Understanding Fund Accounting: The Backbone of Nonprofit Finances

9 min read

November  6th, 2024

Looking at nonprofit financial management from a for-profit perspective makes the unique needs of a nonprofit's back office seem exceedingly complex.

Thankfully, nonprofit organizations have their own accounting method, fund accounting, that is designed to meet their needs while providing solutions to the unique financial management challenges faced by nonprofit organizations. Fund accounting helps nonprofit organizations improve transparency and accountability, in addition to maintaining tax-exempt status with thorough, accurate, and compliant financial records. 

What Is Fund Accounting? Understanding Fund Accounting for Nonprofits

Fund accounting is an accounting method used by nonprofit organizations. The accounting method is designed to separate a nonprofit's incoming funds into separate buckets, pools, categories, or accounts for different uses and according to various restrictions. 

Read More: How Much Do Bookkeeping & Accounting Services for Nonprofits Cost?

Why Fund Accounting Is Crucial for Nonprofit Organizations: General Accounting vs. Fund Accounting

The average, for-profit business uses general accounting where all of its resources are grouped together in a single account. While the business might be following a budget, it can technically use any of its resources for any purpose with the goal of generating as much profit as possible. 

In nonprofit organizations, the goal and rules of accounting differ from the for-profit world. Nonprofit organizations aim to use almost all of their resources to further their mission in the smartest, most efficient, and most impactful way while also facing limitations and restrictions on certain types of resources. 

The importance of fund accounting in nonprofit finances originates in the basic financial structure of nonprofit organizations, the way they generate funds and use funds, and the different types of funds generated. Unlike for-profit businesses that can spend their revenue however they choose, nonprofit organizations face limitations in the way they spend one category of funds compared to its other categories of funds. 

Since nonprofits must manage and comply with the limitations of restricted funds (such as grant terms and earmarked donations), they require a different type of accounting that provides a structure for organizing, managing, and maximizing ROI on different categories of money. Fund accounting fulfills these unique nonprofit needs, allowing nonprofits to organize their funds in separate, purpose-based buckets (accounts). So, each of an organization's purposes has its own designated fund. 

Additionally, a fund accounting system also improves the transparency and accountability of nonprofit organizations, helping to maintain tax-exempt status, strengthen donor trust, and generate donations from supporters. 

This Nonprofit jumped from a $75,000/year grant to a $150,000/ year grant, in just ONE year. 

How? Read the full case study 👉 here. 

How to Use Fund Accounting in Your Nonprofit Finances: Three Basic Steps to Fund Accounting in Nonprofit Organizations

1. Define Your Nonprofit's Funds

Nonprofits should separate their funds into three basic buckets of money:

• Unrestricted Funds - Unrestricted funds include any type of money (donations, grants, endowments, etc.) that is without limitations. Since other types of funds come with designations that restrict their use, unrestricted funds are usually most effectively spent on general operations like overhead operating expenses such as office rent, utilities, office supplies, and employee salaries.
• Restricted Funds - Restricted funds are given to an organization with a set of stipulations. For example, a donor might write your organization a check and put a specific purpose for the money in the memo line, such as scholarships or building maintenance. Those funds would then need to be in the restricted category and only used for scholarships or building maintenance. In addition to purpose, restrictions can also put time limitations on funds, requiring that they be spent on the earmarked purpose by a certain date. 
• Temporarily Restricted Funds - Some funds are only restricted temporarily. For example, an organization might receive a donation that is earmarked for a particular purpose over a particular period of time or for a particular project (e.g. a scholarship for the upcoming school year or maintenance on a specific project). As long as the money does not have to be returned after that time period (as is the case with some grants), the organization can then move the money into an unrestricted fund if it is unable to use the funds within the designated temporary restrictions. 

2. Categorize Funds Based on Purpose and Source

Within each basic fund (unrestricted, restricted, and temporarily restricted), nonprofit organizations also maintain separate buckets of money that are categorized based on purpose and source. This helps the organization follow all rules and restrictions with respect to funds from different grants, endowments, or donors.

Read More: Why Your Nonprofit Needs a Sustainer Program (And How To Get Started)

It is essential for compliance, transparency, accountability, and donor trust that organizations adhere to the restrictions placed on funds, accurately track and manage their grants, and make the most of the resources available to ensure their mission impact is maximized. 

3. Use GAAP-Compliant Accounting Software Designed for Nonprofit Fund Accounting

Attempting to maintain an accurate, thorough, and up-to-date fund accounting system by hand is almost impossible, especially in larger organizations or in organizations with multiple funding sources and types of funds. For this reason, nonprofit organizations must implement tools for GAAP-compliant fund accounting automation. 

We strongly recommend Sage Intacct for nonprofits because the software's core functions include industry-based modules designed specifically for fund accounting in nonprofit organizations. Additionally, the software boasts more than 350 fully integrated applications, many of which have been developed for nonprofit management. 

Sage Intacct features fully customizable, dynamic reporting capabilities that enable nonprofit organizations to swiftly categorize, separate, and manage funds by fund type, specific restrictions, purpose, and source. As a result, nonprofit leaders can easily generate reports based on any of these categories while also being able to look at global reports that encompass the entire organization's financial health and structure. 

Advance Your Mission With Outsourced Nonprofit Accounting Experts

Sure, nonprofit organizations are not concerned with "making money," but they must be highly concerned with the responsible management and effective use of their funds. Plus, they need creative and financially savvy ways to maximize ROI on fundraising efforts, focus their resources on the most impactful programs, and stretch every penny of the budget - restricted or not - for the good of the organization and its mission. 

Nonprofit organizations can make the most of their resources and maximize the benefits of their back offices through fund accounting services with outsourced accounting professionals. Nonprofits should look for outsourced accounting providers with extensive experience in the nonprofit industry. Only these financial professionals can understand the intricacies of nonprofit accounting and the challenges and opportunities of the nonprofit landscape. 

With a reputable outsourced accounting provider, like GrowthForce, you can provide your organization with the team, tools, technology, and expertise to advance your mission, elevate fundraising, and take your programs to the next level.