BlogOrganizational Management Nonprofit Financial Planning: How to Create a Blueprint for Sustainability Organizational Management Nonprofit Financial Planning: How to Create a Blueprint for Sustainability Author: Sayana Izmailova July 2, 2020 Contents 🕑 9 min read This is a guest post byJoseph Scarano, CEO ofAraize. Whether you’rejust starting your nonprofit or have recently added employees to your accounting staff, one of the most important things you’ll need to focus on is nonprofit financial planning. It’s key to becoming sustainable, because it provides the strategy to secure the financial resources needed to execute your organization’s vision and mission. Once you’ve created it, this plan should be included in your business plan along with an executive summary, analysis of community needs for your services, operational plan, and a fundraising plan. To make your vision a reality, here are the steps you’ll need to follow to create your nonprofit financial plan: Start Here Why You Need to Use Sound Accounting Practices Implement a True Nonprofit Accounting System Answer the Who, What and Why A Sample Nonprofit Financial Plan Let’s dive in! 1. Start Here To begin, you should create an analysis of your current and projected financial status. Your nonprofit financial plan should be a detailed, multi-year analysis of sources of revenues, use of expenses and projected cash flow requirements.This will allow you to be sure that all of your expenses and revenue will be planned for and that you’ll be able to cover all of them. When analyzing revenue and expenses, start with a specific date. Determine what is owned (assets) and what is owed (liabilities). This will determine your net assets, net worth or equity. The income statement shows amounts of income and expenses for a certain period of time. Assess your current financial position by calculating the ratio of your current assets divided by your current liabilities. This is where accounting for nonprofits becomes critical to your organization’s sustainability and success. If you’re looking for a quick introduction, check out the video below to learn more: In short, the accounting goals for nonprofits are slightly different from for-profit companies. First and foremost, a nonprofit must be accountable, transparent, and provideproper stewardship of donor funds. 2. Why You Need to Use Sound Accounting Practices If you’re the only staff member at your nonprofit or haven’t had time to hire a full time accountant yet, there are several financial management methods that you’ll need to implement. While profitability is not the goal of a nonprofit, making profit will allow you to continue funding projects and fulfilling your mission (to say nothing of allowing you to hire more staff!). Having sound accounting practices will ensure that management and potential funding sources (such as grants and foundations) can measure your organization’s sustainability. It will also help you make informed business decisions. At its most basic level, accounting is a mechanism to track how much money is coming in from revenue and how much is going out for expenses. An accounting system will provide the information needed to create reports to show the organization’s financial transactions and net worth. The two most helpful summary reports you’ll need to keep track of are the balance sheet and income statement. A balance sheet shows what an organization owns, what their liabilities are and their net assets (net worth). An income statement shows an organization’s revenue, expenses, and net income. But, for a nonprofit, the income statement must be broken down into three main categories – Program Services, Management and General and Fundraising. This helps determine the feasibility of your business plan by measuring whether or not you have the resources (revenue) available to cover your expenses. In order to generate specific reports, it is important to include the following practices: Budgeting – This is essential for all the rest of the planning you’ll be doing. Program Costs – Understanding the actual costs of programs can help you plan to scale them. Diverse Funding Sources – Donations, grants, sponsorships, and any other sources of funding you receive would be included here. Functional Accounting – Tracking expenses for program services and general and administration and fundraising overhead. Cash Flow – Monitoring for daily cash for day-to-day expenses. Accountability and Transparency – Demonstrating how funds are received and used so that if you are audited, you can share where all your funds are going. Sharing this kind of information can also help improve donors’ trust in your organization since they know the funds are being properly used. 3. Implement a True Nonprofit Accounting System Without an accounting system, your nonprofit can’t know whether or not it has enough financial resources available to operate efficiently. Basic accounting principles are the same for nonprofits and for-profit businesses. The difference is the net worth on a balance sheet. For a for-profit, that represents owners’ equity. Since a nonprofit does not have owners, the net worth is represented as different classifications of net assets. In order to be compliant with the accounting standards for nonprofits, GAAP and ASU 2016-14,FASB, a nonprofit’s funds must be grouped into two categories of net assets: Net Assets Without Donor Restrictions and Net Assets with Donor Restrictions. Net Assets Without Donor Restrictions is revenue received that is not subject to the donor/grantor-imposed restrictions. In other words, the revenue has ‘no strings attached’ and the nonprofit can use the revenue wherever it needs it. When a donor makes a contribution to a nonprofit and does not designate the use of the fund, then the revenue is classified in the “Without Donor Restricted Fund.” Net assets represent the cumulative excess or deficiency of revenue minus expenses. Net Assets With Donor Restrictions includes sources of revenue that are restricted by the donor/grantor either in perpetuity (endowment), or restricted for specified purposes, or by the passage of time. This is basically revenue received ‘with strings attached’. The nonprofit must comply with the donor/grantor imposed ‘strings’ for the use of the funds, or they can jeopardize future funding. When a donor makes a contribution to a nonprofit and designates what they want their donation used for then it is classified as Revenue in the Donor Restricted Fund. When the nonprofit uses the funds for the designated purpose, then the revenue is moved from the With Donor Restricted Fund to the Without Donor Restricted Fund to match the revenue with its intended expense. Net assets represent the cumulative excess or deficiency of revenue minus expenses. A nonprofit can set up multiple sub-categories of net asset funds as part of their internal reporting, such as Board Designated Funds and Capital Funds. Regardless of how many funds are set up in an internal accounting system, when it comes to reporting to the general public, they all must be consolidated into the two net asset categories. 4. Answer the Who, What and Why In its most simple form, nonprofit accounting provides information on the Who, What and Why for all financial transactions you do: Who identifies the source of revenue and provider of services and expenses. Who is donating or granting funds to the nonprofit? To whom is the nonprofit paying expenses such as salaries, payroll taxes, services, rent, utilities? What is the designated purpose of the revenue and what the expense is used for. What is covered by the principle of (1) fund accounting, or net asset classifications and (2) functional accounting. Fund accounting allows a nonprofit to identify ‘what’ their revenue is designated for, and to monitor the restrictions often attached to that revenue, which provides stewardship and transparency. By identifying revenue into appropriate designations, nonprofit accounting enables organizations to keep the revenues that it receives in the proper classifications and prevents those revenues from being spent on inappropriate expenses. The first ‘what’,fund accounting, allows a nonprofit to match their sources of revenue with its designation. This provides a method of measuring if a nonprofit has the resources available to meet their mission-based goals. It identifies the sources of revenue and shows how efficiently a nonprofit is using those revenues for their designated purpose. Proper fund accounting highlights areas of strength and weakness and provides transparency for external audiences. The second ‘what’ is the functional expense category that expenses are used for. A nonprofit exists to perform specific services and programs, as stated in their mission. The purpose of functional accounting is to present the nonprofit’s major types of activities, primarily program or mission-based services and supporting services such as management and general (administration) and fundraising. Breaking down expenses by functional area reflects the broad outlines of major nonprofit reporting requirements as outlined in SFAS-117 and for filing the IRS Form 990, which requires nonprofits to divide expenses by program, management and general and fundraising. For any organization that undergoes an annual audit, their financial statements must be presented by functional area, or the CPA will be required to qualify their opinion, stating the statements were not prepared in accordance with generally accepted accounting principles. Besides the regulatory requirements of reporting by functional area, the most important reason to report on functional expenses is that it is an ideal method for tracking the real costs of program and supporting activities, making it an invaluable tool for decision-making. It allows you to see exactly what each of your individual programs is costing, whether you have the resources available to effectively run the program and determine if the program is sustainable. Why is the type of revenue received and the type of expense incurred. It classifies the type of revenue and expense of each transaction. It is standard for all accounting and it is a detailed list of the nature of each revenue — grants, program services, contributions and fundraising events — and expenses, such as salaries, payroll taxes, rent, professional services. A lot of organizations mistakenly classify their expenses only on the ‘who’ element, by focusing on the funding source rather than ‘what’ the expense was incurred for. But, if used properly, functional accounting can classify all three elements of the ‘who’, ‘why’ and ‘what’ with appropriate account number segments in your chart of accounts. All of the revenue coming into your organization and the expenses going out should be identified with an account code corresponding to the funding source, or expense (who), the revenue or expense functional area (what) and the type of revenue and expense (why) of that transaction. 5. An Example of a Nonprofit Financial Plan When you’re first preparing a nonprofit financial plan, it may seem confusing. However, you just need to remember that it outlines goals and milestones for funding support from businesses, donors and grants. It should also include a description of primary expenditures for programs necessary to fund and run the organization. And finally, it includes an effective communication system to report fiscal data to the Board of Directors to ensure the ongoing health of the organization. Below are some example items to add to your financial plan: Assumptions: Take into account the economy with and without a major recession. Projected Surplus or Deficit: These consist of monthly, yearly surpluses and deficits. Projected Cash Flow: This shows gross and net cash flows for monthly and yearly revenue. Projected Balance Sheet: Shows managed growth of net worth and financial position. Standard Ratios: Demonstrate ratio analysis of total assets and total liabilities. Wrapping It Up The complexities of nonprofit accounting require an accounting system that is able to properly classify each element of the nonprofit’s ‘who’, ‘what’ and ‘why’. Having an accounting system that incorporates these elements will make it easier to generate more accurate and relevant financial statements both internally and externally. In turn, this will make it easier to measure and determine if each of your organization’s mission-based activities are running efficiently and effectively. A detailed accounting system will provide management with the information needed to make more informed decisions on your organization’s financial health — and will allow you to continue fulfilling your mission for years to come! Joseph Scarano is a former licensed CPA in New York. He currently resides in Chapel Hill, NC and is the CEO ofAraize, developer of FastFund Online Nonprofit Software, a SaaS solution that incorporates nonprofit accounting, fundraising CRM and payroll in a single system. Related Organizational Management Articles Organizational Management 🕑 11 Min Read 31 Free Nonprofit Webinars for September 2023 WildApricot Sep 1, 2023 Organizational Management 🕑 9 Min Read How to Effectively Write and Update Your HOA Bylaws in 2023 Marlena Moore Aug 29, 2023 Organizational Management 🕑 12 Min Read How to Write a Nonprofit Business Plan in 12 Steps (+ Free Template!) Sonia Urlando May 10, 2023 The Membership Growth Report: Benchmarks & Insights for Growing Revenue and Constituents Get the report now!