Improving Nonprofit Bookkeeping: Best Practices to Follow

Practice Fund Accounting

When donors give to your nonprofit, they may add stipulations to how their gifts can be used. For example, a major donor might specify that their gift can only be spent on a certain program that aligns with their values. These agreements aren’t just about respecting an individual donor’s wishes—they’re actually legally binding. If your nonprofit misappropriates donor-designated funds, you might face legal repercussions. 

Bookkeepers help nonprofits avoid this scenario by following the principles of fund accounting.  

To ensure your organization’s records align with this method, use a unified banking platform designed for nonprofits to track whether each gift is:

• Unrestricted. Unrestricted funding can be spent however your nonprofit needs, whether it’s an underfunded program or overhead expenses related to administration or fundraising campaigns. Unrestricted gifts often include gifts from medium and small-dollar donors, merchandise and service fees, and event revenue. 

• Temporarily restricted. Most grants, sponsorship revenue, and major donations will have temporary restrictions attached. These contributions must be spent on a specific initiative. However, if there are funds left over after the designated project is completed or a deadline passes, the funding may become unrestricted.
• Permanently restricted. The most common type of permanently restricted gifts is endowment donations. These gifts are meant to generate investment revenue that funds a long-term initiative, and the initial endowment principal usually can’t be spent directly. 
  

Along with helping you properly allocate revenue, fund accounting also ensures your nonprofit understands how much cash you actually have on hand at any time. For example, if you receive several major gifts, but don’t mark down that they’re restricted, you might assume your nonprofit has greater liquidity than it actually does. 

Fund accounting helps you understand what funding is readily available, allowing you to create more accurate budgets and make better financial decisions. 

Allocate Expenses Consistently

When allocating expenses, maintain consistent documentation and procedures. This helps you better understand what resources your nonprofit has available, what parts of your budget are flexible, and how you have historically allocated funding. 

To keep your expense documentation consistent, organize all spending into one of these three categories:

• Program expenses are related to your nonprofit’s mission. For example, a nonprofit that conducts environmental restoration programs might have expenses related to purchasing tools, saplings and other plants, and safety gear. 

• Administrative expenses are costs necessary for managing your nonprofit’s day-to-day operations, such as staff salaries, office equipment purchases, utility bills, and rent or mortgage payments on your facility. 
• Fundraising expenses are upfront costs associated with fundraising. For instance, if you host an in-person event, you’ll likely have fundraising expenses for renting a venue, hiring a caterer, and purchasing decorations. 
  

By accurately labeling all expenses within your bookkeeping system, you can improve your financial data management, ensuring you create accurate internal reports and report your spending accurately on tax documents. 

Implement Internal Controls

To prevent fraud—whether purposeful or accidental—implement internal controls. After all, your bookkeeper is responsible for recording expenses and writing checks for those expenses, meaning it’s possible for them to misuse funds or potentially fall for a scam.

For example, CharityEngine’s guide to nonprofit fraud calls out fake invoices as a common scheme. An overworked bookkeeper might simply pay the fraudulent invoice along with other real payments and not realize their mistake. 

Prevent scenarios like this by implementing internal controls, such as:

• Segregation of duties. Get more eyes on your financial processes to catch mistakes and spot fraud. For example, you might have two staff members sign off on checks and invoices over a certain amount. 

• Software accountability features. Your accounting software should include a number of fraud protection features, such as two-factor authentication, timed logouts, and user permission settings. For instance, when a transaction is recorded in your software, you should be able to see which user made the update, allowing you to follow up with individual staff members and ensure accountability. 

• Conducting fraud training. Your bookkeepers are one of your best defenses against fraud. Have them take fraud training courses, so they can better spot mistakes, fraudulent invoices, and suspicious transactions.

To solidify your internal controls and ensure all team members understand them, create an official policies document. These guidelines should lay out the exact procedure your bookkeeper should take for various processes to prevent fraud and mistakes alike. 

Standardize Your Chart of Accounts

Your nonprofit’s chart of accounts (COA) is an organizational document that lists all of your accounts and ledgers. Think of it as a directory you can use to store and find various financial information. By standardizing this document, you can maintain better data hygiene and ensure all important financial documents are easy to find. 

To create your COA, or organize it if you already have one, Jitasa’s guide to nonprofit COAs recommends dividing it into the following five categories:

• Assets: Resources your nonprofit owns, such as cash, property, and accounts receivable 

• Liabilities: Anything your nonprofit owes, such as debt, deferred revenue, and accounts payable

• Net assets: The value of your assets minus your liabilities, which shows what your organization is worth 

• Revenue: The funding your nonprofit brings in from various sources, including donations, grants, corporate sponsorships, and earned income

• Expenses: Your nonprofit’s expenditures, organized according to the aforementioned categories of functional expenses (program, administrative, and fundraising)

Using this information, your nonprofit’s accountant can create various financial reports that improve internal decision-making and external transparency. To ensure these reports are accurate and up-to-date, your bookkeepers should regularly update your COA by adding new data, removing unused accounts, and generally keeping the document easy to navigate. 

Final Thoughts on Nonprofit Bookkeeping

Effective nonprofit bookkeeping sets your nonprofit up for success. With accurate financial data, you’ll be able to create reliable reports, present your finances to your board, and file tax forms on time. You can start improving your bookkeeping practices by standardizing your bookkeeping practices, educating your bookkeepers on nonprofit financial practices, or even outsourcing to a professional bookkeeping service.