THE BASICS OF FUND ACCOUNTING | KEY CONCEPTS FOR NONPROFITS
Posted on 23rd Feb 2021
The accounting needs of nonprofit organizations are incredibly different from those necessary for for-profit companies. The goal of for-profit businesses is ultimately make money, while nonprofit organizations are focused on their funds being used to contribute to their overall mission. This is where fund accounting comes in.
Nonprofit organizations find that fund accounting helps hold them accountable to their donors. Plus, fund accounting helps nonprofits make smart choices in their budget and fundraising efforts in order to best serve their community.
This guide will lead you through all of the fund accounting basics your nonprofit needs to know. Either start from the beginning, or jump to the section you need using the navigation below:
Fund Accounting Basics
Organizations that Use Fund Accounting
Types of Funds
Importance of Fund Accounting
Fund Accounting Benefits
Fund Accounting Software
Fund accounting can help your nonprofit stay organized with a system that is especially designed for you. Let’s dive in to learn more about how it works!
WHAT IS FUND ACCOUNTING?
Fund accounting holds your organization accountable for allocating money to the correct project and purpose. Because the money is donated from various sources and each source holds different restrictions, nonprofits need to divide their income into “funds” to track each one separately.
Instead of focusing on profitability, as private sector accounting tends to do, fund accounting focuses on accountability of the organization to their donors and other income sources.
Essentially, fund accounting helps your organization monitor and manage the allocation of funds that are donated from multiple outside sources.
These sources may carry restrictions that need to be tracked and reported upon using a comprehensive accounting system. Each restriction dictates where the the money provided should be allocated. Each separate “fund” is used for a different aspect of your nonprofit’s mission.
Fund Accounting Glossary
Unrestricted fund: Unrestricted funds come from donations made to an annual fund for an organization. The organization can choose to allocate these funds however they see fit.
Temporarily restricted fund: Temporarily restricted funds are funds that have a restriction during a particular time frame. The restriction may expire, in which case the funds will be reclassified as unrestricted funds
Permanently restricted fund: Permanently restricted funds have restrictions that never expire. They are restricted by the donor to only be used for a specific purpose or project. They cannot be used for operational costs or anything outside of the donor’s preference.
Endowment fund: Endowment funds hold assets in order to make additional income for an organization. The original donation may not be touched, but the income from that original investment can either be placed in either a restricted or unrestricted fund.
Board-designated fund: Board designated funds are unrestricted funds that are reclassified by the board of directors and earmarked for a particular purpose. In this case, instead of the donor restricting the organization’s use of a fund, the board of directors makes the decision as to what project the funds should be allocated to.
Fixed asset fund: Fixed asset funds are set aside to pay for the large assets of an organization, like land, vehicles, equipment, buildings, etc. This fund is set up so that fixed payments are not withdrawn from the unrestricted fund.
Specialized fund groupings: Specialized funds can be set up to be used for any purpose, but all the money donated to that fund must be used for that purpose. For instance, universities often have specialized fund groupings in the form of scholarship funds.
WHAT TYPES OF ORGANIZATIONS USE FUND ACCOUNTING?
Organizations that use fund accounting tend to be non-business entities. These organizations usually rely on multiple funding sources. The basic principle of fund accounting is that it separates income into various resource streams for organizations who have more allocation direction from their various revenue sources.
Some organizations that use fund accounting regularly include:
Nonprofits
Nonprofit organizations make use of fund accounting because they benefit from so many different funding sources. Plus, the money given to nonprofit organizations supports a specific mission rather instead of a profit. The funds tend to be broken down based on to whom the nonprofit is reporting.
Generally, larger donations, such as those given to the nonprofit as major or planned gifts, may have donor restrictions, for which fund accounting is especially useful.
This is especially important because according to the 80-20 rule, about 80% of nonprofit income comes from these large donation sources. Therefore, using true fund accounting software instead of off-the-shelf software will behoove nonprofits by simplifying the accounting process.
Government Entities
Government entities have an incredibly complex approach to finances. Whether it’s a federal, state, or local government, the legal and financial restrictions on funds complicate the accounting needs.
Government entities receive their money largely from taxpayers and are therefore required to be completely transparent about how their funds are allocated and spent.
Government fund accounting breaks up the money into various funds based on functionality in order to manage the community components of each fund. The unique conditions of government accounting require careful planning and a specialized software solution can help to ease the burden.
Schools and Universities
Many schools, especially higher education, use fund accounting basics to classify what aspect of the school the funds are allocated for. For instance, some funds may be allocated for instruction, research, admissions, outreach, or other purposes.
Universities also often set up specialized fund groupings for scholarships and other similar projects to support their student body.
Schools also use fund accounting a bit differently than nonprofits because they receive more federal aid than an average nonprofit organization. Therefore, the restrictions encountered for their funds may be federally or state regulated instead of donor restricted.
Healthcare Organizations
Accurately tracking the grants, gifts, and government funding given to a healthcare organization is tough in itself. Then, on top of all that, the administration is bombarded with rules and regulations for these funds.
Fund accounting helps healthcare organizations keep organized and stay focused on their services as opposed to spending all their time worried about cash flow. Healthcare professionals need fund accounting to segment their money across programs and track the money in and out of the system.
WHAT TYPES OF FUNDS DO NONPROFITS HAVE?
As we mentioned in the first section about fund accounting basics, nonprofits have multiple types of funds that have different purposes in their budgetary and accounting strategy. These funds help maintain an organized system that adheres to the needs of the nonprofit as well as the donor.
Because there are so many types of funds with different restrictions and designations, general accounting software is ill-prepared to cover all of your needs. Specific fund accounting software is key to keeping track of all of these factors in a single accounting system.
While you probably read a simple definition of the types of the types of funds above, this section is designed to expand on these terms and give your nonprofit a better understanding of the types of funds you may encounter in your accounting processes.
Unrestricted Funds
Unrestricted funds are those that nonprofits self-allocate to needs they consider to be the greatest. Usually, these funds are a part of a nonprofit’s annual fund and used for the operating costs for nonprofits.
Annual funds are generally donated by the mid-tier to lower-level donors. These donors are less likely to place restrictions on the use of their donation than those who give planned or major gifts.
For example, let’s just say one of your donors gives $50 to your nonprofit. This donation is placed in your unrestricted fund. Your nonprofit then decides that this money will be well-spent to pay for the water bill for your headquarters. While this may not be a flashy use of the donation, it’s necessary to keep the nonprofit running.
Temporarily Restricted Funds
Temporarily restricted funds have a restriction on their use, but this restriction has an expiration date. This means that your donor has restricted the use of the donation for a particular project or program in a specific time frame.
For example, a donor might give a $5,000 donation, but requests that it’s used to help fund a building project your nonprofit is executing. Once this building project is complete, if there is still money left over from that initial donation, it is reclassified as an unrestricted fund.
Permanently Restricted Funds
The restrictions set on permanently restricted funds never expire. This fund must be used for the purpose specified by the donor. It’s very important to accurately record and report upon permanently restricted funds in your nonprofit’s financial statements in order to establish accountability with the donor.
Establishing and maintaining a fund accounting system for your nonprofit is especially important the more permanently restricted funds you have. 501(c)3 organizations are required to send out annual reports of the use of their funds, and these reports hold nonprofits accountable for the nonprofit spending their funds as promised.
Board-Designated Funds
Board-designated funds are fairly self-explanatory. Instead of the donor restricting the fund to go towards a specific project, the board of directors designates the fund for a particular purpose.
Technically, board-designated funds are still considered unrestricted because the board can change their minds and undesignate it.
An example of board-designated funds is when the board requests that certain funds are used for a scholarship program your nonprofit sponsors. This money would be classified as “designated” within your unrestricted funds.
Endowment Funds
Endowment funds are assets which are held as an investment opportunity for your nonprofit organization. The interest on these funds can be earmarked as restricted or unrestricted by request from the donor.
Generally, endowment funds are designed to produce a steady source of income for your nonprofit. The money donated is invested so that the interest can be allocated towards projects, but the original donation can’t be spent by your nonprofit.
This type of fund is a very popular choice for major donors for universities. For example, an alum gives a major gift to their university as an endowment, but requires the proceeds go towards an undergraduate scholarship program.
Fixed Asset Funds
Fixed asset funds are those that are designated to pay for the large assets your organization holds. Many times these assets require monthly payments, such as a mortgage or car payments.
Fixed asset funds ensure these assets have their own fund allocation instead of money being withdrawn from the unrestricted fund to pay for them.
For example, if your nonprofit organization delivers meals to the hungry and needs vans to deliver the food, the car payments on those vans would come from a fixed asset fund.
WHY IS FUND ACCOUNTING IMPORTANT FOR NONPROFITS?
Fund accounting is necessary for nonprofits to keep track of the many different restrictions, designations, and sources of their income and expenditures. In order to accurately report the use of funds to their donors (and create a trustworthy relationship with them), nonprofits need a transparent and effective accounting method. Enter: fund accounting.
501(c)3 organizations who have an annual gross income of more than $50,000 are required to send an annual report to their donors. Plus, they are required by law to file a form 990 with the financial information about the nonprofit.
These documents are designed to hold nonprofits accountable to their donors and to maintain their tax-free status. Therefore, it’s incredibly important to have all of a nonprofit’s accounting information available for accurate annual reporting.
Fund accounting is also necessary for nonprofits in their preparation for growth. In general, when a nonprofit talks about growing, they are talking about expanding their reach and increasing their services. However, with growth comes changing accounting needs.
According to our 2018 study, about three-quarters of nonprofits worry about their accounting needs as their organization grows. This is a common anxiety, especially because 79% of nonprofits expect to grow within the upcoming year.
As your nonprofit grows, it becomes that much more important to have all of your information organized in a way that is easy to comprehend. Therefore, it’s important to make sure you:
Are transparent with funders. 61% of nonprofits found that with growth, they needed to become more transparent. Accurate accounting with a comprehensive ledger, payroll tracking, and budget management ensures you can get back to your donors with the most up-to-date information.
Report effectively and frequently. 44% of nonprofits change their reporting methods after they’ve grown and 28% report to their donors more frequently. When your funds and budget are well-organized, this reporting becomes easier to complete in a timely manner.
To make sure your nonprofit fulfills all of your growth needs, from transparency to reporting, you’ll need fund accounting software that offers a comprehensive solution. When your software takes care of all of your needs, you can measure all of the necessary metrics with minimal effort.
Plus, as your organization grows, the more important auditing becomes. Even if you’re not required to conduct a regular audit, it can help your nonprofit realize the strengths and weaknesses in the way you structure your finances.
An audit from an outside source can even further prepare your organization for growth: over time, regular audits improve your ability to raise money, run efficient projects, and effectively carry out your mission.
WHAT ARE THE BENEFITS OF FUND ACCOUNTING FOR NONPROFITS?
Fund accounting for nonprofits is beneficial in streamlining their accounting needs. It provides a single system that tracks multiple variables and all of the specifications for each variable.
This single system increases the efficiency of your nonprofit’s accounting and makes it easier to follow a budget. Variables and restricted funds can make navigating a budget difficult, but our Building a Roadmap resource can help your nonprofit use fund accounting to keep organized.
This basic fund accounting budget will help your organization:
Plan fundraising initiatives. With an organized budget, your nonprofit can better plan out how much fundraising needs to go on for specific projects (and what funds will be withdrawn from to support those projects).
Remain transparent with donors. When your organization has well-organized information that is reported on accurately, donors will better understand your financial standing. The easier it is for you to track your own budget, the easier it is for donors to follow.
The benefits for fund accounting go full circle for nonprofit organizations: streamlined accounting leads to better efficiency, which leads to more accurate budgeting, resulting in greater transparency with your donors through reports. These reports later help you become more efficient in your fund accounting for the future.
WHAT IS FUND ACCOUNTING SOFTWARE?
Fund accounting software is technology specifically created to manage your fund accounting basic needs. It provides for all of your nonprofit’s needs when it comes to classifying or designating your multiple sources of income for various projects and campaigns.
Unique Benefits of Fund Accounting Software for Nonprofits
As we stated earlier, fund accounting concepts are quite different from those of general accounting. General accounting software, like Quickbooks, doesn’t take into consideration the complexities of a nonprofit’s needs or the lack of emphasis on profit.
Fund accounting software is especially made for nonprofits to handle these complexities. Why wouldn’t you want a more specialized solution?
Plus, nonprofits are constantly changing. Between high turnover rate, less predictable income, and project changes, nonprofits need a specialized software solution to continuously track and report on changes year after year. Fund accounting software ensures that finances and budgets are kept track of throughout all of these changes.
What to Look for in Fund Accounting Technology
When you are looking for fund accounting software for your nonprofit organization, look for a solution that augments the benefits that fund accounting already brings to the table.
Whether you’re new to fund accounting or have outgrown your current software, there are certain features you should make sure to look for. These integral features include:
Customizable reports. Standard and custom reports help your nonprofit to keep track of the fund accounting variables that are most important to your organization. Plus, it helps you quickly create accurate and easy-to-read annual reports for your donors, helping improve transparency.
Flexibility and scalable components. A scalable solution that has the ability to grow with your nonprofit ensures that you won’t need to change solutions as the needs of your nonprofit change. Add-on modules help make sure all of your needs are met at any point in the engagement.
Operational needs. Streamlined budgeting that helps you to track campaigns, manage your annual fund, and create (and stick to) budgets helps ensure your operations at your organization are in-check. Plus, when you can handle payroll and human resources through the same software, all of your financing needs are met in a single location.
Fund accounting software is about more than just tracking your funds. It should also help you to manage these accounts and maintain all of your finances in a single location.
Why MIP Fund Accounting Stands Out
MIP Fund Accounting by Community Brands is a comprehensive solution for all of your nonprofit’s financial needs. The modules available include everything from a basic (or custom) ledger, budgeting sheets, bank reconciliation, direct deposit, and more.
The scalable packages available through MIP Fund Accounting help you to get the solutions you need without overpaying for the features you don’t. Plus, your nonprofit gets to choose between cloud and on-premise information storage. Both are perfectly secure, but your preference dictates your solution.
Finally, at Community Brands, we believe in building a relationship with our customers. We want to be there for you during every step of the processes of purchasing, implementation, and training, and even into the future of your engagement with us.
ADDITIONAL FUND ACCOUNTING RESOURCES
Fund accounting basics are key to understanding the financial standing of your nonprofit organization. And as you prepare for your organization to grow, the more important comprehensive and accurate accounting management becomes!
Check out these resources to learn more about how fund accounting can benefit your nonprofit:
Generating Reports Relevant to Your Nonprofit. Check out this article to see what kinds of reports you should generate and how they can help your nonprofit continue to grow.
Top 10 Low-Cost Nonprofit Accounting Software. Looking for accounting software? This Double the Donation article features the top 10 software options for nonprofits!
Benefits of Visual Data for Nonprofits. Make your reports even better by using visual data to represent the financial standing of your organization.
Fund Accounting Fundamentals. Did one of the fund accounting basic concepts above intrigue you? Learn more fundamentals with this article by DonorSearch.
By: Melea Guilbault