Nonprofit Financial Management | Best Practices to Know

Your nonprofit’s number one priority is your mission. It’s what your organization was started to accomplish and probably what motivates you to work hard every day. However, all of that hard work would be fruitless if your nonprofit had no money to work with. That’s why you need to track your finances carefully and manage them well.

Effective financial management’s true value comes from its ability to provide your staff with the resources and finances necessary to pursue your mission.

In this guide, we’ll discuss the key elements of effective financial management for nonprofits. By learning about best practices and determining the resources you need to manage your finances well, you can ensure your team has the financial capacity to effectively run your programs and expand in the future. We’ll cover the following:

• Policies for Good Nonprofit Financial Management
• Creating a Budget for Effective Nonprofit Financial Management
• Nonprofit Financial Management Statements and Reports
• Nonprofit Financial Management Stakeholders
• More Tips for Effective Nonprofit Financial Management

Ready to learn more about how you can better manage your finances to drive your mission further? Let’s dive in to learn more about effective nonprofit financial management best practices.

Policies for Good Nonprofit Financial Management

To have effective management practices, your organization must lay the groundwork by enacting specific policies and procedures. Nonprofit financial management is no different. You need to lay out a foundation with financial policies that define certain rules for finances.

We’ll walk through several common policies that nonprofits should implement as a part of their financial management practices:

Gift Acceptance Policy

Imagine your organization receives an?in-kind donation ?from a generous supporter, but that gift is of no use for your mission. Unfortunately, that means the gift will likely go to waste, either being donated elsewhere or thrown away.

Gift acceptance policies help prevent this very situation from occurring. A gift acceptance policy covers more than simply in-kind donations. According to?Candid’s guide to nonprofit gift acceptance , these policies also cover questions such as:

• The types of gifts your organization will and won’t accept
• The circumstances under which you’ll accept various gifts
• How you will record and track contributed gifts
• Major donations and how they will be tracked and recorded

This policy has explicit directions and instructions regarding how nonprofits should accept the contributions they receive from their generous supporters. Therefore, it’s a key document for your finance team to play a part in creating. They should understand how to best record the financial gifts and track non-financial contributions as well.

Conflict of Interest Policy

A nonprofit’s conflict of interest policy prevents directors, board members, and other key players from making decisions that could be influenced by outside financial interests. For example, if a board member owns a software company and the nonprofit is considering purchasing that software, the conflict of interest policy may require the board to choose a different solution or that the company owner must abstain from voting.

This financial management documentation should define the situations which are considered a conflict of interest and provide the next actions if a conflict arises. It should?include the following elements :

• The definition of what a conflict of interest is for the organization and what circumstances constitute a conflict
• The timeline and method through which the director or board members must disclose conflicts that have arisen
• How the board will record the conflict of interest once it’s discovered or disclosed
• The next steps taken after the discovery or disclosure of a conflict of interest
• Processes for how the policy is updated and reviewed

Even if a potential conflict falls into a “gray area” and it’s unclear if one took place, it’s always best to act on the side of caution. Treat potential conflicts as confirmed conflicts to be sure you’re always covered.

Expense Reimbursement Policy

While your nonprofit has a bank account with funding set aside for each of your organization’s expenses, there will be times when your staff members or volunteers spend money from their personal accounts on behalf of your cause. When this occurs, they may be able to be reimbursed for their expenses.

For this reason, your nonprofit needs to put together a plan and documentation regarding how you’ll reimburse expenses. Your expense reimbursement policy is a vital element of nonprofit financial management because it confirms that all funds reimbursed have actually been used on behalf of the organization and prevents fraud.

In your expense reimbursement policy, include information about:

• What expenses can be reimbursed. These expenses should be related to your nonprofit and accounted for within 60 days of the expense taking place.
• What information should be submitted in order to receive reimbursement. This includes items like who incurred the expense, what they purchased, and when and why they purchased the item.
• Who is responsible for providing the reimbursement to the staff member.
• How the reimbursement information should be recorded by your nonprofit.

If excess reimbursements are provided, they must be returned to your organization within 120 days after they’re provided.

Your reimbursement policy may be folded into your nonprofit fiscal policies and procedures document, which we’ll cover in more detail next.

Nonprofit Fiscal Policies and Procedures

Your nonprofit’s fiscal policies and procedures documentation is one of the most important manuals you’ll create and update on an annual basis. It outlines the internal controls for the organization’s well-being and ensures compliance with the Generally Accepted Accounting Principles.

Essentially, this is a rulebook as to how your nonprofit will conduct its financial operations for the year. It should be reviewed on an annual basis and updated as necessary.

In this?sample document , the table of contents for the nonprofit fiscal policies and procedures document included the following:

• Introduction, manual protocol, accounting guidelines, and internal controls
• Annual audit
• Annual budget, financial statements
• Insurance coverage, security
• Record retention
• Cash receipts and revenue processing
• Cash disbursements and accounts payable processing
• Travel expense reimbursement
• Payroll and human resources
• Net asset classifications
• Notes payable
• Board conflict of interest policy
• Whistleblower policy
• Code of conduct

Small organizations may be tempted to forgo these policies, saying that they trust their employees and have no need for them. However, they’re about much more than just trust. They provide a resource that staff members can use when they’re confused about a policy or procedure. Plus, it helps ensure financial compliance at your nonprofit.

Creating a Budget for Effective Nonprofit Financial Management

One of the most recognizably vital elements of nonprofit financial management is your organization’s budget. The purpose of your budget is to plan your organization’s various expenses for the upcoming year.

You’ll create your budget from scratch once each year, but you’ll need to make adjustments sparingly throughout the year as financial situations change. Generally, we recommend adjusting your annual budget on a quarterly or semi-annual basis.

An effective?nonprofit budget ?has the following elements:

• Defined activities. Your budget should go hand-in-hand with your organization’s strategic plan, specifically spelling out the funding that is necessary for each activity you hope to accomplish. For example, an animal shelter might set aside $10,000 to pay the veterinary expenses for 100 dogs.
• Specific time frames. Spell out when you expect to generate revenue. Many nonprofits find summer to be a dry period for fundraising and generate more funding during year-end activities or on #GivingTuesday.
• Realistic and measurable goals. Use previous expenses and planned versus actual budgets to establish goals and concrete metrics for your various initiatives. Even if you’re taking on a new project, set an estimate for the funding it will require. Then acknowledge that you might need to make adjustments in the future.

Even the best budgets sometimes go astray. And your organization will need to review your finances regularly throughout the year to ensure you stay on track. We recommend your finance and executive teams meet every:

• Year. Your annual meeting is when you’ll set your budget for the following fiscal year. It’s likely the longest meeting you’ll have, where you and?your accountant ?will meet to review past finances and determine where you stayed on course and where you strayed in your financial planning.
• Quarter. During the quarterly meeting, your team should compare your budgeted revenue and expenses for the quarter and compare it with the actual amounts. This is also where you can review grants that were won, lost, unused, etc. You should also note any discrepancies in the budget to catch mistakes before they become a problem for your organization.
• Month. Use monthly reviews to compare your planned versus actual expenses and revenue to make small adjustments where necessary. Also look for discrepancies in the budget to ensure future information is correct.

Don’t toss your old budgets when the year is done. Instead, use the metrics and actual expenses from the past year to refine your budget for the next year, making it more accurate over time.

Nonprofit Financial Management Statements and Reports

Another key element of your nonprofit’s financial management processes is pulling reports and statements from?your chart of accounts ?to summarize your organization’s use of funds. These reports provide information and can generate insights into your nonprofit’s financial health.

Your accountant should compile and review these statements and determine what next actions should be taken. These are also the statements that your?nonprofit auditor ?will review as a part of their financial review.

Statement of Activities

Your nonprofit statement of activities is also known as your income statement. It allows your organization to review your revenue versus your expenses over time, categorizing your various expenditures and funding into categories.

This statement is split into three main categories:

• Revenue. In the revenue section of your statement of activities, you’ll record revenue such as those generated through contributions, fees, dues, investment income, and the funding released from restriction.
• Expenses. The expenses section will include categories such as your organization’s main programs, fundraising activities, and operating expenses.
• Net Assets. Finally, the net assets section of your statement of activities will show the difference between your revenues and expenses.

As you can see above, the columns also report the amount of funding that is unrestricted, temporarily restricted, and the total. This provides your organization insight into the funding that is usable currently versus usable in the future.

Statement of Financial Position

Your?statement of financial position ?offers another view of your nonprofit financial management. This statement is used to determine the amount of risk that your organization can take on. This report is also known as your organization’s balance sheet, and it provides a snapshot view of your organization’s financial health.

This report is also split into three main sections:

• Assets. This section defines what your organization owns, including cash, accounts receivable property and equipment investments, long-term receivables, prepaid expenses, and more.
• Liabilities. Your liabilities section shows what your organization owes, including accounts payable, debt, and other expenses.
• Net Assets. Your net assets are your organization’s total assets minus your total liabilities. This section of your report will note how many of your assets have restrictions and how many are free to be incorporated into your budget.

From this document, your organization can calculate your months of liquid unrestricted net assets (LUNA), showing how many months you can cover your regular expenses given the liquid assets you have on hand. Your months of LUNA can be recorded with the following calculation:

Months of LUNA = (Total Unrestricted Net Assets - Property and Equipment Assets) / Average Monthly Expenses

When your months of LUNA are less than zero, it means your nonprofit doesn’t have the cash on hand to cover your current expenses. If it’s between 0 and 3 for several years, you should readdress your financial position to get back to a healthier place. If your months of LUNA are 3 or greater, you are in a healthy financial position. The higher the number, the more cash you have on hand to take on risks and attempt growth.

Statement of Cash Flows

Your?nonprofit’s statement of cash flows ?shows how cash moves in and out of your organization on a regular basis, providing insight into your organization’s spending and fundraising habits. If you’ve ever over-drafted from your personal bank account because you didn’t realize how much you had already spent, you know the importance of determining cash flow for your organization.

This important nonprofit financial management statement is composed of three sections:

1. Operating activities
2. Investing activities
3. Financing activities

There are two ways your nonprofit can choose to record your cash flows on a regular basis: direct and indirect.

• Direct method. The direct method of cash flow calculates your cash flow based on your organization’s actual transactions. It’s more time-consuming, but also tends to be more accurate. When you use this method, your accountant will need to reconcile accounts to separate the cash flows. Depreciation is also ignored in this method.
• Indirect method. The indirect method of cash flow uses net income as the basis, then calculates the net adjustments for assets and liabilities to create your cash flow statement. It tends to be faster, yet less accurate. However, depreciation is accounted for with this method.

Very few organizations use the direct method as it tends to be more time-consuming even though it’s more accurate. Choose whether you’ll use the direct or indirect method of cash flow to record everything correctly and consistently.

Statement of Functional Expenses

The nonprofit statement of functional expenses is the final financial statement fundamental to effective nonprofit financial management. This report breaks down your organization’s expenditures into categories according to their functions: program expenses, administrative, and fundraising.

The categories listed on the statement of functional expense are parallel to those listed on your?nonprofit's annual form 990 . Organizations began disclosing this nature of their expense activities when these categories were added to the Form 990 in 2017.

Not only does this form allow your organization to review detailed information about your expenses, but it also makes it easier for you to file your annual tax forms each year.

Nonprofit Financial Management Stakeholders

Who is responsible for ensuring your nonprofit financial management processes are effective? More than one person maintains effective financial processes and measures your organization’s financial health. It requires input from your entire nonprofit team. Some of the key stakeholders in your financial management processes include your board of directors, executive director, and finance team.

Board of Directors

Your board of directors’ role ?is primarily to provide organizational oversight. When it comes to your financial management, your nonprofit board will review and approve several key financial documents for your organization, such as your:

• Annual audit
• IRS Form 990
• Annual budget

Most of your board of directors will be coming from for-profit jobs and will have little experience with nonprofit financial statements. Therefore, when new board members join your team, they should go through reporting and nonprofit financial management training.

The review process shouldn’t just be a rubber stamp “approval” from your board. They should understand the importance and implications of each of these documents and ask appropriate and insightful questions about each one.

Executive Director

Your executive director is in charge of your organization’s day-to-day operations. They not only oversee your finance team but also act as the liaison between your organization and the board of directors. This means they also need to both understand and be able to articulate the various financial reports coming from the finance and fundraising departments.

This key team member also needs to monitor organization spending and ensure the nonprofit is on track with the budget and following financial best practices.

Essentially, the executive director needs to have a thorough understanding of your nonprofit financial management processes in order to both oversee and manage your organization’s other departments and teams.

Finance Team

Your nonprofit finance team is the on-the-ground team working to ensure your organization has effective financial management processes. They compile financial reports and interpret the results, reporting back to the executive director. This team includes your organization’s accounting and bookkeeping personnel.

While some organizations choose to employ these individuals internally, many others recognize the potential to?outsource these responsibilities ?to an outside organization. For small to mid-sized organizations, this not only puts your financial information in the hands of professionals, but it’s also far less expensive than hiring internally.

More Tips for Effective Nonprofit Financial Management

Effective nonprofit financial management is more than just implementing the right policies and creating the best reports. It also comes from the decisions you make according to your current and ideal financial policies.

These eight nonprofit financial management tips will make sure your organization is implementing healthy financial spending, fundraising, and reporting processes.

1. Diversify your funding.

The importance of diversification hit many organizations in 2020 when the COVID-19 pandemic began. Many who relied on one or two major funding sources saw those funding sources pull out or postpone their funding. For instance, major donors who were hit hard with the financial crisis may have found themselves unable to make their usual annual contribution.

This left these nonprofits in disarray, scrambling to replace that single important funding source. Diversifying your funding adds greater stability to your nonprofit finances. Here are some steps you can take to diversify your organization’s income:

• Determine the percentage of your income that comes from each of your current funding sources. Determine if any of them could be increased. For example, mid-tier donors are often under-stewarded by fundraising teams who prefer to focus on major gifts. However, mid-tier donations add up quickly if you’re able to reach these donors.
• Consider the services you currently offer. Are there opportunities you can charge for those services?
• Look into business activities that you can operate tax-free alongside your other services. For instance, you may open a thrift store or rent out space for third-party organization events.

As you look into?diversification opportunities , keep in mind that taxable income cannot make up a significant portion of your total income as a nonprofit organization.

2. Transparently communicate program expenses.

When you reach out to major supporters, grantmakers, and other funders, transparently communicate the expenses that running your programs incurs. While it can be tempting to make it seem like you’re more fiscally frugal than you actually are, transparency is key to obtaining the funding you need. Plus, honesty is always the best policy.

3. Focus on sustainable funding.

Donors tend to give more money over time as they develop stronger connections with your organization. And, it’s more expensive to acquire new supporters than it is to retain them. You can save on your fundraising expenses by retaining the supporters you’ve already reeled in.

You can build a more sustainable fundraising base by focusing on donor retention. According to?Bloomerang’s donor retention guide , the average donor retention rate has rested around 45% for years, providing an opportunity for your organization to go above and beyond. They provide an example that shows how a nonprofit that improves its retention rate by 10% is able to save $456,349 over time.

4. Cut down on fixed expenses.

The small things you do at home can also help your nonprofit cut back on the expenses you incur on a regular basis. For example, set your office temperature lower in the winter and warmer in the summer to save on power bills. You can also look for opportunities to create more efficient fundraising or programming processes.

The?Better Business Bureau recommends that organizations spend no more than 35% of their funding on overhead expenses and 65% on programs. This is simply a recommendation and can be adjusted to your organization’s needs.

Keep in mind that lower overhead should not come at the expense of quality. Find the balance between the overhead necessary to run your organization effectively and eliminating excessive overhead expenses.

5. Invest in nonprofit-specific finance software.

Nonprofit finances operate differently from for-profit organizations. While for-profits sell goods and services to obtain revenue, nonprofits rely on the generosity of their supporters and grantors to operate. Nonprofits also need to manage restrictions placed on various funding sources. This is why you leverage fund accounting practices to manage your finances.

Because this system of accounting is so unique, your organization needs specific software that can account for these unique elements. Leverage fund accounting software to manage your nonprofit’s finances and ensure your accounting system stays organized. For instance, Quickbooks offers a solution specifically designed for nonprofit organizations.

6. Prepare for necessary audits.

Many nonprofits conduct annual?financial audits ?to ensure they are maintaining effective financial management practices every year. Generally, if this is the case, the audit is required according to the organization’s bylaws. However, it may also be required if your nonprofit meets certain requirements set by the state, if you receive more than $750,000 in federal funding, or if grantmakers require one.

By leveraging effective nonprofit financial management processes year-round, your organization will be prepared for financial audits every time. Review your checklist of the last things to do before the audit, including:

• Ensuring every transaction has been captured
• Reconciling bank accounts
• Analyzing adjustments for prepaid expenses
• Reviewing expenses for items that should be capitalized
• Crafting financial statements and reports

Keep in mind that nonprofit financial audits are not designed to point out your organization’s flaws. They’re designed to help you better manage your finances and implement best practices that will help your organization succeed.

7. File tax forms on time.

Avoid unnecessary expenses to maintain effective nonprofit financial management. For example, one major expense you could incur is late fees for filing your tax forms past their deadline. Your?annual Form 990 ?is due every year on the 15th day of the 5th month after your fiscal year ends. For nonprofits using the calendar year, this means it’s due on May 15th.

However, if you don’t file on time, you risk incurring fees at $20 per day the form is late. Or, for very large organizations, $100 per day the form is late. Plus, you could lose your ability to accept tax-deductible contributions and your tax-exempt status, which could cause you to lose revenue and pay taxes. Not filing your annual forms on time is expensive! Be sure to set a calendar reminder about these forms or keep up with your accountant to file on time.

While these fees add up over time, they’re not necessary. If you’re worried your organization won’t make the tax deadline, you can file for an extension with the IRS with a Form 8868. This extends the deadline for filing by six months, making it due on the 15th day of the 11th month after the end of your organization’s fiscal year.

8. Work with nonprofit financial management experts.

We mentioned earlier that many small to mid-sized organizations choose to?outsource their accounting and bookkeeping services . This helps them save money and time in their financial practices. But outsourcing to the experts also provides a number of other nonprofit financial management benefits, including:

• Improved internal controls, providing additional safety for financial information
• Access to experts who have encountered the most common financial management questions in the past
• Fundraising assistance from nonprofit experts who understand the ins and outs of the financial component

Hiring new individuals to manage your bookkeeping, accounting, and financial strategy can be expensive and challenging. Instead, look into outsourcing options with?Jitasa .

Effective nonprofit financial management is necessary to ensure your organization is financially healthy enough to pursue your mission and take on additional growth opportunities. Use the advice in this guide to make sure you’re on the right track.