Today, we're privileged to feature an insightful piece from Rachel Peterson of RP Finance. With her vast expertise in financial structuring, Rachel delves into one of the cornerstone elements of nonprofit financial management: 'Creating an Effective Chart of Accounts.' She also has a special download for you, which you can grab here!
Creating an Effective Chart of Accounts for Nonprofits
Understanding financial reports is crucial to the success of any business, for-profit or nonprofit. A well-organized and straightforward chart of accounts is a reliable foundation for financial reporting. Just as a strong foundation supports a sturdy building, an efficient chart of accounts ensures accurate and streamlined financial management. It provides the structure for reliable financial reporting and decision-making, preventing errors and confusion that could lead to instability.
Nonprofits depend on willing donors to fund their missions and goals. When a potential donor requests financial information, sending them reporting that is easy to read and glean information from is crucial to obtaining new funding and developing fiscal trust. The chart of accounts is the foundation of all your financial statements and should be the priority in improving your financial position.
Creating a more straightforward chart of accounts can be overwhelming, especially if your list has more than three hundred items. An ideal chart of accounts has only one-hundred items and groups similar Expense and Revenue lines. Each item falls under one of two umbrellas; the Statement of Financial Position, which holds your Assets, Liabilities, and Net Assets; and the Statement of Activity, which contains the Revenue and Expenses.
Statement of Activity
Anytime a nonprofit organization receives income, it is considered Revenue. It can be tempting to create a line item for every donor or every type of business that donates, but resist the temptation! There only need to be four main types of Revenue listed on the Statement of Activity; Grant Revenue, Contribution Revenue, Fundraising Revenue, and Sponsorship Revenue. These four parent accounts allow revenue streams to be organized based on their relevance to the total Revenue, not the donor.
Each organization is different and will have different types of Revenue, including State Grants, Foundation donations, Raffle ticket sales, and so much more. It is up to each organization to determine what categories to place items in to communicate a helpful report of the Revenue streams.
Grant management is, at its core, the bookkeeping around expenses. Which donor funds pay for which expenditures? How should wages be expensed to grant funds? The key to successful and sustainable grant management is simplification. Like with Revenue, every nonprofit should use four primary parent accounts to categorize their expenses: Programs, Administrative, Fundraising, and Payroll.
There should not be separate accounts for printing, paper, paperclips, staples, postage, or envelopes. Office supplies will do just fine. You can have repeating names of accounts to reflect the types of Expenses for each parent account. For example, it is perfectly reasonable to have a Supplies & Materials account under Programs and another Supplies & Materials account under Administrative.
Statement of Financial Position
Luckily, the Assets portion of the Financial Position report is simple. This section covers bank accounts, Accounts Receivable, Fixed Assets, and Inventory. Simplifying the Assets section is about grouping accounts to be more visually digestible. Instead of listing each bank account as a parent account, creating a Bank Account parent account and listing each open account beneath it allows for simple reporting and a lack of confusion if there is more than one bank. Also, organizations should ensure that each fixed-asset item has a contra account for depreciation.
Credit cards and tax liability accounts need just as much organizing in the Statement of Financial Position as Assets do. This section only has four main liability categories: Accounts Payable, Credit Cards, Current Liabilities, and Long-Term Liabilities. Like with Assets, having parent accounts for all the open credit cards will provide a better visual for any investor or board member. If the Liabilities section is messy, it is safe to assume that the organization has debt that is also messy. Organizations can avoid that assumption by cleaning up their Liability accounts and grouping them to make the total Liabilities easier to identify.
Equity is the result of subtracting the total Liabilities from the Total Assets. The resulting net assets belong entirely to the organization, so it is essential to report these funds to help an organization make intelligent financial decisions quickly and confidently. Nonprofits' equity is divided into Net Assets Without Donor Restrictions and Net Assets with Donor Restrictions. Sometimes organizations track the status of funds, whether restricted or unrestricted, using other field methods in their accounting software. Reporting what net assets are limited and which are not, allows an organization to register flexibility in liquidating and fundraising.
Embrace Change and Simplicity
Adjusting the chart of accounts for any organization can feel overwhelming and scary. However, providing disorganized and over-complicated financial reports is much more frightening and overwhelming to those who must read and interpret them. By simplifying the chart of accounts, all reporting becomes more effective and helpful to those who use them to make decisions about operations, payroll, budgeting, funding, and fundraising, to name a few choices every nonprofit faces daily.
Suppose the simplification process still feels too daunting. In that case, the team at Rachel Peterson Finance is available to help consult on the organizing process and transition into a more effective chart of accounts. Contact our firm today!