Nonprofit Accounting: How Nonprofits Use Fund Accounting

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Nonprofit organizations bring in some $1.4 trillion in annual revenue—more than 5% of the US economy—and employ as many as 12.5 million workers. Even with this economic weight, smaller nonprofits often underinvest in their own financial infrastructure, including the systems and practices that support nonprofit accounting.

Nonprofits that invest in sound financial practices are likely to see greater sustainability and more effective social service programs. Learn the fundamentals of nonprofit accounting, including how fund accounting works, which financial statements you need, compliance requirements at federal and state levels, and best practices that support effective financial management.

What is nonprofit accounting?

Nonprofit accounting is how charitable organizations manage, record, and report their finances. Unlike traditional accounting, nonprofit accounting is designed to manage the diverse revenue sources that nonprofits rely on. These sources may include grants, individual donations, program fees, and sponsorships, which often come with restrictions on how funds can be used.

To manage these funding restrictions, nonprofits rely on fund accounting. This accounting approach separates your revenue into different pools of funding, creating dedicated funds that each adhere to different spending requirements. 

For example, if you receive a $10,000 grant specifically for your tutoring program, fund accounting requires you to track that money separately from your general donations. You can’t use it to pay rent or staff salaries unless they’re directly related to the tutoring program. Nonprofit accountants also manage unrestricted funds that can be used as needed throughout the organization.

Comprehensive nonprofit accounting gives you a clear picture of your organization’s financial health, helping inform future strategy and providing financial transparency to potential donors and partners.

Nonprofit accounting vs. nonprofit bookkeeping

Hiring the right people starts with understanding the difference between nonprofit accounting and nonprofit bookkeeping. Both work together to manage an organization’s finances, but each serves a different purpose. 

Accounting handles the big-picture oversight, while bookkeeping handles the day-to-day work that makes broader financial monitoring possible. Nonprofit accountants are responsible for tracking funds, producing financial statements, and ensuring compliance, while nonprofit bookkeepers handle recording financial transactions, processing payroll, and reconciling bank accounts.

Understanding this distinction helps you hire the right people and allocate resources appropriately. Smaller organizations might combine these roles, while larger nonprofits need dedicated staff for each function.

Financial statements for nonprofit accounting

Nonprofits often need to present financial statements for grant applications and as a standard part of their annual report. Grant applications and annual reports typically require these financial statements:

• Statement of financial position. Often referred to as a balance sheet, this document shows assets, liabilities, and net assets for your nonprofit. Unlike for-profit businesses that track equity or profit, nonprofits track net assets—the difference between what the organization owns and what it owes. This statement is frequently requested in grant applications.

• Statement of activities. Similar to a profit and loss statement or an income statement, this outlines revenue and expenses for major accounting categories, such as salaries, benefits, rent, and program expenses. It shows changes in net assets rather than profit or loss. It is also often requested when applying for a grant.

• Operating budget. This is the official annual projected budget for a nonprofit organization, usually approved by the nonprofit’s board of directors or key staff members at the beginning of the fiscal year.

• Statement of functional expenses. This breaks down a nonprofit’s expenses by function, including program services, management and general activities, and fundraising.

• Statement of cash flow. This outlines the inflow and outflow of cash for the nonprofit over a designated period. It helps you anticipate cash shortages before they become crises and time major purchases strategically.

Nonprofit accounting compliance requirements

• Form 990
• State-level requirements

Nonprofits have compliance requirements at both the federal and state levels. They are exempt from most income taxes, but they must still meet annual reporting obligations to maintain their tax-exempt status and the right to solicit donations. These requirements include filing Form 990 with the IRS and completing charitable registration filings that vary by state.

Form 990

Form 990 is the core federal tax document used by all nonprofits. It comes in three versions, based on your organization’s size: 

1. Form 990-N for nonprofits earning revenue below $50,000

2. Form 990-EZ for organizations earning below $200,000

3. Full Form 990 for all other nonprofits

The tax form also includes a number of compliance and governance questions—such as disclosures about compensation, governance policies, or revenue sources—that may require the expertise of a nonprofit accountant.

The IRS Form 990 requires detailed and robust financial transparency. Questions request information about a nonprofit’s revenue, expenses, net assets, key individuals, program descriptions, and, with some exceptions, a list of donors with contributions at or above $5,000. Public charities may redact donor names and addresses on the publicly available version of the form. 

All Form 990s are publicly available, with many forms published online one or more years after they’re submitted to the IRS. Data from Form 990s is used by multiple charitable rating websites and fundraising platforms, and is referenced by many donors and organizations to assess an organization’s financial health. Strong financials on publicly available 990s build donor confidence and improve your visibility on charitable rating platforms.

State-level requirements

While requirements vary from state to state, most charitable organizations need to register with their state either annually or biennially. Submission requirements often include a copy of your completed Form 990, with some states requiring annual reports, detailed donor data, or additional state tax filings.

State rules vary widely in terms of stringency. For example, California requires charities to register within 30 days of receiving their first charitable asset and may impose audit requirements once an organization exceeds certain revenue thresholds. In contrast, Texas has relatively relaxed rules, and most charities are not required to register with the state to solicit donations. Other states fall somewhere in between, with registration requirements that depend on factors such as revenue levels, solicitation activities, or organizational structure.

Missing a state filing deadline can result in losing your tax-exempt status and the right to solicit donations. Search for your state’s attorney general or secretary of state charitable registration page to find specific deadlines and forms for your organization.

Best practices for nonprofit accounting

• Revisit your budgets regularly
• Keep your funds separate
• Implement reliable safeguards
• Use quality accounting software

These best practices can help ensure your nonprofit accounting stays meticulous and accurate:

Revisit your budgets regularly

Regular budget reviews are a common nonprofit practice. Many nonprofits will formally revise their operating budget multiple times a year, with changes often approved by the board of directors.

If your operating budget, or any other program budget, changes significantly, try to identify the reason why. Many nonprofits underestimate their administrative or overhead expenses or incorrectly predict future grant prospects. These reviews help you spot patterns—like consistently underestimating overhead expenses—so you can budget more accurately next year.

Keep your funds separate

Some nonprofits manage fund accounting practices by keeping certain funds in separate bank accounts, especially for programs or projects that are more financially independent from the nonprofit’s other activities. Not only does this keep funds separate,it also makes it easier to manage program costs and track the funds over time.

Separate bank accounts are also used for projects that legally need to be kept separate from a nonprofit’s general fund, such as fiscal sponsorship agreements. In a fiscal sponsorship arrangement, a nonprofit offers financial and legal oversight to an outside project. Keeping a separate account ensures that fiscal sponsorship funds aren’t accidentally spent.

Implement reliable safeguards

Internal controls keep your financial management practices more transparent and ethically sound. They often include distributing financial responsibilities to multiple staff members, such as separating the duties for approving purchases and recording the transactions. They may also include approval workflows so that multiple staff members are required to approve major expenses. These rules can strengthen your nonprofit’s financial transparency and facilitate smooth audits.

Safeguards can also protect against errors, offering more opportunities to catch mistakes before they snowball. Consistent bank reconciliations and regular budget reviews help keep data accurate and consistent, making tax filings and budget snapshots easier to produce.

Use quality accounting software

Accounting software plays a central role in nonprofit financial management. Because the needs of nonprofit finances differ from for-profit accounting practices, traditional accounting tools may be an imperfect fit for your nonprofit. 

Nonprofits often look for accounting software that supports fund accounting and produces key financial statements on demand. It should also be able to accommodate a chart of accounts, which is the list of categories nonprofits use to organize all financial transactions, so revenue and expenses are recorded consistently.

QuickBooks is popular among nonprofit organizations, but other popular accounting systems include Aplos, Blackbaud Financial Edge, and NetSuite, with larger nonprofits often selecting platforms that support more advanced reporting and internal controls. When configured properly, your accounting software should automate essential financial data and integrate smoothly with other existing systems.