash from financing activities.

Step 5: Become familiar with Form 990

Though many nonprofit organizations are classified as exempt from federal income tax, they still need to prepare tax forms at the end of the year.

Form 990 is due by the 15th day of the fifth month after the organization's accounting period or fiscal year ends, so if your fiscal year ends on December 31, Form 990 would be due by May 15 of the following year.

It’s important to note that Form 990 is available for public inspection at all times once filed, and it will need to be filed annually in order for your organization to maintain its nonprofit status.

Step 6: Start entering accounting transactions

With the majority of the setup work now completed, you’re ready to start entering transactions for your nonprofit.

The most important thing to remember when entering transactions is that if you’re funded by donors or grants, you need to track how that money is spent. Budgets are also used more widely in nonprofits, with multiple budgets typically prepared for each program or grant.

In addition, if you accept in-kind donations, you will also need to know how to properly record them.

Nonprofit organizations require nonprofit accounting

While smaller nonprofits can certainly get by with standard accounting software, in order to properly track multiple programs, funds, and grants, you’ll be best served if you use nonprofit or fund accounting software.

Nonprofit accounting basics are more complex than accounting for a for-profit business, but using industry-specific software will make the process much easier.

The Top 25 Tax Deductions Your Business Can Take — And 5 You Can’t

Are you paying more in taxes than you need to? Every dollar makes a difference, and you can save more of them by taking ALL the tax deductions available to your business. In this 12-page report, we've outlined the top 25 business tax deductions you could be taking (and 5 to watch out for)!

Enter your email to get this free report, “The Top 25 Tax Deductions Your Business Can Take – And 5 You Can’t.”

The Motley Fool has a Disclosure Policy. The Author and/or The Motley Fool may have an interest in companies mentioned.