How to Address 4 Common Challenges in Accounting for Nonprofit Organizations

Published by BradyRenner CPAs | December 17, 2018

One of the great advantages of working in the nonprofit sector is the ability to combine a mission with a career. Nonprofit organizations exist to solve key social problems, and as a result they have the ability to create cultures that are mission-driven from top to bottom. Nonetheless, executing on the mission is only one part of the roles and responsibilities of a nonprofit, and like any entity a healthy nonprofit needs to operate efficiently and be managed effectively.

Whether it’s the capital budget, the question or whether to rent or buy assets, or preparing financial statements for donor reporting, nonprofits often find themselves overseeing a complicated and wide-ranging set of operating demands.

Accounting is certainly one of these critical domains, and in fact a nonprofit is accountable to a huge range of parties including board members, donors, foundations, auditors, banks, and the communities it serves. All of these parties have expectations and requirements for financial transparency and accounting precision that help ensure the organization’s fiscal health and legal compliance. Recognizing that, here are four common accounting challenges the nonprofits often face:

Challenge #1. Cash Flow

In any organization, the number one accounting priority should be to protect and enhance cash flow. “Cash is king” as they say, and all other functions need to support strong cash flow. This begins with a clear understanding of the nonprofit’s run rate, including its daily cash requirements and consumption of funds over time.

That being said, many nonprofits fail to consider the cash flow impacts of seasonal activities or variations in grant or donation funding. A nonprofit that is highly dependent upon individual donors may receive most of those funds unevenly over the course of the year. In many cases, a majority of donor funds are received during an annual fundraising drive, and again during the holiday season. In other cases, a nonprofit that is dependent upon key foundation grants may have contracts that only issue part or all of a given grant’s funds on a reimbursement basis. This scenario can delay receipt of funds and require ‘bridge’ funding to cover operating costs while the organization awaits grant disbursements in the near future.

Another common challenge is the high percentage of restricted funds that a nonprofit may have to rely on, while other funds necessary for day-to-day operations and capacity building are often smaller and harder to come by. The management team should not just be worried about positive cash balances at any given point during the year, but also maintaining positive, unrestricted cash balances. By properly planning cash flow and closing the books monthly, you can monitor this challenge via the Unrestricted Net Assets balance on the Balance Sheet.

The organization would also benefit from preparing a monthly cash flow budget and/or projection that treats each month as its own activity period. Look at each month as a separate activity period with due consideration towards seasonality and activity within the organization.

Furthermore, consider preparing a cash flow report for each initiative, program or service line that has restricted funding. Then, consider unrestricted funding to these programs on a monthly basis and have each of the programmatic budgets roll up into the overall budget to ensure you are maintaining both the programs and the overall organization as a whole.

Challenge #2: Staffing

Staffing is another area of great challenge and responsibility for nonprofits, especially since mission-driven organizations tend to build a base of employees who are passionate about the cause. In contrast to private sector culture which is typically focused on the bottom line (and is perhaps more flexible in acknowledging that certain positions or longtime roles are no longer necessary), nonprofit leaders often struggle to make personnel changes that are necessary to the mission. This is, in part, because nonprofit leaders recognize and reward loyalty to the mission even when staff who demonstrate that loyalty are not an ideal fit for the organization’s future direction.

Regardless, nonprofits often either outgrow the skills of longtime team members (and need to replace them with differently-skilled personnel) or find themselves over-staffed in times of financial weakness, since they are unable to accept the reality that key players may need to be sacrificed in order to protect the organization as a whole. This is especially trying in nonprofits that focus on the alleviation of social problems and service to the less fortunate, since it feel hypocritical to lay off personnel in an organization dedicated to helping people who have been laid off or otherwise forced into hardship.

In addition, the tendency to recognize such a high priority around enthusiasm for the mission can also skew hiring decisions toward less-skilled or inexperienced individuals who are nonetheless highly enthusiastic about the mission. If these individuals are willing to accept guidance, training and supervision (and if the nonprofit is in a position to provide it), then this enthusiasm can be harnessed effectively. If not, the organization may find itself weighed down by a complement of highly engaged but fundamentally under-skilled personnel who, collectively, can put the nonprofit’s overall viability in the future at risk.

Challenge #3. Payroll

In addition to focusing on putting the right people in the right positions and ensuring that the organization’s staffing itself is appropriately configured and effective, we also must make sure that payroll support and planning for employee benefits are protected as well. Employees in the nonprofit sector choose to make a difference by directing their career skills and energies toward helping others, and they already sacrifice other opportunities to pursue a career in this field. That should never turn into a pretense for under-paying personnel or delivering inadequate benefits to your team. Effective nonprofit leaders recognize and commit to the management philosophy that when managing cash flow and core financials, one of their very first responsibilities is to ensure that payroll is executed accurately, fully, and on time – every time.

Proper staffing, training, and compensation cannot be emphasized enough as financial and accounting priorities for nonprofits. When the need for personnel is definite, speaking with an accountant to see where the organization stands and how financials would be affected by new hires or a shift in benefit strategy or offerings is incredibly important.

Challenge #4: Grant and Revenue Tracking

Properly following and tracking revenues throughout the nonprofit organization is a process that involves multiple essential components. One key priority is effective tracking of restricted funds, which requires careful coordination as well as precise configuration of the chart of accounts to ensure that funds are appropriately designated and disbursed.

Many nonprofits have been faced with bad publicity and even legal investigations and donor claw-back demands on the basis of misapplying restricted funds to other uses. That’s why it is important to understand and keep in mind that not every restricted donation should automatically be accepted — and that when they are, in many cases you will need an increase in unrestricted giving to offset the loss of operational resources necessary to execute on the restricted donor’s intentions.

Also important is close coordination with development staff to ensure that all funds received from donors and funders come with clearly understood parameters and designations. Finally, both the accounting and development departments need to add and maintain accurate and current contact records.

At the same time, grant and revenue tracking creates other challenges. While the grant-maker may provide infrastructure and some support for grant execution (for example, scheduling progress payments on the grant so that the nonprofit can plan when to expect funds), the challenge with many grants is accurate tracking of how funds are received, disbursed and applied to the activity categories and objectives defined in the grant. This is essential not only to ensure that future grant fund disbursements are executed on time, but also to protect the nonprofit’s ability to apply for and secure future grants from the same grant maker.

It is clear that nonprofit accounting presents an enormous range of requirements, responsibilities and considerations that can pull even an experienced nonprofit executive in many directions. The key to nonprofit accounting success begins with an understanding of the various components of an effective nonprofit accounting operation, and this continues with a strategic commitment to focus on activities, opportunities and decisions that protect and support the organization’s core mission, and its core needs (such as cash flow needs and operating realities).

Through your commitment to consistent and well-defined accounting processes and procedures at the outset, you will set your nonprofit on a path to consistent success in its financial affairs and operating capabilities.

Photo by rawpixel on Unsplash