Top Non-Profit Accounting Challenges and How to Overcome Them
November 1, 2022
Every year, non-profits receive millions of dollars in donations.The Forbes list of the Top 100 Charities for 2021 alone received a minimum of $167 million in donations. The sheer value of contributions handled by non-profit organizations (NPOs) from multiple sources makes non-profit accounting incredibly complex. An NPO faces a range of accounting challenges almost daily, such as cash flow management, employee payroll and reimbursement, and the scrutiny of financial reports by auditors, the public, and the board of directors.
Common Nonprofit Accounting Challenges
The following are the top non-profit accounting challenges that NPO leaders grapple with almost every day.
Bookkeeping is the most difficult non-profit accounting challenge. On the one hand, there are large amounts of incoming funds collected from various sources (individual donors, fundraiser events, members, and grants), which are received in different modes (cash, paper checks, credit cards, and EFT/ACH) and often with restrictions and specific instructions. On the other hand, NPO’s must pay invoices, and process expenses to keep the organization running as well. When you have a team of part-time bookkeepers and volunteers, it can be difficult to ensure the recording of financial data accurately and on time. Additionally, these volunteers are not often aware of the proper accounting practices for managing all of the financial entries which can result in incorrect financial reporting, or even audit findings. All of this can result in a loss of confidence by donors, board members, and the public.
One thing that can cause accounting nightmares for non-profit organizations is when there are multiple systems that aren’t integrated or aligned. Many organizations have separate platforms for their donor database, financial management, financial reporting and AP management – none of which are usually set up to work together. It leads to a lack of information interchange, and therefore inefficiency, as the different systems don’t, and can’t, talk to each other. This results in the non-profit not being able to efficiently generate reliable financial reports that accurately represents the organization’s financial performance versus goals. Even generating the bare minimum monthly financial report becomes an arduous task in this scenario, which ends up consuming valuable time of the accounting staff rather than having them focus on strategic work that ensures the longevity of the organization.
Reliance on paper-based processes
The reliance on paper-based processes complicates the operations and financial reporting of a non-profit accounting department and makes it more complex than it should be. This is especially true of organizations that started small but have seen growth over the years and never adjusted their processes and practices to grow with them. Unfortunately, most non-profit enterprises have failed to put any real resources into moving towards the digitization of operational and financial workflows.
Accounting for grants and pledges
Writing and receiving grants presents a unique set of non-profit accounting challenges that for-profit organizations never deal with. To secure grants, non-profits must submit audited financials. Then, after securing the grant, they must submit regular financial reports to keep the funding. There are also very particular rules about the use and allocation of grant funds – for instance, the grant funds can’t be used to cover your operating expenses. Also, specific accounting laws apply to how grants are shown on the non-profit’s books. All of this requires that the non-profit has a very specific chart of accounts in place that allows them to track and report at the level that is required to support the use of these types of funds. Additionally, if the proper reporting isn’t completed in a timely manner each month then the NPO runs the risk of losing their funding or “leaving money on the table”.
Because most non-profits operate with a mix of volunteers, contractual staff, and employees, managing payroll presents unique non-profit accounting challenges. Furthermore, one person may manage multiple projects/tasks, and their time must be allocated appropriately for the time spent performing in each role. WIthout the right systems, technology, and resources in place that know how to deal with all these industry-specific challenges, many NPO’s find themselves blind-sided by the issues that arise and aren’t sure how to adjust for them.
Tax law reportingand compliance
The Form 990 that non-profits file each year are public records. To keep their tax-exempt status, non-profits must file a 990 every year. Failure to file the form for three years will lead to revocation of the non-profit’s exemption status. In addition, compliance with industry best practices and state laws in non-profit accounting is a must for successful audits. The audit requirements for non-profits are more stringent than the financial audits for most other businesses. Therefore, leaders of a non-profit, must ensure that the financials and internal controls of the organization can withstand any scrutiny it will come under.
Financials for the Board of Directors
In non-profit accounting, donations are counted as revenue when the amounts are pledged rather than when the funds are received (as is the case in for-profit accounting). The differences in non-profit accounting can initially confuse board members who lack non-profit experience, so it is vital to have transparent financials that show a clear picture of the organization’s financial status as well as a CFO that can explain those financials and answer questions the Board has about them. Also, the board of directors will need detailed and repliable financial reporting to help them set budgets and make strategy decisions about the future of the organization.
Retaining trust of donors
For non-profits, gaining the trust of contributors is an important objective. All public donations must be properly distributed, and the distribution must be accurately recorded. Public trust in your nonprofit organization might be eroded by using funds for other activities, planning fundraisers, or paying administrative costs. Even if done unintentionally or without malice, if an improper use of funds is discovered, it will have a major impact on the reputation of the organization which can impact the longevity of the group and its ability to carry out its mission.
Overcoming Non-profit Accounting Challenges
So how does an NPO improve its accounting processes and ensure that it is able to generate accurate, transparent financial data? The most obvious answers would seem be to set up an in-house professional non-profit accounting team and automation of accounting processes.
However, most non-profits operate under a tight budget. Building the right in-house team can be expensive and difficult because experienced non-profit accountants and bookkeepers are hard to find. And even if you are lucky enought to have built a great in-house accounting team, finding staff replacements can be a full-time job in itself when someone leaves the team – especially in today’s tight job market. In addition to having the right people, an NPO also needs the right software in place and buying expensive financial and donor tracking software may not be an investment that pays for itself. That is why most modern NPO leaders choose to outsource the function entirely to an accounting service provider with non-profit experience and knowledge.
An experienced accounting service provider can help you navigate the non-profit accounting challenges in the following ways:
- You have access to a team of non-profit accounting experts who have first-hand knowledge of common accounting challenges faced by NPOs.
- The partner’s accounting expertise, technology, and knowledge of best practices ensure greater accounting compliance and information security for the NPO.
- An accounting service provider can scale the accounting team to meet the demands of your growing NPO, especially when you suddenly receive a huge grant or donation.
- The accounting service provider’s team will work with your staff to digitize paper-based invoicing and payments.
- They will simplify your payroll process and allocation.
- They will ensure you have the information and reports to answer board members questions and needs.
- They will ensure that your books are audit-ready at any point throughout the year when you need to write a grant or share financial statements for other funding.
Working with a third-party service provider for your non-profit accounting needs will increase transparency, produce improved financial insights for informed decision-making, and strengthen the trust stakeholders have in your organization. Outsourcing non-profit accounting is more affordable than setting up an in-house team and offers greater operational flexibility. If you decide to outsource accounting, ensure that you work with a service provider that is well-versed with fund accounting and can answer non-profit-specific questions.