How to Prepare Financial Statements for a Nonprofit

Financial statements offer a transparent view of a nonprofit’s health and operations. They demonstrate accountability to stakeholders and guide internal decisions. Accurate statements build trust and support the mission, making this process crucial.

Understanding Core Nonprofit Financial Statements

Nonprofits prepare four primary financial statements, offering a comprehensive financial overview.

The Statement of Financial Position, like a balance sheet, snapshots a nonprofit’s assets, liabilities, and net assets at a specific time. It shows what the organization owns, owes, and its residual value, categorizing net assets by donor restrictions.

The Statement of Activities, like an income statement, details revenues, expenses, and changes in net assets over a period. It shows how income was generated and resources expended to fulfill the mission, segregating net assets by donor restrictions.

A Statement of Cash Flows shows how cash is generated and used in operating, investing, and financing activities. It assesses liquidity and solvency, revealing the organization’s ability to meet short-term obligations and fund operations. This statement clarifies cash sources and uses, differing from accrual-based reports.

The Statement of Functional Expenses breaks down expenses by functional and natural classification. It shows how resources are allocated among program services, management and general activities, and fundraising. Expenses are itemized by natural categories like salaries, rent, and supplies.

Key Accounting Principles and Classifications

Nonprofit financial statements primarily use accrual accounting, recognizing revenues when earned and expenses when incurred, regardless of cash flow. This provides a comprehensive picture of financial performance and obligations. Accrual accounting is generally mandated for larger nonprofits and those undergoing audits.

Net assets, the residual interest in an organization’s assets after liabilities, are categorized into “Net Assets Without Donor Restrictions” and “Net Assets With Donor Restrictions.” Unrestricted assets can be used for any mission-consistent purpose, including general contributions, unrestricted grants, and earned income.

Net Assets With Donor Restrictions are subject to donor stipulations on use or timing. Funds might be restricted for a specific program, endowment investment, or held until a future event. Once satisfied, these net assets are reclassified as Net Assets Without Donor Restrictions.

Nonprofit revenue recognition varies by source. Contributions (cash, pledges, goods, services) are recognized when an unconditional promise to give is received. If donor-restricted, the contribution is initially recorded as Net Assets With Donor Restrictions. Funds are released and reclassified when conditions are met or time restrictions expire.

Exchange transactions (e.g., program service fees) are recognized as revenue when services or goods are provided. Unconditional grants are recognized when the agreement is signed and legally enforceable. Conditional grants are recognized only when grantor-specified conditions are substantially met.

Expense classification uses a dual approach: functional and natural. Functional expenses group costs into program services, management and general, and fundraising. Program services expenses relate directly to mission activities. Management and general expenses cover administrative costs, such as executive salaries and accounting.

Fundraising expenses are costs to solicit contributions, including direct mail, special events, and staff salaries. Natural expenses are expenditure types, such as salaries, occupancy, supplies, or professional fees. Organizations allocate these natural expenses across functional categories, like allocating an employee’s salary based on time spent on program services, management, or fundraising. This allocation provides transparency on resource utilization.

Gathering and Organizing Financial Data

Accurate financial statements begin with organizing data from source documents. These provide evidence for every transaction, including invoices, receipts, bank statements, payroll records, grant agreements, and donor pledge forms. They offer critical information on restricted and conditional grants.

A well-structured chart of accounts is crucial for organizing financial data. It lists all financial accounts used by the nonprofit, ensuring transactions are recorded in the correct category, aligning with accounting principles for net asset classification and functional expenses. The chart should be tailored to the organization’s needs for accurate reporting.

Maintaining accurate bookkeeping records is a continuous process. This involves entering transactions into a general ledger, which records all financial activity. Subsidiary ledgers, like accounts receivable or payable, offer detailed breakdowns for specific account types. Consistent record-keeping ensures comprehensive capture of financial information.

The adjusted trial balance is the primary starting point for financial statements. This internal report lists general ledger accounts and their balances after all adjusting entries. A balanced trial balance indicates total debits equal total credits, signifying mathematical accuracy.

Regular reconciliations ensure financial record accuracy and reliability. This involves comparing internal records with external statements, such as bank statements with the general ledger cash balance. Reconciling donor databases with accounting records is important to ensure contributions are properly recorded and classified, correcting discrepancies before statements are prepared.

Assembling the Financial Statements

Assembling financial statements involves transferring and summarizing organized data from the adjusted trial balance and other records into prescribed formats. This process begins by classifying all accounts correctly by nature and restrictions.

The Statement of Financial Position lists assets, starting with liquid assets like cash and receivables, then less liquid ones like property and equipment. Liabilities are presented similarly, with current liabilities preceding long-term liabilities. Net asset balances, separated into Net Assets Without Donor Restrictions and Net Assets With Donor Restrictions, are listed. The accounting equation (Assets = Liabilities + Net Assets) must balance, confirming accuracy.

The Statement of Activities compiles all revenue and expense accounts for the reporting period. Revenues are presented first, categorized by source and donor restrictions. Expenses are then detailed by functional classification (program services, management and general, fundraising). The difference between total revenues and expenses yields the change in net assets, added to the beginning net asset balance to reach the ending balance, aligning with the Statement of Financial Position.

Nonprofits commonly use the indirect method for the Statement of Cash Flows, starting with net asset changes and adjusting for non-cash items and working capital. Operating activities reflect cash effects on net assets. Investing activities include cash flows from buying and selling long-term assets. Financing activities involve cash flows related to liabilities and net assets. The sum of these three activities reconciles to the net cash change, which, with the beginning cash balance, equals the ending cash balance.

The Statement of Functional Expenses details how natural expenses are allocated across functional categories. It lists natural expense categories (e.g., salaries, occupancy, professional fees) down the left column. Functional categories (program services, management and general, fundraising) are listed across the top. Each natural expense is allocated to the appropriate functional column using objective methods, like square footage for rent or time spent. This matrix illustrates the total cost and expense types for each functional area.

Essential Disclosures: Notes to Financial Statements

Notes to financial statements are an integral part of a complete financial report, providing additional context and detail not fully conveyed numerically. These notes clarify figures, explain accounting policies, and disclose information relevant to understanding the organization’s financial position and activities. They enhance transparency and provide a comprehensive picture of the nonprofit’s financial health.

The Summary of Significant Accounting Policies is a mandatory disclosure outlining the organization’s specific accounting methods. This includes policies for revenue recognition (e.g., how contributions and grants are recorded) and asset capitalization thresholds. It also details policies for investments, estimates, and other areas where management judgment is applied, providing insights into the basis of financial reporting.

Another disclosure addresses liquidity and resource availability, explaining how the nonprofit manages liquid assets for short-term cash needs. This note often includes information about financial assets available for general expenditure within one year and outlines any limitations on their use. It helps stakeholders understand the organization’s ability to cover immediate obligations and fund operations.

Other common disclosures enhance financial statement utility. These include details on fair value measurements of investments, explaining valuation techniques for assets and liabilities. Related party transactions (e.g., with board members) are also disclosed for transparency. Notes may cover commitments and contingencies (e.g., pending lawsuits, lease obligations) and provide details on donor restrictions on net assets, offering a deeper understanding of resource limitations.

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