A nonprofit organization (NPO) is an organization that has no owners and which uses its net income to help it achieve its established aims. The organization retains all surplus net income and does not pay out dividends or distributions. Such an organization produces nonprofit financial statements.
The principles of double entry bookkeeping used by a nonprofit organization are the same as those used by any other for-profit business, except that the format of the financial statements changes.
The three main nonprofit financial statements are as follows:
- The statement of financial position
- The statement of activities
- The statement of cash flows
The Statement of Financial Position
The statement of financial position is equivalent to the balance sheet for a for-profit business. The main difference is that as there are no owners, the term equity is not relevant.
The accounting equation is normally written as follows:
As the term equity is not relevant, the accounting equation for a nonprofit organization is simply restated as shown below
The term equity is replaced by the term net assets which is sometimes referred to as accumulated funds.
The statement of financial position shows a financial snapshot of the nonprofit organization at a specific date, usually at the beginning and end of an accounting period. It sets out the assets of the organization and how they have been funded. It tells you what your organization is worth at book value.
The top of the statement of financial position shows the assets of the organization, property, machinery, fixtures, inventory, accounts receivables, cash etc. The bottom part of the statement of financial position shows how those assets have been funded by liabilities such as supplier credit, bank loans, and by net assets. Net assets or accumulated funds represents the net income surplus of the organization and is equivalent to the net worth in a for-profit business.
|Long term assets||450,000|
|Total net assets||400,000|
|Total liabilities and net assets||800,000|
Under generally accepted accounting principles (GAAP), the net assets are divided as shown above into one of three types:
Unrestricted net assets are any net assets or funds which are not restricted and which can be used by the organization as it sees fit. Unrestricted funds are further separated into two types.
Designated net assets are unrestricted net assets which have been set aside by the organization for a specific (designated) purpose and are not generally available.
Undesignated net assets are those which are generally available for use by the organization. Notice that it is the organization itself which decides whether the unrestricted net assets are designated or not.
2. Temporarily restricted
Temporarily restricted net assets or funds are usually funds contributed by a donor who has placed restrictions on what the funds are to be used for.
3. Permanently restricted
Permanently restricted assets are usually endowments. In a true endowment, the principal amount donated cannot be spent (held in perpetuity), and is used to generate income which must be spent in accordance with the donors wishes. As the endowment principal is not spent, it is normally invested in long term investments to generate the income.
The endowment fund is set up by the organization to deal with the administration of the endowment. The endowment fund will normally establish an investment policy to deal with how the fund can be invested, a withdrawals policy to establish how much can be taken from the fund, and a usage policy to determine how the funds withdrawn can be spent.
The assets and liabilities can be subdivided into various categories depending on the activities of the non profit organization. Our free downloadable nonprofit chart of accounts template is available to assist in setting up the types of asset and liability accounts needed.
The closing net assets shown above at 400,000 is highlighted in blue as it reconciles to the closing net assets on the second of the nonprofit financial statements which is the statement of activities discussed below.
The Statement of Activities
The statement of activities is the non profit organization equivalent to the income statement, and shows the financial performance over an accounting period. The accounting period can be any length but is usually a month or a year.
The statement of activities is used to tell whether an organization has made a net income surplus or deficit for the period, and follows the general format of Income – Expenses = Net Income.
|Unrestricted||Temporarily Restricted||Permanently Restricted||Total|
|Opening net assets||125,000||60,000||155,000||340,000|
|Closing net assets||150,000||75,000||175,000||400,000|
The income and expenditure are analysed into the categories of unrestricted, temporarily restricted and permanently restricted which have the same meaning as defined for the statement of financial position above.
As the net income surplus or deficit is retained within the organization it also represents the change in net assets for the accounting period. The closing net assets, which should agree to the net assets in the statement of financial position (in this case 400,000 highlighted on blue), is simply the net income for the year added to the opening net assets for each category.
The income and expenditure can be subdivided into various categories depending on the activities of the non profit organization. Our free downloadable nonprofit chart of accounts template is available to assist in setting up the types of income and expenditure accounts needed.
The Statement of Cash Flows
The non profit statement of cash flows shows a organizations cash inflow and cash outflow over an accounting period, and has a similar format to the cash flow statement used by a for profit business.
|Add back depreciation||12,000|
|Net cash flow||29,000|
|Opening cash balance||1,000|
|Closing cash balance||30,000|
The net cash received or paid during the accounting period is referred to as the cash flow. In the above example, the cash flow is 29,000 into the organization.
Notice that the closing cash balance on the cash flow statement (30,000) is the same as the cash balance on the closing statement of financial position.
The Three Nonprofit Financial Statements Connected
There are three financial statements which you need to understand to operate a nonprofit organization effectively, the statement of financial position, the statement of activities, and the statement of cash flows.
The statement of financial position shows the assets of a organization and how they have been funded by liabilities and net assets (funds) at a particular point in time, usually the beginning and end of the accounting period.
The statement of financial activities shows the net income surplus or deficit of the organization for the period, which is equal to the movement in the net assets between the opening and closing statement of financial position.
The statement of cash flows shows the net cash in or out of the organization for the period, and the cash flow is equal to the movement on the cash balance between the opening and closing statements of financial position
About the Author
Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping. He has worked as an accountant and consultant for more than 25 years in all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a BSc from Loughborough University.