Nonprofit vs. For-Profit Accounting: 3 Differences to Know
Nonprofit vs. For-Profit Accounting: 3 Differences to Know
You’re likely familiar with the concept of accounting as a way for businesses to manage company finances in a way that maximizes their profits. Although nonprofits don’t focus on making a profit in the same way as businesses, financial management is still essential to running an effective organization. One of the biggest financial mistakes nonprofits can make is not to prioritize accounting.
By definition, nonprofit accounting isn’t concerned with maximizing profits as all of the revenue your nonprofit brings in has to be invested back into the organization. Therefore, nonprofits use a system of fund accounting, which prioritizes accountability over profit. Fund accounting allows nonprofits like yours to be transparent with stakeholders to ensure your organization has sustainable funding and a strong financial position.
To help your organization understand fund accounting, we’ll dive deeper into three specific differences between nonprofit and for-profit accounting:
- Earning Revenue
- Creating Budgets
- Filing Tax Forms
Nonprofit financial management works side by side with the fundraising efforts you devote much of your time and resources to. Your organization’s number one goal—furthering your mission—depends on your ability not only to bring in enough revenue to cover all of your program and overhead expenses but also to keep track of that revenue through an effective accounting system. Let’s get started!
1. Earning Revenue
For-profit organizations tend to bring in the majority of their revenue by earning income on products or services. Some revenue may come from other sources like making investments or selling company assets, but these businesses mainly need to track customer sales or client payments in their accounting systems.
Your nonprofit may bring in revenue from earned income as well—for example, if you rent out your facilities to another organization for an event, charge membership fees, or set up an online store to sell branded merchandise. However, nonprofits also make money from a variety of other sources, including:
- Individual contributions. This category includes small, mid-tier, major gifts, as well as donations made during fundraising events.
- Corporate philanthropy. For-profit organizations, foundations, and other nonprofits may contribute to your organization through event sponsorships, volunteer grants, matching gifts, or other corporate social responsibility initiatives.
- Grants. Government entities and foundations can provide critical grant funding to support specific projects or initiatives. You’ll need to write compelling proposals and compete with other organizations to secure these funds.
- Investments. Infinite Giving’s guide to nonprofit investing explains that having a well-managed investment account can be an important revenue-generating strategy alongside your fundraising initiatives. Your nonprofit can use an investment account to build assets and save for the future.
Make sure that your nonprofit’s accounting system takes each of these funding sources into consideration so you have a complete, accurate record of all of your revenue as you make a plan for how to use those finances each year.
2. Creating Budgets
Both nonprofit and for-profit organizations create annual budgets in which they break down all of their revenue and expenses for the year. However, nonprofits have to keep two unique considerations in mind when it comes to budgeting.
First, remember that all of your revenue has to be reinvested into your organization (that’s why you’re classified as a nonprofit, after all!). This doesn’t mean nonprofits have to break even every year—in fact, it’s beneficial if you can budget for a surplus. However, you’ll need to designate any surplus funding for your organization as you create your budget by investing it or putting it into a reserve account for emergencies.
Additionally, you have to consider any restrictions that may have been placed on your revenue by donors or grantmakers. Jitasa’s guide to restricted funds outlines the three classifications of nonprofit funding to take into account as you budget:
- Unrestricted revenue. These contributions can be used to cover any necessary costs at your organization, whether operating expenses or those dedicated for a specific program.
- Permanently restricted revenue. These funds are only provided if an organization meets specific conditions set by a donor or funder. They often come in the form of endowments, which your organization can’t spend directly but instead uses to earn interest. The interest is then spent on a specific, ongoing initiative, such as a yearly scholarship.
- Temporarily restricted revenue. This type of funding is restricted only until a certain purpose has been fulfilled or a designated time period has passed. At that point, the funder agrees that leftover funding can be released from restrictions. For example, if a major donor gives $100,000 to a capital campaign, but your organization only needs to spend $95,000 of it on the campaign project, the remaining $5,000 can be allocated toward any area of your organization’s budget after the project is completed.
While restricted funds can present challenges when it comes to ensuring all of your programs receive the exact amount of funding they require, they make up some of the largest contributions to your organization. Make sure to account for restricted and unrestricted funds in your budget so you can set accurate fundraising campaign goals and follow through on the agreements you’ve made with donors.
3. Filing Tax Forms
One of the key benefits of registering your organization as a 501(c)(3) nonprofit is an exemption from the federal taxes for-profit organizations have to pay. However, nonprofits still need to file a specific tax form, known as Form 990, each year in order to maintain this tax-exempt status.
To make filing taxes easier for your organization, try these tips:
- Choose the right version of Form 990. Only nonprofits who have more than $200,000 in gross receipts or $500,000 in assets need to fill out the full Form 990. Mid-sized organizations can often complete the Form 990EZ, the smallest nonprofits use Form 990N, and foundations of any size have to use Form 990PF.
- Compile financial documents ahead of time. Your nonprofit statement of activities will help you report on your revenue and expenses accurately. Your organization could also use a statement of functional expenses to streamline the filing process by organizing financial information in the same format as the Form 990.
- File by the deadline. Unless your nonprofit is granted an extension, your Form 990 is due on the 15th day of the fifth month after your fiscal year ends. If your organization’s fiscal year follows the calendar year, your filing deadline is May 15. If your fiscal year runs from July to June, your deadline is November 15.
If your nonprofit is planning to undergo an audit, make sure it ends well before your Form 990 deadline so you have time to start incorporating the auditor’s recommendations into your financial management practices and can report on them accurately. You may need to request an extension to your tax filing deadline to ensure this is possible. But as long as your books are in order and you use the resources available to you, tax season can be a breeze for your organization.
Nonprofit accounting is unique from for-profit accounting as your organization needs to consider how to remain accountable to stakeholders, donors, grantmakers, and even the IRS. For-profits think about financial management in different ways—usually with a greater emphasis on profit. If your organization is looking for help managing your own finances, consider investing in a nonprofit accounting firm because they’ll also keep these specific considerations top of mind.