Chapter 43. Managing Finances | Community Tool Box

• What are the elements of an annual budget?

• Why should you prepare an annual budget?

• Some practical considerations

• Planning and gathering information to create a budget

• Putting it all together: Creating and working with a budget document

What are the elements of an annual budget?

Creating an annual budget can feel challenging, especially if you are unfamiliar with accounting and financial terminology. A budget becomes easier to work with when it is understood as a planning tool: it translates the organization's priorities, expected resources, responsibilities, and financial assumptions into numbers for a defined period of time.

Accurate and up-to-date budgets help organizations plan responsibly, monitor their financial position, communicate with boards and funders, and make informed decisions as circumstances change. How detailed the budget needs to be will depend on the size and complexity of the organization, its programs, funding sources, reporting requirements, and financial systems.

At a minimum, an annual budget generally includes:

• Projected expenses. Estimate what the organization expects to spend during the coming fiscal year, organized into meaningful categories such as personnel, program costs, facilities, technology, transportation, insurance, accessibility, professional services, and administration.

A fiscal year is the 12-month period an organization uses for budgeting and financial reporting. It may or may not match the calendar year. Choose and maintain the fiscal year appropriate to your organization's legal, accounting, governance, and funding requirements. Prepare and approve the annual budget before the new fiscal year begins whenever possible.

• Projected revenue and other support. Estimate the resources you reasonably expect to receive during the coming fiscal year, broken down by source. Depending on the organization, these may include grants, contracts, individual contributions, foundation support, public funding, membership dues, earned revenue, investment income, sponsorships, and in-kind resources.
• Restrictions and relationships between revenue and expenses. Some funding can be used only for specific programs, positions, populations, activities, or cost categories. Build these restrictions into the budget and financial system so the organization can understand which resources are available for which purposes.
• Cash-flow considerations. A balanced annual budget does not necessarily mean cash will be available when bills are due. Consider the timing of grant payments, reimbursements, fundraising revenue, payroll, contracts, and other major receipts and expenses.
• Updates based on actual results. A budget begins with assumptions. Throughout the year, compare the budget with actual revenue and expenses, investigate significant differences, update forecasts where appropriate, and communicate meaningful changes to organizational leadership and the board.

Why should you prepare an annual budget?

• It connects financial decisions with organizational goals. Developing the budget requires the organization to identify what work it intends to prioritize and what resources are required to carry it out.
• It provides a realistic picture of available resources and gaps. A budget helps show what the organization can responsibly support, what requires additional resources, and where tradeoffs may be necessary.
• It supports proactive financial planning. Identifying gaps before the year begins creates more time to pursue additional funding, revise plans, build partnerships, or adjust expenses thoughtfully.
• It provides information required by boards, funders, partners, lenders, and regulators. Budget information may be required in grant applications, contracts, financial reports, governance processes, and other organizational documents.
• It creates a basis for discussing financial priorities and tradeoffs. Staff, board members, and others involved in governance can use the budget to understand how resources support the organization's mission.
• It helps reduce financial surprises and strengthen financial oversight.
• It supports accountability. Comparing actual results with the approved budget helps leaders understand where assumptions were accurate, where conditions changed, and where corrective action may be needed.

Some practical considerations

Budget development and financial management require knowledge and time, and responsibility should not automatically fall to one person. Depending on the organization, the process may involve an executive director, finance staff, program leaders, bookkeeper, accountant, treasurer, chief financial officer, board finance committee, or other people with appropriate knowledge.

Smaller organizations that do not have financial staff may seek support from nonprofit associations, community foundations, accountants, pro bono professional networks, universities, fiscal sponsors, or shared-service arrangements with other organizations. Whatever approach is used, organizational leaders and the board should still understand the budget well enough to carry out their oversight responsibilities.

Obtain professional accounting, tax, legal, or audit guidance when necessary. Requirements vary according to the organization's legal status, location, funding, contracts, size, and other circumstances.

Planning and gathering information to create a budget

The preliminaries: What resources will you need next fiscal year?

Budgeting should begin with organizational priorities rather than simply copying last year's numbers. Consider the work the organization intends to carry out, what it has learned, what conditions have changed, and what resources are needed to fulfill its mission responsibly.

Consider questions such as:

• Which programs, activities, and organizational functions are most important to advancing the mission and responding to community priorities?
• What staffing capacity is required to carry out that work effectively and sustainably?
• What compensation, employee benefits, contractor costs, training, and other workforce investments are required?
• What facilities, supplies, technology, communications, insurance, transportation, accessibility supports, security, professional services, and other resources are required?
• What costs are likely to increase because of inflation, compensation adjustments, insurance changes, contracts, program growth, or other known factors?
• What investments would help reduce risk or strengthen long-term organizational capacity?

Estimating expenses: What will it cost?

Step 1: Develop realistic forecasting assumptions

Begin with reliable information such as current contracts, payroll records, vendor quotes, historical spending, known rate changes, program plans, and other available evidence.

Where exact amounts are not known, develop reasonable estimates and document the assumptions behind them. Consider several scenarios when costs are particularly uncertain rather than relying on one arbitrary number.

Prudent forecasting means using evidence, documented assumptions, and reasonable caution when projecting both expenses and revenue. Avoid overstating likely revenue or understating known costs simply to make the budget appear balanced.

A reasonable contingency may be appropriate for uncertain or unexpected costs, but avoid using a large "miscellaneous" category that makes it difficult to understand what the organization actually expects to spend.

Step 2: Estimate the organization's core operating expenses

These may include:

• Salaries and wages
• Payroll taxes, employee benefits, leave, insurance, retirement contributions, and other employment costs
• Rent, mortgage, coworking, or other facility costs
• Utilities
• Communications services
• Internet, software, cloud services, cybersecurity, website hosting, and other technology costs
• Insurance
• Accounting, payroll, legal, human resources, data security, and other administrative services

Step 3: Estimate the costs of carrying out programs and activities

• Program and office supplies, educational materials, software, subscriptions, and other consumable resources
• Equipment and technology, including purchase or lease costs, maintenance, repairs, replacement, licensing, and service agreements
• Participant compensation or stipends, childcare or dependent-care support, interpretation, translation, transportation, and other resources needed for equitable participation
• Evaluation, communications, outreach, training, and professional-development expenses

Funders may classify expenses differently and may limit certain administrative or indirect costs. Use each funder's current definitions and rules rather than assuming that the same percentage or classification applies to every grant.

Step 4: Include other financial obligations and necessary costs

• Debt payments and other financial obligations
• Consulting, accounting, bookkeeping, legal, evaluation, audit or financial-review services, and contracted services from other organizations
• Printing, design, and production costs
• Transportation and travel for staff, participants, and volunteers, including appropriate vehicle costs
• Mailing, shipping, and delivery

Financial reviews and audits: Do not assume that every nonprofit is required by the IRS to obtain an annual independent audit. Audit, review, compilation, and other financial-reporting requirements may depend on state law, federal-award expenditures, funder or lender requirements, contracts, governing documents, or board policy. Determine which requirements apply to your organization and budget accordingly.

Step 5: Identify additional priorities and strategic investments

After identifying core costs, list investments that are desirable but may depend on additional resources. These could include new positions, expanded programs, compensation improvements, new technology, accessibility improvements, professional development, equipment replacement, facility improvements, or reserve contributions.

Step 6: Add the projected expenses

The result is the amount you estimate the organization would spend during the coming fiscal year under the assumptions in your plan.

Estimating revenue and other support

Use historical information when it is relevant, but do not assume that last year's revenue will automatically continue. Review current grant periods, contracts, donor trends, fundraising performance, membership, earned revenue, and other known conditions.

Step 1: List committed or reasonably predictable funding

This may include grants and contracts already awarded, recurring government support, foundation grants, recurring contributions, or other resources with a strong basis for inclusion in the forecast.

Distinguish between funds that are committed, reasonably expected, and aspirational or still being pursued. This helps leaders understand the level of uncertainty in the budget.

Step 2: Estimate fundraising revenue

Fundraising may include individual giving, major gifts, events, peer-to-peer campaigns, direct mail, online fundraising, sponsorships, workplace giving, planned giving, or other approaches. Base projections on realistic participation, historical results, fundraising costs, and current strategy.

Step 3: Estimate earned revenue

Include fees for services, consulting, training, publications, merchandise, facility use, or other mission-aligned earned-income activities when applicable. Consider affordability and whether fees could create barriers to access.

Step 4: Estimate membership revenue

If your organization charges membership dues or fees, estimate revenue using realistic assumptions about membership levels and collection rates.

Step 5: Estimate sales or other earned-income activities

Include projected revenue from products or other business activities where appropriate, along with the expenses required to generate that revenue.

Step 6: Estimate rental or shared-space revenue

If the organization rents or sublets space, include reasonable estimates based on current agreements or realistic occupancy assumptions.

Step 7: Estimate investment and interest income

Include interest, investment income, or endowment distributions using assumptions consistent with the organization's investment and spending policies. Avoid treating uncertain market gains as guaranteed operating revenue.

Step 8: Add other expected sources

Include other revenue or support that is reasonably expected and clearly identify significant restrictions.

Step 9: Add all projected revenue and support

Compare this total with projected expenses, but also consider timing, restrictions, and uncertainty. Two budgets with the same total revenue may have very different levels of financial risk.

Putting it all together: Creating and working with a budget document

Analyzing and adjusting the budget

Step 1: Organize the information in a useful format

Most organizations use accounting software, spreadsheets, or other financial-management systems that allow expenses and revenue to be organized by program, funding source, department, grant, restriction, and other dimensions.

A useful budget should make it possible to see not only total revenue and expenses, but also which resources are restricted and whether sufficient flexible funding exists to support shared organizational costs.

Expense Category	Public Grant	Foundation Support	Unrestricted Contributions	Service Revenue	Total
Personnel	90,000	30,000	20,000	10,000	150,000
Employee benefits and payroll costs	22,000	8,000	5,000	3,000	38,000
Program supplies and participant support	18,000	10,000	4,000	2,000	34,000
Technology and communications	5,000	3,000	6,000	1,000	15,000
Facilities and utilities	12,000	6,000	14,000	3,000	35,000
Insurance and professional services	4,000	2,000	7,000	0	13,000
Total	151,000	59,000	56,000	19,000	285,000

A format like this can help an organization see whether restricted funding is assigned to allowable expenses and whether sufficient unrestricted resources are available for shared costs that program-specific grants may not fully cover.

Step 2: Compare projected expenses with projected revenue and support

• If planned revenue and support approximately equal planned expenses, the organization has a balanced operating budget.
• If planned revenue exceeds planned expenses, the organization has a budgeted operating surplus. Depending on restrictions and cash flow, this may support operating reserves, strategic investments, debt reduction, future programs, compensation improvements, or other board-approved purposes.
• If planned expenses exceed planned revenue, the organization has a budgeted deficit. Determine whether the deficit is intentional and supported by available reserves or whether additional revenue, spending changes, or other action is required.

A nonprofit does not necessarily need to budget to exactly zero every year. Building reasonable operating reserves and occasionally budgeting for strategic use of reserves can both be appropriate when supported by clear policies and organizational circumstances.

Step 3: Make sure resources can actually be used as planned

Review restrictions, grant periods, allowable costs, indirect-cost rules, cash timing, match requirements, and other conditions attached to funding.

If there is a mismatch:

• Ask the funder whether a budget modification or reallocation is permitted when appropriate
• Allocate legitimate shared costs across programs using a consistent and supportable methodology
• Reconsider timing, scope, or priorities if resources do not support the planned work
• Seek flexible or unrestricted funding where restricted grants leave essential organizational costs unsupported

The organization's mission, values, community commitments, and strategic priorities should guide funding decisions. Avoid creating or reshaping programs simply because money is available when doing so would pull the organization away from its purpose.

Step 4: Plan responsibly for a budgeted surplus

A projected surplus is not necessarily immediately available cash. Consider when revenue will actually be received, whether any funds are restricted, and what obligations remain outstanding.

Possible uses of unrestricted surplus may include:

• Building or replenishing operating reserves under a board-approved reserve policy
• Improving compensation, benefits, workplace conditions, staffing capacity, or professional development when the organization can reasonably sustain those commitments
• Replacing deferred equipment or technology
• Investing in a new or expanded program after considering its long-term resource requirements
• Making appropriate capital investments
• Supporting partnerships or shared infrastructure with other organizations
• Reducing debt or other financial risk

Investment of organizational funds should follow applicable law, board-approved financial and investment policies, liquidity needs, risk tolerance, donor restrictions, and appropriate professional guidance.

Step 5: Respond thoughtfully to a projected deficit

A deficit deserves attention, but the goal should not simply be to cut until the numbers balance. Understand why the deficit exists, whether it is temporary or structural, how much unrestricted cash or reserves are available, and what effect different choices would have on staff, participants, programs, and the organization's long-term health.

Possible responses include:

• Using board-designated reserves when that use is consistent with the organization's reserve policy and long-term financial position
• Pursuing additional grants, contributions, contracts, earned revenue, or other realistic sources of support
• Sharing services, facilities, purchasing, personnel, or other infrastructure with partner organizations where doing so improves efficiency without reducing quality or accountability
• Reducing or redesigning lower-priority expenses
• Delaying or scaling back activities that are not essential or that can be postponed responsibly
• Revisiting contracts, purchasing practices, insurance, technology, facilities, and other recurring expenses
• Adjusting program scope or timing when the organization cannot responsibly support the original plan

A thoughtful approach to budget reductions

Begin with mission, legal obligations, contractual requirements, safety, accessibility, and the effects on people. Review discretionary or lower-priority spending before making changes that substantially affect staff compensation, benefits, employment, or essential services.

• Identify expenses that can be reduced, delayed, renegotiated, or redesigned without undermining essential work.
• Consider the consequences of reductions for program quality, equity, accessibility, staff workload, and community commitments.
• If workforce changes become necessary, follow applicable employment law, contracts, personnel policies, funder requirements, and organizational values. Communicate clearly and avoid assuming that reductions in hours, benefits, or positions are cost-free solutions; they can affect retention, workload, morale, and service quality.

Borrowing may be another option in some circumstances, but debt creates future obligations. Consider repayment capacity, interest and fees, cash-flow effects, restrictions, board authorization, and professional financial advice before borrowing.

Creating an actual budget document

The budget should be understandable to the people responsible for reviewing, approving, monitoring, and implementing it. Different audiences may need different levels of detail.

A high-level board budget might show projected expenses by major category and projected revenue by source, while staff and finance committees may use more detailed program, department, grant, and account-level reports.

Projected Expenses	Amount
Personnel	$150,000
Benefits and payroll costs	$38,000
Program supplies and participant support	$34,000
Technology and communications	$15,000
Facilities and utilities	$35,000
Insurance and professional services	$13,000
Total Projected Expenses	$285,000
Projected Revenue and Support	Amount
Public grants and contracts	$151,000
Foundation support	$59,000
Unrestricted contributions and memberships	$56,000
Earned revenue	$19,000
Total Projected Revenue and Support	$285,000

A budget narrative can provide additional explanation for assumptions, staffing, major costs, restricted funding, and other items that may not be obvious from the numbers alone.

Working with your budget

The approved budget should be monitored throughout the fiscal year. Many organizations review financial results monthly, although the appropriate schedule depends on the organization's size, complexity, cash position, and governance practices.

Compare actual revenue and expenses with the budget and calculate meaningful variances. Investigate significant differences and update the forecast when new information becomes available.

Budget monitoring should be considered alongside cash-flow reports, balance-sheet information, grant restrictions, fundraising progress, reserves, outstanding obligations, and other indicators of financial health.

Your budget and related financial reports should help you:

• Identify funding gaps, financial risks, and areas where assumptions have changed
• Decide what actions may be needed in response
• Track resources responsibly, comply with restrictions, and avoid unplanned overspending
• Understand whether staffing and program commitments remain financially sustainable
• Provide clear information to the board, funders, staff, and other appropriate stakeholders

In Summary

An annual budget translates an organization's priorities and plans into a financial framework for the coming fiscal year. A strong budgeting process estimates expenses and revenue realistically, identifies restrictions and uncertainty, considers cash flow, and gives organizational leaders and the board information they can use to make informed decisions.

The budget should not be treated as a document that is prepared once and then ignored. Compare budgeted amounts with actual results regularly, understand significant differences, update forecasts as circumstances change, and connect financial decisions with the organization's mission, community commitments, workforce, and long-term sustainability.

Financially healthy organizations also look beyond whether the annual budget mathematically balances. Consider liquidity, reserves, funding concentration, restricted versus unrestricted resources, long-term commitments, program quality, fair compensation, organizational risk, and whether available resources are sufficient to carry out the work responsibly.

Glossary

Accounting: A system for recording, classifying, summarizing, reporting, and interpreting an organization's financial transactions and position.

Audit: An independent examination of financial information performed under applicable professional standards. Different types of audits and financial reviews exist, and whether one is required depends on applicable laws, funding, contracts, organizational circumstances, and other requirements.

Balanced Budget: A budget in which projected revenue and other support approximately equal projected expenses. An organization may also intentionally budget for a surplus or for a planned use of unrestricted reserves when appropriate.

Budget Deficit: A situation in which projected expenses exceed projected revenue and other support.

Budget Surplus: A situation in which projected revenue and other support exceed projected expenses.

Budget-to-Actual Variance: The difference between the amount budgeted for a category and the amount actually received or spent during the same period.

Cash Flow: The timing and movement of cash into and out of an organization. An organization can have a balanced annual budget and still experience a cash shortage if revenue arrives after expenses must be paid.

Prudent Forecasting: Developing realistic financial projections using available evidence, documented assumptions, uncertainty ranges, and appropriate contingency or scenario planning.

CPA: Certified Public Accountant, a licensed accounting professional who may provide audit, tax, accounting, advisory, or other financial services depending on the engagement and applicable requirements.

Fiscal Year: The 12-month period an organization uses for budgeting, accounting, reporting, and closing its books.

Fund Accounting: Accounting practices used to track resources according to restrictions, grants, contracts, programs, or other requirements so an organization can demonstrate that funds are used appropriately.

Line Item: A defined revenue or expense category within a budget.

Line-Item Budget: A budget organized by specific revenue and expense categories. Funders may also approve budgets that limit how much funding can be used within particular categories.

Operating Reserve: Unrestricted funds set aside to help an organization manage unexpected expenses, revenue delays, emergencies, or other financial needs in accordance with an established reserve policy.

Projected Expenses: The costs an organization reasonably expects to incur during the budget period.

Projected Revenue and Support: The grants, contracts, contributions, earned revenue, membership income, investment income, and other resources an organization reasonably expects to receive during the budget period.

Restricted Funds: Resources whose use is limited by a donor, grant, contract, law, or other applicable requirement.

Spreadsheet: A tabular tool used to organize, calculate, and analyze financial information. Modern budget spreadsheets may track revenue and expenses by funding source, program, department, restriction, period, and other dimensions and may be used alongside accounting or financial-management software.

___You know the elements of an annual budget

___You know why you should prepare an annual budget

___You are prepared for the amount of time and effort spent on your budget to bear some relation to the size of your budget

___You have determined what you will need to spend money on in the next year, using these six steps to estimate your expenses:

• Develop ways of estimating expenses
• List yearly expense totals for absolute necessities
• List estimated expenses for things needed to conduct the activities of the organization
• List estimated expenses for miscellaneous costs
• List estimated expenses for items you aren't sure you can afford, but would like to obtain if possible
• Add up all of your expense items

___You understand how to estimate your organization's income, following these nine steps:

• List all actual figures or estimates of amounts you can expect from your known funding  sources
• Estimate the amount you'll raise in the next fiscal year from fundraising
• Estimate the amount you'll take in for fees or services you provide
• Estimate the amount you will receive from yearly membership dues or fees
• Estimate the amount you will receive from items you may sell, such as pins, T-shirts, books, blood pressure cuffs, etc.
• Estimate the income from any spaces you sublet or rent to others
• Estimate the income you will receive from any investments, endowment income, annuities, or interest income (e.g., from a certificate of deposit, or from a Money Market or checking account)
• List and estimate the amounts from any other sources that are expected to bring in some income
• Add up all the income items you have listed to determine your total projected income for the fiscal year

___The five steps of analyzing and adjusting your budget have been followed:

• Laying out your figures in a useful format
• Comparing total expenses to your total income
• Knowing what to do if your budget is balanced
• Knowing what to do if you have a surplus
• Knowing what to do if you have a deficit

___If necessary, you have ideas on how to trim your budget

___You understand how to create a budget document

___You know how to work with your budget, including when and how to review and/or revise it

• Why does your organization need a financial management plan?

• What does everyday financial management include?

• How do you create a financial management plan?

• What issues are involved in being tax-exempt?

• How do you handle cash flow?

• What are some day-to-day financial management issues?

• What are some investment issues?

Organizations need reliable financial systems in order to carry out their missions, pay staff and vendors, comply with funding requirements, manage risk, and make informed decisions about the future.

Effective financial management generally requires:

• A realistic and current budget
• Appropriate banking, payment, and purchasing systems
• Reliable accounting and recordkeeping
• Clear authorization and internal-control procedures
• Systems for paying bills, receiving revenue, and managing payroll
• Cash-flow forecasting and sufficient liquidity to meet obligations
• Procedures for managing grants, contracts, restricted funds, and reporting requirements
• Appropriate cybersecurity, privacy, document-retention, and backup practices
• Clear financial oversight by organizational leadership and the governing board

Why does your organization need a financial management plan?

Even very small organizations need some way to track money coming in and going out, maintain appropriate records, protect organizational resources, and meet financial obligations. The complexity of the system should reflect the size, activities, legal structure, funding, and risks of the organization.

A financial management plan can:

• Help the organization fulfill its mission. Reliable finances make it possible to sustain programs, staff, partnerships, and other work.
• Support effective use of resources. Good financial information helps leaders determine whether money is being used efficiently and in ways consistent with organizational priorities.
• Strengthen control over finances and cash flow. Leaders can identify problems earlier and respond before they become crises.
• Support reliable relationships with employees, vendors, partners, lenders, and funders. Meeting financial obligations and communicating early when problems arise builds trust.
• Strengthen credibility and accountability. Boards, funders, donors, partners, and community members should be able to trust that organizational resources are managed responsibly.
• Save time. Clear procedures and reliable records reduce the time spent locating missing information, correcting errors, or reconstructing transactions.
• Support better decisions. Accurate financial information helps leaders understand what the organization can afford, what risks it faces, and where additional resources may be needed.

What does everyday financial management include?

Financial management is not primarily about advanced mathematics. It is about creating reliable systems, using accurate information, establishing appropriate controls, and making sound decisions.

Financial responsibilities may be carried out by an executive director, finance staff, bookkeeper, accountant, chief financial officer, board treasurer, finance committee, fiscal sponsor, or some combination of these roles. Even when financial work is delegated, organizational leaders and board members should understand the organization's financial position and know what questions to ask.

Useful systems may include:

• An accounting and bookkeeping system that records transactions accurately and produces useful financial reports
• A banking and treasury system that addresses liquidity, fees, security, authorized users, deposit insurance, and access to funds
• A payment and purchasing system defining who can authorize, approve, initiate, and review expenditures
• A controlled process for low-dollar purchases, whether through petty cash, purchasing cards, reimbursement, or another method
• A payroll system that provides accurate and timely compensation and handles applicable taxes, deductions, employee benefits, and reporting
• Accounts-payable and accounts-receivable systems
• A grants and contracts management system for tracking restrictions, budgets, deliverables, reimbursement, reporting, and compliance
• A cash-flow management system
• Financial security and internal controls, including appropriate separation of duties, approvals, account access, reconciliations, and fraud-prevention measures

Cash flow refers to when money actually becomes available and when payments must actually be made. An organization may have substantial grants, contracts, pledges, or receivables on paper and still face a cash shortage if those funds have not yet been received.

Organizations also need to make decisions such as:

• What accounting or financial-management system will we use?
• Which bank accounts and financial institutions meet our needs?
• Who can authorize purchases, electronic payments, transfers, contracts, reimbursements, and other transactions?
• What approval thresholds and separation-of-duties controls should apply?
• How will compensation, employee benefits, leave, and employment classifications be handled consistently with applicable law and organizational policy?
• What purchasing and vendor-selection processes will we use?
• How will grants, contracts, restricted funds, and cost allocations be tracked?
• How will the organization respond to a cash-flow shortage?
• How will financial information be reviewed by leadership and the governing board?

The goal is to create controls strong enough to protect the organization without making routine work unnecessarily difficult. Financial caution and organizational innovation do not have to be opposites. A strong system helps leaders understand which risks are reasonable and which may threaten the organization.

How do you create a financial management plan?

Every organization needs financial-management practices appropriate to its size and circumstances. A small volunteer-led initiative may need a relatively simple system, while an organization managing payroll, grants, contracts, restricted funds, and multiple programs will need substantially more structure.

Accounting

Accounting systems should provide accurate and timely information about revenue, expenses, assets, liabilities, cash, restrictions, grants, and the organization's overall financial position.

Work with an accountant, bookkeeper, or other qualified financial professional when necessary. Community Tool Box guidance can help organizations understand the questions involved, but it is not a substitute for professional accounting, legal, or tax advice.

Organizations may use cash-basis, modified cash-basis, or accrual accounting depending on their circumstances and reporting requirements.

Cash-basis accounting generally records revenue when cash is received and expenses when they are paid.

Accrual-basis accounting generally recognizes revenue when it is earned and expenses when obligations are incurred, providing a broader view of amounts receivable and payable.

The appropriate accounting method depends on organizational needs, legal and tax requirements, funder requirements, and applicable accounting standards. Seek professional guidance when selecting or changing accounting methods.

Communication between financial staff and program or organizational staff is essential. Program staff need financial information they can understand, while accounting staff need timely and accurate information about purchases, contracts, payroll, grants, program activity, and other transactions.

Banking

Choose financial institutions based on the organization's actual needs. Relevant considerations may include:

• Fees and interest rates
• Deposit insurance and management of balances that exceed insured limits
• Online banking and electronic payment capabilities
• Fraud-prevention and account-security tools
• ACH, wire, check, debit-card, and purchasing-card controls
• Positive-pay or similar fraud-prevention services
• Payroll and direct-deposit capabilities
• Lines of credit or other appropriate financing
• Customer service and accessibility
• The institution's community relationships and lending practices, when these are relevant to the organization's mission and values

Do not assume that opening several accounts at the same financial institution automatically increases deposit-insurance protection. Review current deposit-insurance rules and structure organizational accounts appropriately.

Authorization and internal controls

Clearly establish who has authority to approve budgets, authorize spending, sign contracts, initiate payments, approve payroll, transfer funds, and access banking systems.

Governing boards generally provide financial oversight and approve major policies and budgets, while staff leaders usually manage approved day-to-day operations within delegated authority. The exact arrangement should be documented and appropriate to the organization's size and governance structure.

Whenever feasible, separate important financial responsibilities. For example, the same person should not independently authorize a purchase, initiate payment, reconcile the bank account, and review the transaction without another level of oversight.

Organizations may establish transaction thresholds requiring additional approval for significant expenditures. Approval rules should apply to electronic transactions as well as checks.

Organizational debit cards, purchasing cards, banking credentials, and payment accounts should be limited to authorized users. Use individual credentials rather than shared passwords whenever possible, enable multi-factor authentication, document cardholders and limits, and review activity regularly.

Petty cash and low-dollar purchasing

Some organizations still use petty cash, while others rely on purchasing cards, reimbursements, digital payments, or other methods for small expenses.

Whatever system is used, establish limits, authorized users, documentation requirements, approval procedures, and reconciliation. Small transactions still need appropriate records.

Payroll

Payroll is often one of an organization's largest expenses and carries significant legal, tax, and administrative responsibilities.

Organizations should establish clear procedures for:

• Pay periods and payroll schedules
• Employee classifications and timekeeping
• Salaried and hourly compensation
• Overtime and other wage requirements where applicable
• Employee benefits and leave
• Payroll taxes and withholding
• Direct deposit and other payment methods
• Required payroll and year-end reporting
• Secure retention of payroll and personnel records

Definitions of full-time and part-time work and eligibility for particular benefits depend on applicable law, benefit plans, and organizational policy. Avoid relying on a single informal number of weekly hours for all purposes.

Organizations may manage payroll internally or use a payroll provider, accountant, professional employer organization, or other service. Even when payroll is outsourced, the organization remains responsible for providing accurate information, reviewing payroll, protecting employee data, and ensuring obligations are met.

Payables and receivables

Accounts payable are amounts the organization owes for goods or services already received or other obligations already incurred.

Accounts receivable are amounts owed to the organization, such as unpaid invoices, reimbursement claims, contract payments, or other earned revenue.

Establish procedures addressing:

• Who reviews and approves invoices
• Who initiates and authorizes payment
• How purchases are approved before commitments are made
• How invoices, receipts, purchase records, and contracts are retained
• When customers, partners, or funders are invoiced
• How grant or contract reimbursement requests are submitted
• How overdue receivables are monitored and followed up

Purchase orders or electronic purchasing workflows can provide useful documentation and approval controls, particularly for organizations with significant purchasing activity.

Grants and contracts management

Grants and contracts may include requirements concerning allowable costs, budgets, reporting, performance, procurement, documentation, cost sharing, indirect costs, payment schedules, and other conditions.

Do not assume that every grant provides money in advance or that every contract reimburses costs after they have been incurred. Payment structures vary substantially. Review the specific award or contract terms.

Track revenue and expenses for each significant grant or contract within the accounting system so the organization can demonstrate how resources were used and whether spending remains consistent with the approved budget and terms.

A separate bank account for every grant is usually unnecessary unless the award, law, banking arrangement, or other requirement specifically calls for one. Modern accounting systems can typically track grants, programs, departments, restrictions, and funding sources through separate classes, projects, funds, or account codes while using shared organizational bank accounts.

When changes to an approved grant or contract are needed, determine whether prior approval is required and obtain authorization in the form required by the funder before making changes that require approval.

What issues are involved in being tax-exempt?

Nonprofit status and tax-exempt status are related but are not the same thing. Nonprofit organizational status is generally created under state law. Federal tax exemption is governed by federal law, and most organizations seeking recognition of exemption must separately apply to the Internal Revenue Service unless an exception applies.

State and local tax treatment also varies. Federal recognition does not automatically mean an organization is exempt from every state or local income, sales, property, or other tax. Determine which exemptions, registrations, renewals, filings, and documentation requirements apply where your organization operates.

Organizations should pay attention to requirements such as:

• Applying for federal recognition of tax-exempt status when required
• Maintaining appropriate state nonprofit registrations and charitable-solicitation registrations
• Applying separately for available state or local tax exemptions where necessary
• Using appropriate exemption documentation for qualifying purchases
• Filing the appropriate Form 990-series annual return or notice when required
• Filing applicable state and local reports
• Maintaining payroll-tax compliance
• Reviewing whether unrelated business or other activities create additional tax obligations

Annual federal filing requirements vary by type and size of organization. Some organizations file Form 990, Form 990-EZ, or Form 990-PF, while certain smaller organizations may be eligible to file Form 990-N. Some organizations are excepted from particular filing requirements. Use current IRS guidance to determine which filing applies.

Do not assume that all nonprofits must undergo an annual independent financial-statement audit. Audit, review, compilation, and other financial-reporting requirements may arise from state law, federal awards, funder or lender requirements, contracts, governing documents, or board policy. Determine which requirements apply to your organization and obtain professional guidance when necessary.

How do you handle cash flow?

Cash flow is the timing of money entering and leaving the organization. An organization can have a balanced budget or substantial receivables and still be unable to meet payroll or other obligations if cash has not arrived when needed.

Causes of cash-flow problems

Common causes include:

• Delayed grant, contract, reimbursement, or government payments
• Slow invoicing or reimbursement requests
• Large expenses occurring before related revenue is received
• Seasonal fundraising patterns
• Uncollected accounts receivable
• Unexpected expenses
• Rapid organizational or program growth
• Restricted funding that cannot be used for current obligations
• A structural operating deficit rather than a temporary timing problem

Distinguishing a temporary cash-flow problem from an underlying financial deficit is important. Borrowing may help address a timing mismatch, but it does not solve a long-term shortage of revenue.

Ways to address cash-flow problems

• Prepare a rolling cash-flow forecast. Estimate expected cash receipts and payments by month or, when necessary, by week.
• Maintain an appropriate operating reserve. Reserves can help organizations manage revenue delays and unexpected expenses.
• Invoice and request reimbursement promptly. Know the documentation and approval requirements before payments are needed.
• Discuss payment timing with funders or contracting organizations. When permitted, explore advances, revised payment schedules, more frequent reimbursement, or other arrangements.
• Maintain communication with vendors and other creditors. If payment may be late, discuss the situation before the due date and obtain agreement about revised terms whenever possible.
• Establish access to responsible short-term financing before a crisis. A line of credit or other financing may be useful when repayment capacity is clear and borrowing is consistent with organizational policy.
• Monitor restricted and unrestricted cash separately. Cash may be in the bank but unavailable for a particular obligation because of donor or grant restrictions.

When cash is insufficient to pay every obligation on time, do not rely on an informal rule that one creditor can simply be delayed because it is more likely to tolerate late payment. Consider legal obligations, payroll and payroll taxes, contractual requirements, critical services, consequences for employees and vendors, and any negotiated payment arrangements. Seek professional guidance when the organization's ability to meet its obligations becomes uncertain.

Credit cards may provide payment flexibility, but they can also carry significant interest, fees, and risk. Review card terms, establish organizational controls, and avoid using revolving credit as a substitute for a sustainable cash-flow strategy.

What are some day-to-day financial management issues?

Once systems are established, financial management depends on consistent use. Reliable software does not help if transactions are not entered, accounts are not reconciled, approvals are bypassed, or reports are not reviewed.

Trusted professional relationships with vendors, funders, financial institutions, partners, and others can make communication and problem-solving easier. At the same time, purchasing and financial decisions should follow transparent organizational policies rather than depend solely on personal relationships.

Purchasing goods and services

Consider overall value rather than simply selecting the lowest price.

Relevant considerations include:

• Price and total cost of ownership
• Product or service quality
• Accessibility
• Reliability and customer support
• Data privacy and cybersecurity
• Maintenance and replacement costs
• Shipping and delivery
• Contract terms and cancellation provisions
• Vendor reputation and financial stability
• Applicable procurement requirements
• Mission-related considerations when they are appropriate and consistent with organizational policy

Organizations may also reduce costs through cooperative purchasing, shared services, group contracts, joint technology platforms, shared facilities, or other collaborations.

Online purchasing can simplify comparison shopping, but organizations should also consider vendor security, counterfeit or unsupported products, licensing, warranty terms, subscription renewal practices, and whether organizational purchasing policies are being followed.

Working with funders

Grant and contract terms should be followed carefully. When circumstances change, however, some funders permit budget revisions, extensions, revised payment schedules, scope adjustments, or other amendments.

Do not assume that a change will be approved. Review the award terms and communicate with the appropriate funder representative before making changes that require prior approval. Document significant approvals and amendments in writing.

Maintaining financial systems

Areas requiring ongoing attention include:

• Transaction entry and reconciliation. Enter financial activity promptly and reconcile bank, credit-card, investment, payroll, and other accounts on a regular schedule.
• Access controls and cybersecurity. Limit financial-system access to authorized users, use strong authentication, review permissions regularly, and protect sensitive financial and employee information.
• Backups and recovery. Maintain secure backups and test procedures for recovering critical accounting and financial records.
• Payables and receivables. Pay approved obligations, issue invoices, pursue reimbursements, and follow up on overdue receivables consistently.
• Payroll and payroll taxes. Maintain accurate payroll data and comply with applicable withholding, reporting, wage, benefit, unemployment, workers' compensation, and other requirements.
• Grant and contract compliance. Track expenditures, deliverables, reporting deadlines, modifications, and restrictions.
• Tax and financial-reporting requirements. Complete applicable federal, state, local, audit, review, and other reporting requirements according to their current deadlines.
• Document retention. Maintain invoices, receipts, approvals, contracts, payroll records, grant documentation, board records, and other financial documents according to organizational policy and applicable requirements.

Financial systems should be reviewed periodically to determine whether controls remain appropriate as the organization changes. Growth, new funding sources, staffing changes, new technology, remote work, and new payment methods can all create new risks or require different procedures.

What are some investment issues?

An organization with funds beyond its immediate operating and liquidity needs may consider holding some of those resources in interest-bearing deposit accounts or other investments.

Investment decisions should begin with the purpose of the funds. Operating cash, emergency reserves, board-designated reserves, restricted funds, endowments, and long-term capital funds may have very different time horizons and risk tolerances.

Consider factors such as:

• How soon the funds may be needed
• Liquidity
• Preservation of principal
• Investment risk and volatility
• Expected return
• Fees
• Donor or grant restrictions
• Deposit-insurance limits
• Applicable laws and fiduciary responsibilities
• The organization's board-approved reserve and investment policies

Checking accounts, savings accounts, money market deposit accounts, certificates of deposit, Treasury securities, and other relatively liquid instruments may be appropriate for funds that must remain accessible, depending on the organization's needs and policies.

Organizations with long-term reserves or endowments may use diversified investment portfolios when appropriate. Decisions about stocks, bonds, pooled investment funds, and other assets should reflect the organization's time horizon, risk tolerance, liquidity needs, restrictions, governance responsibilities, and professional investment advice rather than a general rule that one type of investment is appropriate or inappropriate for all nonprofits.

If organizational deposits approach or exceed applicable deposit-insurance limits at one institution, review how the accounts are structured and consider appropriate treasury-management strategies.

Capital investments

A capital investment involves committing significant organizational resources to an asset expected to provide value over an extended period. Examples might include a building, land, vehicles, major technology systems, or specialized equipment.

Before purchasing real estate or another major asset, consider:

• Purchase and financing costs
• Maintenance and repairs
• Insurance
• Accessibility and renovation needs
• Utilities and operating costs
• Property-tax treatment under applicable state and local law
• Liquidity and debt-service effects
• Whether ownership or leasing better fits the organization's mission and long-term plans
• Risks associated with future organizational growth, contraction, or relocation

Real estate may become an organizational asset and may sometimes produce rental income, but ownership also creates long-term costs and responsibilities. Analyze the full financial implications rather than assuming that purchasing property will automatically reduce costs.

In Summary

Effective financial management combines reliable systems, appropriate internal controls, timely information, and thoughtful decision-making. Organizations need ways to manage accounting, banking, purchasing, payroll, payables and receivables, grants and contracts, cash flow, financial reporting, and organizational resources.

These systems should be proportionate to the organization's size and complexity and should evolve as programs, staffing, technology, funding, and financial risks change. Organizational leaders and boards should understand the financial position of the organization even when accounting or financial tasks are delegated to specialists.

Strong financial management is not an end in itself. Its purpose is to protect organizational resources, strengthen accountability and sustainability, support staff and partners, and make it possible for the organization to carry out its commitments to the people and communities connected to its mission.

Tool: Spreadsheets

A spreadsheet is a way to display a budget or the finances of an organization in a way that makes it clear how much money can be and/or has been spent for each line item from each funding source. In its simplest terms, a spreadsheet is a grid with a list of funding sources along its top edge and a list of expense categories running down its left-hand edge, so that each vertical column represents a funding source , and each horizontal row represents an expense category. Where each column and row meet (this meeting place is called a cell), there should be a number representing the amount of money from that particular funding source (the column) that goes to that particular expense category (the row).

While you can make a spreadsheet either by hand or by computer, the advantage to a computer spreadsheet is that it allows you to put formulas in particular cells to total up a column or row, or to otherwise make sure that the number in that cell reflects a change elsewhere. In the spreadsheet below, for instance, each of the cells in the "Totals" row at the bottom automatically adds all the figures in its column, so that if you enter a new number in one of the cells in that column, the total at the bottom will change automatically. The same is true for the cells in the "Totals" column on the right, with the difference that those cells are set up to total their rows. In the "Fringe" row, each cell - except for the "Total" ones - is set to figure 25% of the total salaries in its column, because you already know that fringe benefits are 25% of salary.

Consolidated United Conglomerated Community Health Program

	United Way	Department of Health	County	Raffle	Totals
Coordinator Salary	2,000	22,000	5,000	1,000	30,000
Aide Salary	5,000	8,000	4,000	1,500	18,500
Fringe	1,750	7,500	2,250	625	12,125
Rent	750	5,500	2,000	125	8,375
Insurance	0	1,500	0	0	1,500
Office Supplies	500	1,200	275	0	1,975
Program Materials	0	1,300	475	0	1,775
Totals	10,000	47,000	14,000	14,000	74,250

Because the cells change their totals automatically when new figures are introduced , a computer spreadsheet makes it easy to test out different ways of spending money , and to see immediately how much you can afford to spend in particular categories.

Have you included the following systems in your management plan?

___Accounting

___Banking

___Money-handling

___Petty cash

___Payroll

___Payables and receivables

___Grants management

___Handling cash flow issues

Have you included the following decisions in your management plan?

___Computerizing your accounting

___Types of bank accounts

___What constitutes full-time employment

___Which bills and obligations to settle first

___Determining your elegibility for tax-exempt status

Have you determined a plan for handling cash flow?

___Anticipate when cash flow problems may occur

___Set your priorities beforehand

___Develop a cash flow contingency plan based on your priorities and the situation of your organization

Have you considered the following management and investment issues?

___Day-to-day money handling

___Shopping for goods and services

___Negotiating with funders

___Maintaining systems

___Investing in a Certificate of Deposit

___Investing in a Money Market Account

• What is accounting?

• How is nonprofit accounting different from accounting for for-profit organizations?

• What is an accounting system?

• When should you develop an accounting system for your organization?

• Why should you do accounting for your organization?

• How do you do accounting for nonprofit groups?

Community organizations often devote substantial attention to securing the financial resources needed to carry out their work. An equally important question is how to manage, document, protect, and understand the resources the organization already has.

Reliable accounting and financial-reporting practices are essential to organizational sustainability. They help organizations understand their financial position, meet legal and funder requirements, protect resources, maintain appropriate internal controls, and make informed decisions about programs, staffing, partnerships, and future commitments.

In this section, we'll provide an overview of accounting and its role in community organizations. We'll also discuss accounting systems, financial reporting, audits and other forms of external financial review, professional accounting support, accounting technology, and the basic processes organizations use to maintain reliable financial information.

This section is intended to provide a general foundation for understanding nonprofit accounting. It is not a substitute for professional accounting, audit, tax, or legal advice. Requirements vary according to an organization's legal structure, size, funding sources, activities, location, and other circumstances. Work with qualified professionals when specialized guidance is needed.

What is accounting?

Accounting is a system for recording, classifying, summarizing, analyzing, and reporting financial information about an organization. Accounting helps leaders understand where resources come from, how they are used, what the organization owns and owes, what restrictions apply to particular resources, and how the organization's financial position changes over time.

Accounting is related to, but broader than, bookkeeping. Bookkeeping generally refers to recording financial transactions and maintaining supporting records. Accounting includes those records but also includes activities such as financial reporting, reconciliations, analysis, budgeting support, grant and fund tracking, internal controls, and interpretation of financial information.

An accountant or other qualified financial professional may help an organization design its accounting system, prepare financial statements, interpret financial information, meet tax and reporting requirements, establish internal controls, and address complex accounting issues.

Accounting standards

Organizations should determine which accounting and financial-reporting standards apply to them. In the United States, the Financial Accounting Standards Board (FASB) establishes generally accepted accounting principles for nongovernmental entities, including nongovernmental nonprofit organizations. Accounting guidance specifically relevant to nonprofit entities is included in the FASB Accounting Standards Codification, including Topic 958, Not-for-Profit Entities.

The Governmental Accounting Standards Board (GASB) establishes accounting and financial-reporting standards for state and local governmental entities. Receiving government funding by itself does not necessarily make a nongovernmental nonprofit organization subject to GASB accounting standards.

Organizations may also have accounting and reporting requirements established by government awards, contracts, lenders, foundations, state regulators, accrediting organizations, or other entities. A qualified accountant can help determine which standards and requirements apply.

Special topic in accounting: What is an audit?

An audit is an independent examination of financial statements and related information performed under applicable professional auditing standards. The purpose of a financial statement audit is to allow an independent auditor to express an opinion about whether the financial statements are presented fairly, in all material respects, in accordance with the applicable financial-reporting framework.

Audited nonprofit financial statements commonly include:

• A statement of financial position
• A statement of activities
• A statement of cash flows
• Information about expenses by their nature and function, presented in the financial statements or notes as applicable
• Notes explaining significant accounting policies, restrictions, commitments, contingencies, investments, leases, contributions, grants, and other relevant matters
• The independent auditor's report

Depending on the engagement and the organization's funding, an audit may also involve consideration of internal controls or compliance with particular laws, regulations, grants, contracts, or federal award requirements.

Not every nonprofit organization is required to obtain an annual financial-statement audit. Requirements may arise from state law, federal awards, grant or contract terms, lender requirements, organizational bylaws, board policy, or other circumstances.

Organizations that expend federal awards above the threshold established under the federal Uniform Guidance may be required to obtain a Single Audit or, when permitted, a program-specific audit. Because federal thresholds and requirements can change, organizations receiving substantial federal awards should review the current Uniform Guidance and obtain appropriate professional advice.

Tax-exempt organizations may also have federal and state filing requirements that are separate from audit requirements. Depending on the organization, federal reporting may include Form 990, Form 990-EZ, Form 990-N, Form 990-PF, and applicable schedules. Schedule A, for example, applies to organizations required to provide information about public charity status and public support; it is not simply a universal attachment for every tax-exempt organization.

An organization may choose to obtain an audit even when one is not legally required.

Reasons may include:

• A funder, lender, partner, or governing board requests audited financial statements
• The organization has grown significantly or its financial transactions have become more complex
• The board wants additional independent assurance regarding the organization's financial statements
• The organization wants to strengthen financial reporting and internal controls
• Significant financial concerns or irregularities have occurred and independent review is appropriate

Other CPA services may include a review or a compilation. These provide different levels of service and assurance from an audit. A review provides limited assurance based primarily on inquiry and analytical procedures. A compilation involves presenting financial information supplied by management in financial-statement form and does not provide assurance on the financial statements.

Work with a qualified CPA or other appropriate professional to determine which service fits your organization's legal requirements, funding requirements, governance needs, and resources.

How is nonprofit accounting different from accounting for for-profit organizations?

Many accounting principles apply to both nonprofit and for-profit organizations. Both need reliable transaction records, internal controls, financial statements, cash-flow management, appropriate tax reporting, and accurate information for decision-making.

Nonprofit accounting, however, also reflects the organization's mission, donor restrictions, grants, contributions, and accountability for resources that may be limited to particular purposes.

Financial challenges should be addressed through responsible planning rather than assuming that staff members will work without pay, defer compensation, or absorb unsustainable workloads to keep an organization operating. Organizations facing financial stress may need to examine revenue, expenses, reserves, staffing, program scope, financing, partnerships, and other options while considering legal obligations and effects on staff and community commitments.

Some areas especially important in nonprofit accounting include:

• Accounting for contributions and grants. Nonprofits may receive contributions, grants, donated assets, and other forms of support that require specialized accounting. Current FASB guidance for nonprofit entities addresses issues such as donor restrictions and whether contributions are conditional or unconditional.
• Donor restrictions. Financial statements for nongovernmental nonprofit organizations generally distinguish between net assets with donor restrictions and net assets without donor restrictions.
• Grant and contract accounting. Organizations may need to distinguish among contributions, exchange transactions, government contracts, and other arrangements and track the requirements associated with each.
• Contributed nonfinancial assets and services. Certain donated goods, professional services, facilities, and other nonfinancial contributions may require accounting or disclosure under applicable standards.
• Capital assets and depreciation. Buildings, vehicles, technology, equipment, and other long-lived assets may be capitalized and depreciated over their estimated useful lives according to applicable accounting policies and standards.
• Functional expense reporting. Nonprofit organizations may need to report expenses both by their nature - such as salaries, rent, supplies, and professional services - and by function, such as program services, management and general activities, and fundraising.

Cash-basis and accrual-basis accounting

Organizations may encounter several accounting methods.

Cash-basis accounting generally records revenue when cash is received and expenses when cash is paid.

Accrual-basis accounting generally recognizes revenue when it is earned or otherwise recognizable under applicable accounting guidance and records expenses when obligations are incurred, regardless of when cash is received or paid.

Some smaller organizations may maintain internal records using a cash or modified-cash approach. Financial statements intended to comply with generally accepted accounting principles, however, need to follow the applicable GAAP requirements. Organizations should select accounting methods with guidance from a qualified accountant and based on their reporting, tax, funder, and management needs.

Regardless of accounting method, organizations must also monitor actual cash. An organization can appear financially healthy on an accrual basis while still experiencing a shortage of cash available to meet immediate obligations.

What is an accounting system?

An accounting system includes the records, technology, policies, controls, processes, and people used to capture financial transactions and produce reliable financial information.

The goals of the accounting system are to ensure that transactions are authorized, documented, recorded accurately, classified appropriately, protected from loss or misuse, reconciled, and reported in a timely way.

Components of an accounting system

• Chart of accounts. The chart of accounts is the organized list of accounts used to classify financial activity.
  • Common categories include assets, liabilities, net assets, revenue and support, and expenses.
  • An organization may also use dimensions such as program, department, grant, funding source, location, restriction, or project so that financial information can be analyzed in several ways.
• General ledger. The general ledger contains the organization's financial transactions organized by account and forms the foundation for financial reporting. Modern accounting systems generally update ledger information automatically as approved transactions are entered.
• Subledgers and transaction records. Organizations may maintain detailed records for accounts payable, accounts receivable, payroll, fixed assets, grants, contributions, purchasing, credit cards, and other areas. These records should reconcile with the general ledger.
• Bank and payment records. Bank statements, electronic payments, checks, credit-card transactions, deposits, and other cash activity should be recorded and reconciled regularly.
• Supporting documentation. Invoices, receipts, contracts, grant agreements, donor documentation, timesheets, payroll information, approvals, reimbursement records, and other evidence should be retained according to organizational policy and applicable requirements.
• Accounting policies and procedures. Written procedures explain how financial responsibilities are handled, including purchasing, payments, deposits, payroll, reimbursements, grants, restricted funds, journal entries, reconciliations, financial reporting, record retention, cybersecurity, and approval authority.
• Internal controls. Controls help reduce errors, misuse, fraud, and unauthorized transactions. Examples include separation of duties, approval thresholds, bank reconciliations, restricted system permissions, documentation requirements, multi-factor authentication, and review by people independent of the original transaction when feasible.

Small organizations may use simpler systems than large organizations, but simplicity should not mean incomplete records or lack of oversight. Even a small organization should know how much money it has, where resources came from, what restrictions apply, what it owes, what others owe it, and whether transactions are properly documented and authorized.

When should you develop an accounting system for your organization?

Develop basic financial controls and accounting records as soon as your organization begins receiving, spending, or managing money.

The system can grow with the organization. A small volunteer-led group may begin with a relatively simple accounting platform and a limited chart of accounts. As the organization adds employees, grants, contracts, programs, restricted contributions, credit cards, property, or other financial complexity, the accounting system should evolve accordingly.

It is usually easier to establish appropriate procedures early than to reconstruct financial records later.

Periodically reassess whether the accounting system still meets the organization's needs. Growth, remote work, new funding requirements, new programs, increased transaction volume, cybersecurity risks, staffing changes, or expansion into new locations may require different technology, controls, or expertise.

Why should you do accounting for your organization?

Reliable accounting can help your organization:

• Meet applicable legal, tax, accounting, grant, contract, and regulatory requirements
• Provide staff, board members, funders, donors, partners, and other appropriate stakeholders with useful financial information
• Understand the organization's financial position and operating results
• Track restricted and unrestricted resources appropriately
• Monitor programs, grants, contracts, and departments
• Prepare realistic budgets and forecasts
• Manage cash flow and avoid committing resources the organization does not have
• Identify financial risks and unusual transactions
• Strengthen internal controls and accountability
• Support strategic and operational decision-making
• Demonstrate responsible stewardship of organizational resources

How do you do accounting for nonprofit groups?

For purposes of this section, three areas deserve particular attention:

• Obtaining appropriate accounting expertise
• Choosing and maintaining an accounting system
• Carrying out and reviewing the accounting process

Obtaining accounting expertise

Decide who will handle routine bookkeeping, higher-level accounting, financial reporting, tax filings, and other financial responsibilities. These responsibilities may be divided among employees, contractors, accounting firms, volunteers, board members, or shared-service providers depending on the organization's size and resources.

A very small organization may be able to handle routine bookkeeping internally with periodic professional review. Organizations with payroll, significant grants or contracts, complex restrictions, substantial assets, or external financial-reporting requirements will often need greater professional accounting expertise.

Look for professionals who understand nonprofit accounting and the types of funding your organization receives. Experience with grants, restricted contributions, federal awards, indirect costs, functional expenses, payroll, Form 990 reporting, and nonprofit governance may be particularly important.

Pro bono or volunteer professional assistance can be valuable, particularly for technical advice, board service, training, or short-term projects. However, organizations should not assume that essential ongoing accounting work will or should be provided free of charge. Include adequate financial-management capacity in organizational budgets whenever possible.

When looking for accounting support, consider:

• Professional qualifications and licensing where relevant
• Experience with nonprofit organizations
• Experience with your organization's funding sources
• Knowledge of current accounting and tax requirements
• Availability and responsiveness
• Cost and scope of services
• Ability to explain financial information clearly to non-accountants
• Independence requirements if the professional will provide audit or other assurance services

Choosing accounting software

Most organizations use digital accounting systems, whether locally installed or cloud-based. Accounting technology can improve efficiency, accuracy, reporting, collaboration, and recordkeeping, but software cannot compensate for weak financial procedures or inaccurate information.

Begin by identifying the functions your organization actually needs.

Questions to consider include:

• Can the system track programs, grants, contracts, departments, projects, and donor restrictions at the level we need?
• Can it produce the financial statements and management reports required by leadership, the board, funders, auditors, and regulators?
• Does it integrate appropriately with payroll, fundraising, banking, expense-management, accounts-payable, budgeting, and other systems?
• Does it provide user roles, approval workflows, audit trails, and separation-of-duties controls?
• Does it support multi-factor authentication and other appropriate security controls?
• How are backups, disaster recovery, encryption, and data privacy handled?
• Can access be limited appropriately for staff, board members, accountants, contractors, and auditors?
• Can data be exported in usable formats if the organization changes systems?
• Does the system scale with expected organizational growth?
• Is the interface accessible and reasonably easy for staff to use?
• What are the implementation, subscription, training, integration, support, and migration costs?
• What customer support and training are available?

Some nonprofit-specific accounting systems provide specialized grant, fund, restriction, and nonprofit-reporting features. Other organizations may successfully use broader accounting platforms configured to track nonprofit activities appropriately. Discuss your requirements with an accountant and with people who will actually use the system.

Before selecting a system, consider requesting a demonstration or trial and testing typical tasks such as recording restricted revenue, entering expenses, allocating costs, reconciling bank accounts, generating grant reports, preparing financial statements, and correcting transactions.

Carrying out the accounting process

The exact workflow depends on the organization and its accounting system, but the process generally includes:

• Conducting and authorizing financial transactions
• Collecting appropriate supporting documentation
• Determining how transactions should be classified
• Recording transactions in the accounting system
• Posting activity to the general ledger and appropriate program, grant, fund, or project records
• Reconciling bank accounts, credit cards, receivables, payables, payroll, and other accounts
• Reviewing transactions and making properly documented adjusting entries when necessary
• Closing accounting periods on a regular schedule
• Preparing financial statements and management reports
• Comparing actual results with budgets and forecasts
• Reviewing reports with organizational leadership and the governing board
• Maintaining appropriate records for taxes, grants, contracts, audits, and other reporting requirements

Good accounting also requires regular review. Bank accounts should be reconciled promptly, unusual transactions should be investigated, restricted resources should be monitored, and financial reports should be reviewed by people who understand both the numbers and the organization's activities.

The board should receive understandable financial information often enough to perform meaningful oversight. Program staff should receive financial information relevant to the programs and grants they manage. Financial staff, in turn, need accurate and timely program information so accounting records reflect what actually occurred.

In Summary

Accounting provides the financial information an organization needs to manage resources responsibly, comply with requirements, monitor its financial position, and make informed decisions. It includes more than recording transactions: accounting also involves classification, reconciliation, financial reporting, analysis, internal controls, grant and restriction tracking, and communication among financial staff, organizational leaders, program staff, and the governing board.

The complexity of an accounting system should reflect the complexity of the organization. Even a small community group should maintain reliable records and basic controls, while organizations with employees, grants, contracts, restricted funds, multiple programs, or substantial assets may need more sophisticated systems and professional expertise.

Accounting standards, tax rules, audit requirements, software, and financial practices change over time. Review your systems periodically, use current authoritative guidance, obtain qualified professional assistance when needed, and make sure financial procedures continue to support the organization's mission and accountability to the people and communities connected to its work.

Tool: Glossary of accounting terms

Essential Accounting Terms for Not-for-Profit Organizations

• A-133 audit - an audit required for not-for-profits that receive $25,000 or more in federal funding during a fiscal year.
• Accounting - a system for providing financial information about a business or other type of organization.
• Accounting procedures manual - a record of the policies and procedures for handling financial transactions.
• Accounting system - accounting records (checkbooks, journals, ledgers, spreadsheets , etc.) and processes and procedures assigned to staff, volunteers, and/or outside professionals.
• Accrual-basis accounting - accounting procedure that reports income when it is earned and expenses when they are incurred.
• Asset - something with economic value owned by an organization.
• Auditing - the testing of an organization's accounts for accuracy and completeness by people who had no part in their preparation.
• Bookkeeping - the practice of recording business accounts and transactions.
• Cash-basis accounting - accounting procedure that records revenue when the cash is received, and records expenses when they are paid.
• Cash disbursement journal - a chronological record of checks that are written, categorized using the chart of accounts.
• Cash receipts journal - a chronological record of all deposits that are made, categorized using the chart of accounts.
• Chart of accounts - a list of each item that the accounting system tracks.
• Compilation - a report prepared by an accountant organizing financial data supplied by the organization into standard financial reporting formats; does not include a review of the numbers for accuracy or analysis.
• Depreciation schedule - a schedule of the decline in value of certain items the group owns.
• Financial Accounting Standards Board (FASB) - The professional quasi-regulatory organization with primary responsibility for determination of financial reporting standards in the United States. The Securities and Exchange Commission has the power to override FASB standards.
• Fund accounting - a ledger, fund, department and project-tracking system for not -for-profit organizations. Fund accounting includes batch posting for all transactions , with safeguards that prevent the user from quitting posting unless debits and credits balance. Posts to previous, current, or future periods in the current fiscal year . Tracks funds from sources/donors, and maintains budgets and balances for both departments and departmental projects. Produces fund statements, revenue expense statements , budgets, and fund and project listings.
• General journal - a record of all transactions that do not pass through the checkbook , including non-cash transactions (such as depreciation) and corrections to previous journal entries.
• General ledger - a book of final entry summarizing all of a company's financial transactions.
• Generally accepted accounting principles (GAAP) - established accounting rules in the United States administered by the Financial Accounting Standards Board (FASB ) and Governmental Accounting Standards Board. They are largely delineated by Statements of Financial Accounting Standards.
• Governmental Accounting Standards Board (GASB) - organized by the Financial Accounting Foundation, GASB establishes standards of financial accounting and reporting for state and local governmental entities.
• Journals (books of original entry) - used to systematically record all accounting transactions before they are entered into the general ledger.
• Liability - a financial debt or potential loss.
• New assets/worth - the assets of an organization minus its liabilities.
• Opinion - the view of an independent Certified Public Accountant on how fairly the agency's financial statements represent its financial position and whether they comply with generally accepted accounting principles. An opinion is issued on completion of an audit.
• Revenue/sales - total amount generated or collected from goods and services an organization provides.
• Review - similar to an audit but more limited; a review conducts some analysis but does not undertake the extensive testing required for an audit.

___You know accounting is a system for providing financial information about an organization

___You understand the differences between accounting and bookkeeping

___You can name the components of an audit

___You can list major differences between for-profit and not-for-profit accounting

___You know the components of an accounting system

___You understand when and why you should develop an accounting system

___You have a plan for finding an accountant, choosing software, and beginning your accounting process

• What does it mean to be nonprofit and tax-exempt?

• What are the advantages of nonprofit and tax-exempt status?

• What are the disadvantages of nonprofit and tax-exempt status?

• When should you consider applying for nonprofit and tax-exempt status?

• When might you decide not to apply yet?

• How do you establish a nonprofit organization?

• How do you apply for federal tax-exempt status?

• A last word on getting help

Community organizations operate within legal and regulatory systems. As an organization develops, it may need to decide what legal structure best supports its mission, how responsibilities and liabilities will be managed, whether federal tax-exempt recognition is appropriate, and what ongoing governance, tax, reporting, and fundraising requirements will apply.

Common questions include:

• What legal structures are available, and which one fits our organization?
• What does it mean to operate as a nonprofit organization?
• Can a nonprofit organization generate revenue or end the year with a financial surplus?
• Is nonprofit status the same as tax-exempt status?
• Should we seek federal recognition under section 501(c)(3) or another section of the Internal Revenue Code?
• What federal, state, and local tax requirements will still apply?
• Would forming a separate organization make sense, or could fiscal sponsorship or another arrangement better support the work?

This section provides a general overview of nonprofit organizational status and federal tax-exempt recognition in the United States. It discusses some advantages and responsibilities of establishing a separate nonprofit organization, factors to consider when deciding whether to apply, and the basic steps involved.

Laws, tax rules, filing requirements, and fees change over time and vary by jurisdiction and type of organization. This section does not substitute for legal, tax, or accounting advice. Use current information from the IRS and appropriate state and local agencies, and consult qualified professionals when necessary.

What does it mean to be nonprofit and tax-exempt?

Are nonprofit and tax-exempt statuses the same?

No. They are related, but they refer to different legal concepts.

An organization is generally formed under the law of a state, tribal government, or other applicable jurisdiction. Federal tax-exempt recognition is governed by the Internal Revenue Code and administered by the Internal Revenue Service.

Creating a nonprofit organization under state law does not automatically make the organization exempt from federal income tax, and federal tax-exempt recognition does not automatically provide exemption from every state or local tax.

Nonprofit organizational status

A nonprofit organization exists to pursue a purpose rather than to distribute profits to owners or shareholders. A nonprofit may charge fees, sell products and services, receive investment income, and generate more revenue than expenses in a particular year.

What distinguishes a nonprofit is not that it must avoid generating a financial surplus. Rather, its net earnings and assets generally must be used in ways consistent with its organizational purposes and applicable law instead of being distributed for the private benefit of owners.

Organizations may take several legal forms. Depending on applicable state law and federal tax requirements, these may include:

• Nonprofit corporations
• Unincorporated associations
• Trusts
• In some circumstances, limited liability companies structured to satisfy applicable tax-exemption requirements

The best form depends on the organization's activities, governance, liability concerns, funding plans, tax classification, and applicable state law.

Incorporation

Incorporation is a common choice for community organizations that expect to operate over time, enter contracts, employ staff, receive significant funding, own property, or take responsibility for substantial programs.

State law generally governs how a nonprofit corporation is created and operated. Requirements commonly include filing articles of incorporation or another organizing document and establishing appropriate governance procedures, such as bylaws, directors, and officers.

Incorporation may provide some separation between the organization's legal obligations and the personal assets of directors, officers, members, or other individuals. However, incorporation does not eliminate every possibility of personal liability.

Individuals may still face personal responsibility in circumstances involving their own wrongful conduct, certain employment or tax obligations, breaches of fiduciary duty, guarantees, or other matters governed by applicable law. Appropriate insurance, including directors and officers liability coverage when needed, may provide additional protection.

Unincorporated associations and trusts

An unincorporated association may provide a formal structure without creating a nonprofit corporation. State law determines how such organizations are created and what legal protections and obligations apply.

A trust may also qualify for federal tax-exempt recognition when properly organized and operated, although a trust structure may be more appropriate for some purposes than others.

Organizations should obtain legal advice when choosing among these structures because questions of governance, ownership of property, contracting authority, liability, dissolution, and tax treatment can differ substantially.

Informal community groups

Not every community effort needs to create a separate legal organization. Neighborhood groups, coalitions, mutual-aid efforts, advocacy campaigns, and other initiatives may sometimes operate effectively without incorporating.

However, an informal group may eventually need a more formal structure if it wants to employ staff, enter contracts, own significant assets, receive particular grants, manage substantial funds, or obtain federal tax-exempt recognition.

Federal tax-exempt status

The Internal Revenue Code includes several classifications of tax-exempt organizations. One of the most common for charitable community organizations is section 501(c)(3).

Organizations recognized under section 501(c)(3) must be organized and operated for qualifying exempt purposes, such as charitable, educational, religious, scientific, or other purposes recognized by federal law.

Recognition under section 501(c)(3) generally exempts qualifying income from federal income tax, although some activities may still create tax obligations. Organizations may also be subject to employment taxes, unrelated business income tax, excise taxes, and other federal, state, or local taxes depending on their activities.

Contributions to qualifying 501(c)(3) organizations generally may be deductible as charitable contributions by donors, subject to applicable federal tax rules.

Advocacy, lobbying, and political campaign activity

Advocacy and lobbying are not the same as political campaign intervention.

A 501(c)(3) organization may engage in some lobbying related to legislation. However, lobbying cannot exceed the limits applicable to the organization. Eligible public charities may also choose to measure lobbying expenditures under the section 501(h) expenditure test.

A 501(c)(3) organization is prohibited from participating or intervening in a political campaign on behalf of, or in opposition to, a candidate for elective public office.

Nonpartisan voter education, public policy education, voter registration, candidate forums, and related civic-engagement activities may be permitted when conducted in accordance with applicable rules.

Other tax-exempt classifications have different rules. For example, a qualifying 501(c)(4) social-welfare organization may engage substantially in lobbying that furthers its exempt purposes and may engage in some political campaign activity, but campaign activity cannot become its primary activity. Contributions to most 501(c)(4) organizations generally are not deductible as charitable contributions.

Organizations expecting substantial lobbying, electoral, or other advocacy activity should obtain legal or tax guidance before deciding which organizational and tax structure best fits their work.

Applying for federal recognition

Most organizations seeking recognition under section 501(c)(3) apply using Form 1023 or, when eligible, the streamlined Form 1023-EZ.

Organizations seeking recognition under section 501(c)(4) use Form 1024-A. Many organizations seeking recognition under other sections of 501(c) use Form 1024.

These exemption applications are submitted electronically through Pay.gov, and current user fees apply.

When the IRS approves an application, it issues a determination letter describing the organization's recognized tax-exempt status and other relevant information.

Organizations that may not be required to file Form 1023

Some organizations that otherwise satisfy section 501(c)(3) requirements are excepted from the requirement to file Form 1023 or Form 1023-EZ for recognition of exemption.

Examples include:

• Churches, certain church-related organizations, and conventions or associations of churches
• Certain organizations, other than private foundations, whose gross receipts are normally not more than the amount established by federal law
• Qualifying subordinate organizations covered under an appropriate group exemption arrangement

Some organizations that are not required to apply may choose to do so in order to obtain an IRS determination letter and appear in IRS records of recognized tax-exempt organizations.

Fiscal sponsorship

Creating a new tax-exempt organization is not always necessary. A project may instead operate under a formal fiscal sponsorship arrangement with an existing nonprofit organization whose mission is compatible with the proposed work.

Under fiscal sponsorship, the sponsor generally assumes defined legal and financial responsibility for charitable funds and activities associated with the sponsored project. Contributions intended for the project are generally made to the fiscal sponsor, which must maintain appropriate control and oversight of the charitable funds.

Fiscal sponsorship arrangements vary considerably. A written agreement should clarify responsibilities such as:

• Financial oversight and accounting
• Ownership and control of funds
• Grant and donor administration
• Employment or contractor relationships
• Insurance and risk management
• Intellectual property
• Administrative fees
• Decision-making authority
• Reporting requirements
• Procedures for ending or changing the sponsorship relationship

Fiscal sponsorship can be useful for new, temporary, experimental, or relatively small projects and for groups that want to focus on the work rather than immediately creating a separate organization. It also carries responsibilities and tradeoffs, so both the project and sponsor should understand the arrangement clearly.

State and local tax exemptions

Federal tax-exempt recognition does not automatically provide exemption from all state and local taxes.

Depending on the jurisdiction and the organization's activities, separate exemptions or registrations may be required for state income or franchise tax, sales and use tax, property tax, charitable solicitation, and other matters.

Requirements vary significantly. Consult the appropriate state revenue, taxation, charity-registration, property-tax, and corporate-filing authorities rather than assuming that one state office handles every issue.

What are the advantages of nonprofit and tax-exempt status?

The advantages depend on the organization's structure, activities, and tax classification.

Possible advantages of forming a nonprofit corporation include:

• Establishing a separate legal entity that can enter contracts, employ staff, receive funding, and hold assets
• Providing continuity beyond the participation of particular founders or members
• Establishing formal governance and accountability structures
• Limiting personal liability in many circumstances, subject to applicable law
• Making it easier to establish banking, insurance, contracting, and other organizational relationships
• Creating an eligible organizational structure from which federal tax-exempt recognition may be pursued

Possible advantages of 501(c)(3) recognition include:

• Federal income-tax exemption for qualifying activities and income
• Eligibility to receive tax-deductible charitable contributions, subject to applicable law
• Eligibility for grants and other funding opportunities that require or prefer recognized charitable status
• Greater ability to receive and manage charitable funds directly rather than through a fiscal sponsor
• Eligibility for certain state, local, postal, or other benefits when applicable
• An established legal and governance structure that may strengthen continuity and accountability

These advantages should not be overstated. Not every grant requires 501(c)(3) status, and governmental entities, tribal entities, fiscally sponsored projects, schools, or other eligible organizations may also qualify for particular funding opportunities.

What are the disadvantages of nonprofit and tax-exempt status?

Creating and maintaining a nonprofit and tax-exempt organization also involves responsibilities and costs.

• Ongoing governance and compliance. Organizations may need to maintain a governing board, follow bylaws and state corporate requirements, keep appropriate records, make required disclosures, and file federal, state, and local reports.
• Startup and continuing costs. Incorporation, federal exemption applications, professional assistance, registrations, insurance, accounting, annual reports, fundraising compliance, and other responsibilities may involve fees and staff time.
• Federal annual filing requirements. Many tax-exempt organizations must file an applicable Form 990-series return or notice. Requirements vary according to classification, size, and other circumstances.
• Restrictions on private benefit. Organizational earnings and assets cannot be operated for the improper benefit of insiders or other private interests.
• Rules governing lobbying and political activity. A 501(c)(3) may conduct limited lobbying but may not intervene in candidate campaigns.
• Possible tax on unrelated business activity. Tax-exempt organizations may owe federal income tax on certain income from regularly carried-on businesses that are not substantially related to their exempt purposes, subject to exclusions and exceptions.
• Public disclosure. Certain exemption applications and annual federal information returns are generally available to the public.
• Less flexibility than an informal project. Creating a separate organization can add governance, administrative, financial, and legal obligations that may not be necessary for a small or short-term initiative.

When should you consider applying for nonprofit and tax-exempt status?

Establishing a separate nonprofit organization may make sense when the structure supports the work better than available alternatives.

Consider factors such as:

• The organization has a clear charitable or community-focused mission and expects to operate for the foreseeable future
• A separate legal entity would help the organization employ staff, enter contracts, own assets, obtain insurance, or manage substantial funds
• The organization expects to seek grants or charitable contributions for which recognized tax-exempt status would be useful or required
• There is a committed governing body capable of fulfilling legal, financial, and fiduciary responsibilities
• The organization has or can develop the administrative capacity necessary for accounting, tax filings, governance, fundraising compliance, insurance, and other ongoing requirements
• A separate organization fills a meaningful need rather than unnecessarily duplicating the work of an existing organization
• Available fiscal sponsorship, partnership, or coalition arrangements would not meet the project's long-term needs as effectively

An organization does not need to establish a long record of accomplishments before considering incorporation. What matters more is whether creating a separate legal entity is appropriate to the mission, planned activities, governance, resources, risks, and expected duration of the work.

When might you decide not to apply yet?

Forming a separate nonprofit organization may not be the best option when:

• The project is temporary, experimental, or its long-term future is uncertain
• The work can be carried out effectively without creating another legal entity
• An existing organization could appropriately house the program or initiative
• A qualified fiscal sponsor can provide the necessary financial and administrative infrastructure
• The group does not yet have people willing and able to carry out governance and compliance responsibilities
• Available resources would be better directed toward the work itself rather than maintaining a separate entity
• A coalition, partnership, association, or other structure better fits the purpose

Consider both the advantages of independence and the costs of creating another organization. In some communities, strengthening an existing organization or sharing infrastructure may be more effective than creating a new nonprofit.

Timing of a 501(c)(3) application

Timing can affect the effective date of federal exemption.

In general, when an organization files a qualifying Form 1023 or Form 1023-EZ within the period established by IRS rules after legal formation and the application is approved, recognition may be effective from the organization's formation date. Filing later may result in a later effective date unless the organization qualifies for relief under applicable rules.

Because these timing rules have technical requirements, consult the current Form 1023 or Form 1023-EZ instructions rather than relying on an older summary.

How do you establish a nonprofit organization?

Procedures vary by state and organizational form. A general process may include:

• Clarify the organization's mission, activities, governance needs, and long-term plans
• Determine whether forming a separate legal entity is preferable to fiscal sponsorship, partnership, or another arrangement
• Obtain legal and tax advice when appropriate
• Select an organizational form permitted under applicable law
• Choose the jurisdiction in which the organization should be formed based on where it operates and its actual legal and organizational circumstances
• Select and check the availability of the organization's legal name
• Prepare and file the required organizing documents
• Include provisions needed for the intended federal tax classification, such as appropriate charitable-purpose and dissolution provisions when seeking 501(c)(3) recognition
• Adopt bylaws or other governance policies
• Appoint or elect the governing board and officers as required
• Obtain an Employer Identification Number when needed
• Establish banking, accounting, insurance, recordkeeping, and internal-control systems
• Understand ongoing corporate, charitable-solicitation, employment, tax, and reporting requirements

State filing agencies and requirements differ, so use current information from the jurisdiction in which the organization will be formed.

How do you apply for federal tax-exempt status?

The application depends on the section of the Internal Revenue Code under which the organization is seeking recognition.

For many charitable organizations seeking 501(c)(3) recognition:

• Confirm that the organization's legal form and organizing documents satisfy applicable requirements
• Obtain an Employer Identification Number if needed
• Determine whether the organization is required to apply or qualifies for an exception from the application requirement
• Determine whether the organization is eligible to use Form 1023-EZ or must use Form 1023
• Prepare required information about the organization's purposes, activities, governance, finances, compensation, fundraising, and other matters
• Submit the application electronically through Pay.gov
• Pay the current IRS user fee
• Respond promptly if the IRS requests additional information
• Retain the determination letter and application records
• Understand ongoing federal, state, and local compliance requirements

Organizations seeking other classifications should use the current IRS guidance for the appropriate application. For example, Form 1024-A applies to organizations seeking recognition under section 501(c)(4), while Form 1024 applies to many other organizations seeking recognition under section 501(a).

Receiving recognition is not the end of compliance. Tax-exempt organizations must continue to operate consistently with the requirements of their exemption and meet applicable filing, disclosure, governance, employment, fundraising, and tax obligations.

A last word on getting help

Nonprofit formation and tax-exemption questions can involve corporate law, federal tax law, state charitable-solicitation requirements, employment law, accounting, governance, insurance, intellectual property, and other areas. Professional help can therefore be valuable.

Possible sources of assistance include:

• Attorneys and accountants with nonprofit experience
• Nonprofit legal clinics and law-school clinics
• State and local bar-association referral or pro bono programs
• Community foundations and nonprofit-support organizations
• Professional associations for accountants and attorneys
• Fiscal sponsors and nonprofit capacity-building organizations
• Qualified professionals willing to provide reduced-fee or pro bono assistance

When choosing professional help, look for experience relevant to nonprofit organizations and to the specific legal or tax issues involved. Free assistance can be valuable, but affordability should not be the only consideration; inaccurate legal or tax advice can create substantial problems later.

In Summary

Nonprofit organizational status and federal tax-exempt recognition are related but distinct. State or other applicable law generally governs formation of the legal organization, while federal tax exemption is governed by the Internal Revenue Code and administered by the IRS.

Creating a separate nonprofit and seeking tax-exempt recognition can provide important benefits, including continuity, the ability to manage charitable resources directly, eligibility for certain grants, and the ability of qualifying organizations to receive tax-deductible charitable contributions. These benefits come with ongoing responsibilities involving governance, accounting, reporting, public disclosure, fundraising, employment, and compliance.

A separate nonprofit organization is not always necessary. Fiscal sponsorship, partnerships, coalitions, or operation within an existing organization may sometimes support community work more effectively and with less administrative burden.

Before choosing a structure, consider the organization's mission, activities, expected duration, governance capacity, funding strategy, advocacy plans, liability risks, community relationships, and administrative resources. Use current federal and state guidance and obtain qualified legal, accounting, or tax assistance when needed.

Example 1: Filing for 501(c)(3) status by the Lawrence (KS) Partnership for Children and Youth

Sydney Karr is the executive director of Lawrence Partnership for Children and Youth in Lawrence, Kansas. Her group, a non-profit corporation, applied for charitable exemption from federal taxes. "The 501(c)(3) status does a couple of things for you ," Sydney said. "The first thing is that it saves you money because you don't have to pay state income tax or federal income tax. The second thing is that it allows you to solicit more donations (because donors don't have to pay taxes for charitable contributions). To many donors that makes a big difference." Sydney also points out that a 501(c)(3) status can be beneficial in terms of purchasing insurance for the corporation, and in terms of state and their unemployment compensation. "Legally, you are a different kind of entity," she said. And that difference can bring benefits to your organization.

Sydney started her application using an example of another organization who had applied, so that her organization would have a sample of the way they should answer questions. "My accountant has alerted me that when you send this paperwork in," Sydney said, "the federal government will send back questions. It could be a series of questions, and quite often they send you a second series of questions and then you answer those . About the third time you send them something, they send you a letter saying you got it." That is standard practice, according to Sydney's accountant. No matter how thoroughly you fill out the paperwork, or how well you think you've done it, they will always have questions for you. And it's not a matter that they're not going to grant you the status, it's just that they always have questions, Sydney said.

So is it necessary to have both an accountant and a lawyer working on your application? Not necessarily, but in Sydney's experience, she got some legal advice from her lawyer, and then worked closely with her accountant. Her attorney, who works for free, said that if he just sent an example from his files from another organization to Sydney, she probably wouldn't have to come back to him for other questions. "It really is my intention to go ahead and do all of the paperwork myself," Sydney said . "But in the meantime, I was talking with our accountant, because he's the person who really knows both the federal and the state regulations, and he has really kind of pointed out to me the need for the 501(c)(3) status."

Getting 501(c)(3) status can help your organizations in more ways then one. Sydney offers an example about when her organization was trying to get directors and officers liability insurance. That's a way to insure the members of the board of directors against personal liability for the decisions that they make on behalf of the corporation , referring to director's and officer's liability in medical or treatment settings. "For instance, if a client or a patient says that he was harmed as a result of what this not-for-profit corporation did, then he could sue the corporation and each individual member of the board of directors," Sydney said. "The board of directors could actually have their own money at stake. I was trying to check into what the cost would be and get some quotes on the insurance. And one of the insurance companies that I was trying to get the quote from would not even give it to us until we had proof of our 501(c)(3) status. That was kind of an interesting kind of sideline that came up."

And that was not the only one. Sydney remembers when her organization was dealing with the state of Kansas on unemployment compensation insurance. Even though Sydney's corporation is a very small one with only three employees, the board decided that they would like to insure any members of the staff against being unemployed, having that state benefit available to them. "In trying to buy into that, and pay into the unemployment compensation fund, I just learned that we have to have 501(c)(3) papers pending at the very least," Sydney said. She ended up not needing the directors and officers liability, because they are not seeing patients.

"One of the things that is very confusing to people," Sydney remarked, "is the fact that when you say you're tax exempt, many vendors believe that means that you don't pay sales tax. I believe there are a few states where this is not the case, but in Kansas and in many states, just because you are tax exempt from income taxes and have that 501(c)(3) status, it does not exempt you from sales taxes." This can be tricky, because some business may set your business up as sales tax exempt, and then they will come back and ask you for your proof of sales tax exemption, when you might hot even had known they had you down as such. That's happened to Sydney. "I just discovered that a bill [that] was $50 and the amount owing was $50." And I said "that's not right, there's no taxes there." And they said "well, you're a non-profit." We know we are, but we pay sales taxes."

Sydney has experienced some hassles in filing her organization forms. She said that, when dealing with a lengthy federal form like the 501(c)(3) application, you may not know what it is they're asking for in each blank, and it might be helpful to look at an example of someone else and the way they've filled it out. Some of the regulations are very specific, and learning exactly what they are asking for before you submit the application can save an organization many headaches.

Example 2: Creating Affirm Youth, a nonprofit organization serving gay youth in Greenville, South Carolina

Recounted by Paul Evensen

I didn't have "start a nonprofit organization" on my list of things to do in life, and I don't think that is why any of us tackle something so overwhelming and challenging . What happens is that you become either very angry or very sad about what is going on in your community. Then, you get excited about what you could do to change things, and you end up half way into it before you know it.

I was compelled by the stories of several young people in my community who had been thrown out of their homes as teenagers because their parents discovered they were gay. The driving question became, "How can we keep families together and gay teens connected to school, churches and their community?" Part of the answer was to start a non-profit organization dedicated to crisis intervention, advocacy, and support.

I spoke with at least a hundred people including pastors, teachers, counselors, leaders in the gay community, parents, and representatives from the whole spectrum of social service agencies. I shared my ideas and solutions and asked for their feedback and suggestions for next steps and who else I should talk to. Most importantly, I asked for their personal commitment.

Through this process I found a fellow "preacher" who could see my vision and was willing to take a primary role in helping bring it about. It turns out he was a preacher in real life and he eventually became the full-time director of the agency . I also found those willing to shoulder key leadership roles on the board. We held a public meeting and announced the new organization, the name, logo, mission, the newly formed board, and the director to a very surprised community.

From there, it was a team effort to put a fund-raising plan together, to further develop the board, to create appropriate services, and to begin outreach.

I would offer several lessons to anyone trying to create a nonprofit:

• Get legal help early. Preferably, find a volunteer with experience in both nonprofit administration and the subject area your group deals with.
• Network quickly and nationally. Go to a national meeting of similar agencies and ask, ask, ask and ask again for what you need. This is where I found free legal help, as well as mentors from neighboring states and cities who could offer invaluable advice.
• It is not about you. It is about the issues and needs that draw us to common action. Many will want to make it about people, personalities, and politics. To counter this always focus on ideas and vision, and surround yourself with key people who do the same.
• Involve new young leaders. The work is very often not about the needs your organization is going to meet. Rather it is about giving the community a chance to learn and act. This includes new opportunities for young leaders to gain skills and experience. Give them a chance and pair them up with a mentor. They'll be running your organization after you're long gone.

Extending yourself to others is the heart of service. Seeing families changed because of work you've done will give your soul immeasurable rewards and an amazing energy to do more.

Example 3: A Sample Letter of Determination from the IRS

What follows is the text of an actual letter of determination. Special thanks to the United Way of Douglas County, Kansas, for furnishing and allowing the printing of this letter.

Internal Revenue Service
Department of the Treasury
1100 Commerce St.
Dallas, TX 75242

Person to contact: First read Tax Examiner
Telephone Number: (214) 767-1870
Refer Reply to: EP/EO:SBP:495ODAL

Date: May 07, 1986

United Way of Douglas County, Inc.
PO Box 116
Lawrence, KS 66044

Gentlemen:

Our records show that UNITED WAY OF DOUGLAS COUNTY, INC is exempt from Federal Income Tax under section 501(c)(3) of the Internal Revenue Code. This exemption was granted AUGUST 1973 and remains in full force and effect. Contributions to your organization are deductible in the manner and to the extent provided by section 170 of the Code.

We have classified your organization as one that is not a private foundation within the meaning of section 509(a) of the Internal Revenue Code because you are an organization described in section 170(b)(1)(A)(vi).

If we may be of further assistance, please contact the person whose name and telephone number are shown above.

Sincerely yours,

Theresa Nelms
FIRST READ TAX EXAMINER

___You understand the importance of legal counsel when applying for nonprofit status and tax-exemption

___You understand that nonprofit status is granted by the state, while the federal government grants IRS tax-exemption

___You know the three types of federally recognized nonprofit organizations are a corporation, an unincorporated organization, and a trust

___You understand that becoming a corporation is the most common choice for community organizations, because it is well understood, promotes continuity, and limits personal liability

___You know that 501(c)(3) is the "charitable tax-exemption"

___You understand that it allows exemption from federal corporate and income taxes, and that it allows solicitation of tax-deductible contributions

___You know there are a total of 26 different exemptions for different purposes

___You understand that there are three ways to become tax-exempt: application, automatic recognition, and using a fiscal conduit

___You understand the advantages of nonprofit status

___You understand the advantages of federal tax-exemption

___You understand the disadvantages of nonprofit and tax-exempt status

___You understand when you should (and when you shouldn't) consider applying for such status

___You understand how to apply for nonprofit status

___You understand how to apply for federal tax-exemption

___You know where to find inexpensive assistance

• What is a Finance Committee?

• Why do you need a Finance Committee?

• Who should be involved in a Finance Committee?

• How do you create and use a Finance Committee?

Every nonprofit organization that receives or spends money needs reliable financial systems and appropriate oversight. Financial problems can result from intentional misconduct, but they can also arise from weak internal controls, inadequate recordkeeping, misunderstandings of grant or contract requirements, unrealistic budgets, cybersecurity incidents, or simple errors that are not identified quickly.

Good financial oversight helps an organization protect its resources, fulfill legal and contractual obligations, support its mission, and maintain the trust of staff, participants, funders, donors, partners, and the broader community.

One common way for a governing board to carry out more detailed financial oversight is through a Finance Committee. This section discusses what a Finance Committee does, why an organization may need one, who might serve on it, and how to establish and maintain it effectively.

What is a Finance Committee?

Note: Not every organization has a formal board committee structure. A small grassroots or volunteer-led organization may instead use a treasurer, financial advisory group, fiscal sponsor, or qualified outside advisor. Even a very small organization should establish appropriate financial oversight, internal controls, and accountability once it begins receiving or spending funds.

A Finance Committee is generally a committee of the governing board that works with organizational leadership and financial staff to provide financial oversight. Its exact role depends on the organization's size, bylaws, staffing, legal requirements, funding, and complexity.

The committee may be chaired by the board treasurer and may include other board members with relevant knowledge or a willingness to develop financial literacy. Depending on state law, the bylaws, and the committee's authority, qualified non-board advisors may also participate.

The board retains ultimate fiduciary responsibility for the organization. A Finance Committee can perform more detailed review and make recommendations, but establishing a committee does not eliminate the responsibility of the full board to understand the organization's financial condition and make informed decisions.

A standing committee is an ongoing committee established to carry out recurring board responsibilities. An ad hoc committee or task force is formed for a specific, time-limited purpose and generally ends when that work is complete.

Responsibilities of a Finance Committee

Responsibilities should be clearly defined in a board-approved committee charter or other governing document. Depending on the organization, a Finance Committee may:

Oversee financial planning and performance

• Review the proposed annual budget and recommend it to the full board for approval
• Monitor budget-to-actual results and significant variances throughout the year
• Review financial forecasts, cash flow, reserves, liquidity, debt, and other indicators of financial health
• Monitor whether sufficient resources are available to carry out organizational priorities
• Consider longer-term financial sustainability and significant financial risks

Monitor compliance and stewardship of resources

• Monitor whether restricted funds, grants, contracts, and other resources are being used consistently with applicable requirements
• Review significant financial policies and recommend updates when needed
• Support appropriate internal controls governing purchasing, payments, banking, payroll, reimbursements, credit cards, electronic transfers, investments, and access to financial systems
• Monitor compliance with applicable federal, state, local, grant, contract, and organizational reporting requirements
• Ensure that the organization follows current IRS charitable-contribution substantiation and disclosure requirements when acknowledging donations

Identify financial risks and emerging problems

The committee should pay attention to conditions such as:

• Revenue falling below projections
• Expenses increasing significantly above budget
• Cash-flow shortages
• Excessive dependence on one funding source
• Uncollected receivables or delayed reimbursements
• Unexpected debt or other financial obligations
• Weak or outdated internal controls
• Significant budget variances that are not adequately explained
• Cybersecurity or payment-fraud risks
• Transactions or relationships that create actual or potential conflicts of interest

Identifying a problem does not necessarily mean wrongdoing has occurred. The committee should distinguish among errors, inadequate procedures, changing financial conditions, policy violations, and suspected misconduct and respond appropriately to each.

Support reliable financial reporting

The committee can help ensure that the board receives accurate, understandable, and timely financial information. Depending on the organization's needs, reports might include:

• Statement of financial position
• Statement of activities
• Cash-flow information
• Budget-to-actual reports
• Grant, program, department, or project reports
• Reserve and liquidity information
• Debt and investment reports
• Financial forecasts and scenario analyses

Committee members should help the full board understand what the numbers mean rather than merely forwarding financial statements without explanation.

Respond to suspected financial misconduct or control failures

Organizations should have written procedures for reporting, investigating, and escalating suspected financial misconduct, fraud, conflicts of interest, or significant control failures.

The Finance Committee may have a role in those procedures, but it should not improvise a response after a serious allegation occurs. The organization should establish in advance:

• How concerns can be reported, including options when senior leadership is involved
• Who has authority to investigate
• When legal counsel, auditors, insurers, funders, regulators, or law-enforcement authorities should be consulted
• How records and evidence will be preserved
• How confidentiality will be handled
• How people who raise concerns in good faith will be protected from retaliation consistent with applicable law and organizational policy

Serious suspected misconduct should be handled promptly, objectively, and according to appropriate legal and professional guidance.

Audit and external financial-review responsibilities

Not every nonprofit is required to obtain an independent financial-statement audit each year. Audit, review, compilation, or other external financial-review requirements may arise from state law, federal awards, grants, contracts, lenders, governing documents, or board policy.

Determine which requirements apply to your organization and budget for the appropriate service.

If the organization undergoes an independent audit, the board should also consider whether audit oversight belongs with the Finance Committee or with a separate Audit Committee or audit task force. Separating audit oversight from ongoing financial management can strengthen independence, particularly in larger or more complex organizations.

Audit-related responsibilities may include:

• Recommending selection or appointment of the independent auditor
• Reviewing the auditor's independence and potential conflicts of interest
• Understanding the scope and timing of the engagement
• Ensuring that staff provide complete and accurate records requested by the auditor
• Meeting directly with the auditor to discuss findings
• Reviewing recommendations concerning internal controls, accounting, compliance, or financial reporting
• Monitoring management's response to significant findings
• Helping the full board understand the audit report
• Evaluating the audit process and recommending whether the auditor should be reappointed

Independent auditors should have a direct avenue of communication with the board or committee responsible for audit oversight rather than being required to communicate solely through organizational management.

Evaluate financial systems and capacity

The committee may periodically review whether the organization has adequate financial staffing, accounting systems, internal controls, policies, and expertise.

This might include reviewing:

• Staffing and division of financial responsibilities
• Accounting and payroll systems
• Cybersecurity and financial-system access
• Banking and treasury arrangements
• Procurement and reimbursement procedures
• Grant and contract management
• Financial reporting and forecasting
• Document retention and backup procedures

Depending on the committee's charter, it may also participate in defining qualifications for senior financial positions or provide input on the performance of financial leadership. Routine personnel supervision generally remains a management responsibility unless the board has specifically assigned a different role.

Keep financial decisions aligned with mission and strategy

Financial oversight is not only about preventing errors. The committee can also help the board understand whether financial decisions support the organization's mission, strategic priorities, workforce, community commitments, and long-term sustainability.

For example, the committee might identify situations in which:

• Resources are increasingly directed toward activities that are not central to organizational priorities
• A funding opportunity would create obligations or mission drift that outweigh its benefits
• Staffing or compensation is financially unsustainable
• Essential infrastructure has been chronically underfunded
• Short-term savings could create larger long-term risks

Report to the full board

Finance Committee reports should help every board member understand the organization's financial condition and important decisions or risks.

The committee should explain significant issues in clear language, identify trends and uncertainties, and distinguish between matters requiring board action and those being handled by staff within existing authority.

Why do you need a Finance Committee?

Not every board needs a separate Finance Committee, but organizations with significant or complex financial activity often benefit from one.

• To support the board's fiduciary responsibilities. The committee can conduct detailed financial review and help the full board fulfill its duty of financial oversight.
• To strengthen internal controls and risk management. Regular review can identify weaknesses before they lead to larger problems.
• To improve financial planning. The committee can help connect budgets, forecasts, reserves, and financial strategy with the organization's mission and long-term plans.
• To identify intentional or unintentional financial mismanagement. Effective oversight can identify errors, inadequate systems, noncompliance, conflicts of interest, fraud, or other financial risks.
• To protect against actual or potential conflicts of interest. A written conflict-of-interest process can help ensure that decisions are made in the organization's best interests.
• To strengthen the full board's financial literacy. Committee members can help explain financial reports, assumptions, risks, and trends so that all board members can participate meaningfully in financial decisions.
• To provide knowledgeable advice to leadership. Financial expertise can help the organization assess cash flow, borrowing, reserves, investments, capital expenditures, funding changes, and other complex decisions.
• To support appropriate external financial review. The committee can help ensure that audits or other independent financial engagements are properly planned, understood, and followed up on.

Fiduciary duties

Board members generally have fiduciary duties commonly described as the duties of care, loyalty, and obedience. The exact legal standards vary by jurisdiction, but these principles provide a useful framework for responsible governance.

• Duty of care: Board members should act with appropriate attention, preparation, and judgment and should obtain the information needed to make informed decisions.
• Duty of loyalty: Board members should put the organization's interests ahead of conflicting personal or financial interests.
• Duty of obedience: Board members should ensure that the organization remains consistent with its mission, governing documents, and applicable law.

A Finance Committee can support these responsibilities, but the full board should not treat the committee as a substitute for its own oversight.

Conflicts of interest

A conflict of interest exists when a person's financial, family, employment, business, or other interests could interfere with, or reasonably appear to interfere with, their ability to make an impartial decision for the organization.

Organizations should maintain a written conflict-of-interest policy that addresses disclosure, review, recusal, voting, documentation, and related-party transactions.

Depending on the circumstances and applicable law, a relationship involving a board member or related person may not automatically be prohibited. However, the organization should use an independent process, obtain appropriate information about comparability and fairness, document the decision, and ensure that people with conflicts do not improperly influence the outcome.

Who should be involved in a Finance Committee?

A strong committee combines financial knowledge with an understanding of the organization's mission, programs, risks, and community responsibilities.

Not every member needs to be a CPA or financial professional. Financial expertise is valuable, but a committee composed entirely of specialists may overlook important programmatic or community implications of financial decisions.

Potential members may include:

• The board treasurer
• Board members with experience in accounting, budgeting, banking, investments, business operations, risk management, insurance, law, or nonprofit management
• Board members who understand organizational programs and can connect financial decisions to mission and community impact
• People with experience serving on nonprofit finance, audit, or investment committees
• Members who may not yet have extensive financial experience but are willing to develop financial literacy and ask clear, practical questions

Non-board advisors may also contribute useful expertise when permitted by law and organizational governing documents. Clarify whether they are voting committee members, nonvoting advisors, or participants serving another defined role.

Do not recruit someone merely because they have wealth, status, or the ability to make a large donation. Committee membership should be based on the knowledge, independence, perspective, judgment, availability, and commitment needed to perform the committee's work.

Community knowledge is also valuable. Depending on the organization, the committee may benefit from perspectives of people familiar with its programs, community context, accessibility responsibilities, workforce, or the experiences of people who participate in or are affected by its work.

Qualities to consider

• Integrity. Members should be trustworthy and willing to address difficult financial questions.
• Independence. Members should be able to exercise judgment without inappropriate pressure from management, donors, other board members, or outside interests.
• Mission understanding. Financial decisions should be evaluated in the context of the organization's purpose and responsibilities.
• Financial literacy. Members should either understand or be willing to learn basic nonprofit financial statements, budgets, grants, contracts, cash flow, reserves, and internal controls.
• Curiosity. Members should be willing to ask questions when information is unclear or assumptions do not make sense.
• Commitment. Members should have enough time to prepare for meetings, review reports, participate in training, and follow through on responsibilities.
• Respect for confidentiality. Committee members may receive sensitive financial, personnel, legal, donor, or contractual information and should handle it appropriately.

How do you create and use a Finance Committee?

Decide what you want the committee to do

Begin by defining the committee's scope. Finance Committees should generally provide governance-level oversight rather than manage routine accounting or approve every ordinary transaction.

Staff ordinarily carry out day-to-day financial operations within board-approved budgets, policies, and delegated authority. The committee reviews whether systems are working, whether the organization is on track financially, and whether significant issues require board attention.

Organizations with little or no professional financial staff may need more hands-on assistance, but the board should distinguish clearly between governance responsibilities and staff or volunteer management responsibilities.

Consider how audit oversight will be handled

If the organization undergoes an independent audit, decide whether the Finance Committee will oversee the audit or whether a separate Audit Committee or audit task force would provide greater independence.

Factors to consider include:

• Organizational size and financial complexity
• State legal requirements
• The size and composition of the board
• Auditor-independence considerations
• Whether Finance Committee members participate heavily in management of financial activities they would later be reviewing

Choose members based on the committee's responsibilities

The mix of expertise should reflect the work the committee actually performs. For example, an organization with significant debt, real estate, federal grants, an endowment, or complex investments may need different expertise from a small organization funded mainly through local contributions.

Review potential conflicts before appointment and require regular conflict-of-interest disclosures.

Establish a written committee charter

A committee charter should describe:

• Purpose and scope
• Responsibilities and authority
• Relationship to the full board
• Relationship to the executive director and financial staff
• Membership requirements
• Committee leadership
• Terms and rotation when applicable
• Meeting frequency
• Reporting requirements
• Conflict-of-interest procedures
• Confidentiality expectations
• Escalation procedures for significant financial concerns
• Whether and how non-board advisors may participate

Avoid setting an arbitrary monthly meeting requirement if the organization's needs do not justify it. Some committees may meet monthly during budgeting or financial stress and less frequently at other times. The important point is that meetings occur often enough for meaningful oversight.

Provide orientation and ongoing training

New members should receive enough orientation to understand both the organization's finances and the committee's responsibilities.

Training may include:

• The organization's budget, financial statements, accounting system, and financial policies
• How to read nonprofit financial statements
• Budget-to-actual analysis
• Cash-flow forecasting, reserves, debt, and liquidity
• Current grants, contracts, contributions, endowments, and other major funding sources
• Donor restrictions and grant compliance
• Internal controls and fraud prevention
• Cybersecurity and payment-fraud risks
• Conflict-of-interest requirements
• Fiduciary duties and applicable nonprofit law
• Audit and external financial-review processes
• Committee policies, reporting responsibilities, and escalation procedures

Financial practices, laws, risks, and technology change, so training should not be limited to a member's first year.

Decide what information the committee will review

The committee should receive information early enough to identify issues and act on them.

Depending on the organization, regular materials may include:

• Statement of financial position
• Statement of activities
• Budget-to-actual reports
• Cash-flow forecasts
• Accounts receivable and payable information
• Grant and contract financial reports
• Reserve and investment reports
• Debt information
• Fundraising and revenue projections
• Significant contracts or capital commitments
• Internal-control or cybersecurity concerns
• Audit, review, or regulatory findings when applicable

Committee members should have access to supporting information when they need it to investigate an unusual item, while respecting confidentiality and appropriate access controls.

Establish clear reporting and escalation procedures

Decide how the committee will report to the full board and what issues require immediate notification rather than waiting for the next regular board meeting.

Reports should communicate:

• Current financial position
• Significant budget variances
• Cash-flow and liquidity concerns
• Important financial risks
• Matters requiring board decisions
• Significant compliance or internal-control concerns
• Major audit or external-review findings

Establish a process for situations in which the concern involves the executive director, board chair, treasurer, or another person who would ordinarily receive the report.

Maintain independence and evaluate the committee's effectiveness

Finance Committees can lose effectiveness if members become too accustomed to unexplained variances, weak controls, or longstanding practices that no one questions. Members should maintain constructive relationships with staff while preserving their independent oversight role.

Periodically evaluate:

• Whether the committee is receiving the right information
• Whether members understand that information
• Whether major risks and financial trends are identified early
• Whether recommendations are followed up on
• Whether membership provides the needed expertise and perspectives
• Whether rotation or recruitment of new members would be helpful
• Whether the committee's charter still reflects the organization's needs
• Whether a separate Audit or Investment Committee has become appropriate

In Summary

A Finance Committee can help a nonprofit governing board carry out responsible financial oversight by reviewing budgets and financial reports, monitoring risk and cash flow, strengthening internal controls, supporting compliance, and helping the full board understand the organization's financial position.

The committee does not replace either professional financial staff or the responsibilities of the full board. Staff generally manage day-to-day financial operations, while the committee provides governance-level review, asks questions, identifies risks, and makes recommendations. The full board retains responsibility for major financial and governance decisions.

Effective Finance Committees include members with relevant financial knowledge as well as people who understand the organization's mission and operations. Members should demonstrate integrity, independence, financial literacy or a willingness to develop it, sound judgment, and an ability to communicate financial information clearly.

A strong committee should operate under a written charter, use clear conflict-of-interest and escalation procedures, receive appropriate financial information regularly, participate in ongoing training, and periodically evaluate its own effectiveness. Organizations that undergo independent audits should also consider whether separate audit oversight would strengthen independence and accountability.

Ultimately, the purpose of financial oversight is not simply to prevent misconduct. It is to help the organization use its resources responsibly, manage risk, remain financially sustainable, and direct its resources toward the mission and communities it exists to serve.

What is a Finance Committee?

___You use a standing committee, which may include both members and non-members of your board, to oversee your organization's financial operation.

Why do you need a Finance Committee?

You establish a Finance Committee because:

___A Finance Committee helps a board fulfill its fiduciary responsibility.

___A Finance Committee can protect the organization from legal challenges and liability.

___An alert and informed committee should be able to catch both intentional and unintentional mismanagement of funds.

___A Finance Committee can protect the organization from actual or apparent conflict of interest.

___A Finance Committee acts as the board's eyes and ears in the financial operation.

___A Finance Committee can act as an advisory panel to the financial operation.

___A Finance Committee can evaluate both the financial operation and the people in charge of it from a position of knowledge.

___A Finance Committee can be helpful in the hiring of fiscal staff or a new director.

___A Finance Committee can make the audit easier.

___A Finance Committee can interpret the audit for the rest of the board.

___A Finance Committee can be helpful in recommending the hiring, retention, or firing of potential or current auditors.

Who should be involved in a Finance Committee?

___You recruit board members who have a financial background, and who want to serve on the committee - CPA's, lawyers, financial analysts, bankers, etc.

___You recruit non-board members who would be valuable to the committee and with whom your board can benefit by establishing relations.

___You recruit board members who are financially less sophisticated, and who might therefore represent the board at large, and ask the kinds of questions they might ask.

___You recruit people who, by their known integrity and community standing, can lend credibility to the committee.