On the surface, nonprofit organizations may resemble for-profits in many ways, but they differ fundamentally in their primary purpose. For-profit businesses exist to generate money for their owner(s), while nonprofits use donor funding to pursue a cause, such as humanitarian aid, education or other goals that aim to enhance society. That fundamental distinction in purpose leads to profound differences in accounting, as nonprofits must follow specialized rules to demonstrate that their funds are being spent according to donors’ intentions. And nonprofit accounting is a more widespread concern than many people think: Nonprofits contributed $1.5 trillion to the U.S. economy in the fourth quarter of 2022 alone.
Nonprofit accounting shares many of the same characteristics and methods as for-profit accounting — both generate financial statements, track incoming cash and expenses, produce budgets and more. To maintain their nonprofit status and the special tax privileges associated with that status, however, nonprofits follow specific rules that require additional financial accountability based on stipulations that are often attached to contributions. To help them keep multiple programs and funds separated, organized and transparent for donors and other stakeholders, nonprofit accountants tend to rely on specialized accounting software. This article explores these accounting differences to help organizations navigate the complexities of nonprofit accounting.
What Are the 4 Main Differences in Accounting for Nonprofits vs. For-Profits?
The main differences between for-profit and nonprofit accounting can be sorted into four categories — purpose, methods, statements and reporting, and taxation. There is overlap in each category between for-profit and nonprofit accounting requirements, but the differences highlight nonprofit organizations’ uniqueness.
- Purpose: A nonprofit’s primary purpose is to further a cause that benefits society. That requires transparency in how it raises funds and then spends them, either in ways that directly affect that cause or on the administrative overhead required to support its mission. For-profit organizations, on the other hand, primarily exist to make money for owners.
- Methods: Nonprofits often must be more specific about how money is spent than for-profits. Most important, they must create separate funds and programs when their “revenue” is donated for a specific purpose, such as a scholarship or a specific kind of research. Accounting standards unique to nonprofits focus on creating, differentiating and tracking these funds. For-profit companies can generally spend revenue however they see fit.
- Statements and reporting: Nonprofit and for-profit organizations generate similar financial statements, but these statements go by different names and include some different information. Financial statements can be used to tell the story of how a nonprofit’s work furthers its cause and show potential donors how their money will be spent.
- Taxation: Nonprofit organizations have special tax privileges and must show compliance with regulations to maintain those privileges. But nonprofits may have some of the same tax obligations as for-profits, such as payroll taxes, and different localities have different rules for nonprofit taxes.
- A nonprofit’s primary goal is to spend donors’ funds in service of a cause that improves society. Specialized accounting and transparency are necessary to assure regulatory agencies and donors that the right money is spent in the right places.
- Contributions to nonprofits often come with restrictions on how they can be spent. Nonprofit accountants must create and manage separate funds to satisfy these requirements.
- Nonprofits are exempt from paying some, but not all, taxes. Nonprofits must understand their tax obligations and make accurate payments or risk losing their tax privileges.
Nonprofit Accounting Differences Explained
Though they have different goals, nonprofit and for-profit companies share many accounting features. Except for very small organizations, for example, nonprofits typically follow Generally Accepted Accounting Principles (GAAP), just as for-profit companies do. But nonprofits must follow additional rules and best practices not only to ensure that donations are effectively supporting their mission but also to maintain their nonprofit status.
The biggest difference between nonprofit and for-profit accounting is how money can be spent. Donations to nonprofits come in two forms — restricted and unrestricted. Restricted funds come with specific caveats on how they can be used, and accountants must carefully track the related expense accounts to ensure that funds go to the stated purpose, such as a certain field of research. Nonfinancial, or in-kind, donations, such as services, art objects or goods donated to a food drive, may be considered restricted or unrestricted contributions, depending on the situation.
Restricted funds also include endowments, which usually have additional rules on how and when money can be withdrawn. Endowments are meant to provide a nonprofit with an ongoing funding source through a combination of earnings and only limited withdrawals of the principal. On the other hand, unrestricted funds, like those collected through blanket fundraising efforts, can be used at the nonprofit’s discretion to further its mission as it sees fit, assuming it follows all other relevant requirements.
Donors, especially large donors, are customarily concerned that their contributions should go toward growing the nonprofit rather than toward administrative expenses, and they would prefer to give their money to organizations that can efficiently reach their goals. By carefully segmenting donations into their appropriate funds and tracking expenses accordingly, nonprofit accounting increases transparency and accountability so that donors can be confident that their contributions are directly supporting the causes they believe in. Transparent accounting can also help nonprofits track key performance indicators (KPIs), such as donor retention and spending ratios, especially when the nonprofit accounting software is part of an integrated business platform, such as an enterprise resource planning (ERP) system. Directors and staff can analyze KPI values and trends to reach informed decisions.
4 Ways Nonprofit Accounting Differs From For-Profit Accounting
|Effectively maintain accountability and compliance in pursuit of benefiting society.
|Increase profits for owners and stakeholders through financial reporting and analysis.
|Incoming cash from donations is categorized into specific funds and spent through specialized programs.
|Revenue is earned through sales of goods and services and can be spent as the business sees fit.
|Often exempt from federal, state and local income tax, but still must pay payroll taxes and taxes on unrelated business income.
|Tax obligations include federal income tax and required state and local taxes.
1. Purpose of Accounting in For-Profit Organizations vs. Nonprofits
The primary difference in accounting purpose for nonprofits and for-profits is derived from the difference in the respective organizations’ big-picture purposes: generating revenue and profits for owners versus benefiting society through their actions. Nonprofits do not have owners; they are typically controlled by founders and/or a board of directors who do not collect a share of profits. Thus, nonprofits are not concerned with building equity or company net worth, as are for-profit enterprises. Because of this fundamental difference in purpose, nonprofit and for-profit accountants have different goals and measures of success, even if much of the framework is similar. Both for-profit and nonprofit organizations may focus on growth and expansion, but nonprofit growth is centered on fundraising to bring in more donors or creating infrastructure to spend contributions more effectively, while for-profit growth is generally focused on maximizing profits for owners.
For-Profit: Financial Reporting, Budgeting, Tax Planning
For-profit company accounting goals focus on maximizing earnings. Effective accounting helps establish that resources are being properly allocated to maximize revenue and minimize costs. Stakeholders often stress the importance of creating and implementing accurate budgets and forecasts to optimize financial performance. For-profit accounting focuses on profit-measuring metrics, such as margins and sales KPIs. When businesses generate surpluses, they can be reinvested into the business or paid out to shareholders. Proper accounting also ensures that for-profit businesses accurately calculate their owed tax and pay it on time and in full. Another key purpose of for-profit accounting is to develop strategies to minimize taxes. Nonprofits, of course, don’t need to worry about minimizing taxes because they are exempt from most of them.
Nonprofit: Recordkeeping, Accountability, Compliance
Nonprofit accounting’s primary purpose is to make sure the funds available for programs that further the organization’s mission are being spent efficiently and effectively. This requires rigorous recordkeeping to track program spending and administrative costs. That recordkeeping and the financial reports it helps to produce must be done in compliance with GAAP’s specialized fund accounting guidance for nonprofits. Compliance is also nonprofits’ main tax-related concern — i.e., staying compliant with accounting and tax rules so they can maintain their tax-free status. But recordkeeping for nonprofits does more than help optimize results — it is central to fundraising, as potential donors commonly use budgets, financial statements and other records to see how their contributions will be spent and to hold the nonprofit accountable after making their donations.
2. Accounting Methods Used in For-Profit vs. Nonprofit Organizations
At the highest level, both nonprofits and profit-making businesses must choose one of two main accounting methods: cash or accrual. One level down, however, the biggest methodological difference between for-profit and nonprofit accounting has to do with how incoming funds are categorized. For-profit organizations generally have complete freedom about how they spend their revenue and can define their spending categories as they please. Nonprofits must create separate funds when donors stipulate specific goals or causes, and not all contributions have to follow the same restrictions. Understanding the differences between donation types is crucial for proper nonprofit accounting.
For-Profit: Accrual Accounting and Cash Accounting
For-profit companies normally follow either accrual-basis accounting or cash-basis. The accrual method records revenue when it is earned, which is not always the same as when it is received. It also records expenses when they are incurred, regardless of when they are paid. This method is GAAP-compliant and a requirement for public companies. But even smaller private companies may choose to use this method, as it tends to give a more accurate view of a business’s revenue and expenses, rather than relying on payment timing, which can distort the view of when business was actually conducted.
By contrast, the cash method recognizes revenue and expenses only when funds change hands. The cash method is simpler and most often used by smaller companies that don’t need GAAP-compliant records for lenders, partners or tax purposes. The IRS allows exceptions from the accrual method for small corporations and partnerships, which may use the cash method for tax reporting if they pass the “gross receipts test” — annual gross receipts (revenue) must be $26 million or less, indexed for inflation and averaged over the prior three tax years, as per IRS Publication 538.
Nonprofit: Fund Accounting, Program Accounting
Nonprofits have additional layers of bookkeeping than for-profits encounter. Those layers are called “fund accounting” and “program accounting,” and they are the means through which nonprofits create separate funds for specific purposes when organizing their finances. Unrestricted donations can go toward whatever expenses the nonprofit chooses, but restricted donations must be spent through the program chosen by the donor. Similarly, outgoing payments must be tracked and organized into specific programs. For example, a restricted donation to a scholarship fund cannot be spent on anything but the scholarship program. Nonprofits track these expenditures through robust program accounting to ensure that donations are being allocated and spent appropriately. Using fund accounting is a little like having multiple divisions within a company; each results in separate records that all combine within the whole entity. Both restricted and nonrestricted spending should be carefully monitored to track the effectiveness and size of every program created and managed by the nonprofit.
Additionally, all but the smallest nonprofits generally follow accrual accounting guidelines, which deem contributions “earned” when the pledge is made. For example, if a donor pledges to give $300,000 in $100,000 increments over the next three years, the $300,000 would be recorded in full on the date of the pledge, not when each donation installment is paid. Accrual-based fund and program accounting can become complex as nonprofits grow. To deal with the complexity, many rely on a robust chart of accounts, combined with specialized nonprofit accounting software and/or an ERP system, to maintain accurate books and give potential donors peace of mind that their money is going to the right place.
3. Financial Statements and Reporting for For-Profit vs. Nonprofit Organizations
Financial statements and reports provide a picture of a business’s finances over a specific period or up to a certain date. These can be used for internal analysis to find improvements or to show a business’s financial strength to external parties, such as lenders, partners, regulatory bodies or the public. Many nonprofits generate statements that are similar to those generated by for-profit companies, but with some key differences. Understanding these differences helps accountants more effectively meet their goals and maintain high accounting standards as their organizations grow.
For-Profit: Income Statement, Balance Sheet, Cash Flow Statement
For-profit companies typically generate three major financial statements to track and report their financial performance — the income statement, the balance sheet and the cash flow statement. Each one paints an important picture of a business’s financial position.
- Income statement: Also known as a profit and loss statement, or P&L, the income statement shows revenue, expenses, gains and losses over a period of time, usually a month, quarter or year. The income statement is often considered the most important document to demonstrate a business’s financial health, as it shows the overall bottom line for a financial period — i.e., whether the business is generating income or incurring losses.
- Balance sheet: The balance sheet shows what a company owns (assets), what it owes (liabilities) and the owner’s equity as of a specified date. It must always “balance” according to the equation: Assets = liabilities + owner equity. Because balance sheets give an overview of a company’s net worth, they commonly include previous periods or key ratios, such as the debt-to-equity ratio, for comparison and to establish trends in financial well-being over time.
- Cash flow statement: The cash flow statement shows how cash is moving in and out of a business over a specific period. It includes the period’s starting balance, where cash is coming from, how it is being spent and the ending balance. Positive cash flow indicates effective cash management and a financially healthy company that is able to pay down its debts and fund its operations. This statement is especially important for small, midsize or new businesses, as they often struggle with liquidity; the cash flow statement can add important context to periods of negative cash flow.
Nonprofit: Statement of Activities, Statement of Financial Position, Cash Flow Statement, Statement of Functional Expenses
Nonprofit financial statements have a different focus than their for-profit analogs because they primarily focus on transparency and accountability, rather than conveying profitability and net worth. Nonprofits use the following four statements to offer internal analysts, regulatory agencies and potential donors insights into their operation and how they further their cause.
- Statement of activities: The statement of activities is a variation of the income statement, but instead of ending with net income, the bottom line shows the change in net assets over the financial period. Tracking trends in the statement of activities over time can show how well a nonprofit is using its assets to fulfill its mission. While some surplus is considered good, there’s a limit (unlike in a profit-making enterprise). That’s because stakeholders expect nonprofits to allocate as much of their assets as possible toward furthering the mission, as opposed to for-profit stakeholders’ desire for consistently rising profits.
- Statement of financial position: Like a balance sheet, the statement of financial position shows a nonprofit’s assets and liabilities, but, since nonprofits do not have owners, the owner’s equity section is replaced by a discussion of net assets. These assets are typically divided into unrestricted and restricted funds, with the latter further divided into permanently and temporarily restricted funds. This statement reveals a nonprofit’s financial standing at a given time by showing assets that can be invested into future endeavors.
- Cash flow statement: This is very similar to a for-profit cash flow statement in that it shows incoming and outgoing money, and positive cash flow means the organization is bringing in enough funding to meet its obligations. A key difference is that nonprofits do not seek consistently high cash balances because they may lead to trouble attracting donors, who prefer their contributions go toward making a positive difference to the mission, rather than sitting in a bank account.
- Statement of functional expenses: The statement of functional expenses breaks down a nonprofit’s operational spending into three categories: fundraising, management and general costs (i.e., administration), and programs. This expense breakdown is generally required when filing annually with the IRS to maintain nonprofit tax-exempt status. Some nonprofits expand the details on their functional expenses by further dividing expenses into subcategories, such as rent, travel, salaries and more, to provide donors and the public with more information about how resources are allocated.
4. Taxation Differences for For-Profit vs. Nonprofit Organizations
Nonprofit organizations are exempt from some — but not all — taxes. So, nonprofit accountants must take as much care to calculate and accurately pay taxes as those working in for-profit companies. Navigating the complexity of nonprofit tax obligations at the federal, state and local level, however, can present additional accounting challenges that for-profit companies do not share. Beyond that, the overall difference between the tax challenges of for- and nonprofit entities is that the former focuses on tax minimization and the latter on compliance.
For-Profit: Income Tax, Payroll Tax
The biggest difference between nonprofit and for-profit companies lies in the area of corporate income tax. For-profits are required to pay taxes on income, and nonprofits are generally exempt from income tax. But both for-profit and nonprofit companies with employees are required to pay payroll taxes, such as withholding, Medicare and Social Security (in the U.S.). Some local payroll taxes, such as state unemployment tax, vary by location. Both for-profit and nonprofit companies often consult tax accounting experts or rely on accounting software that incorporates all those variations when calculating their tax obligations. For-profit companies generally have other tax obligations as well, such as sales taxes or real estate taxes.
Nonprofit: Exemption From Income Tax, Potential Liability for Unrelated Business Income Tax
U.S. nonprofits are exempt from federal income tax but must annually file IRS informational Form 990 to maintain their nonprofit status and the tax privileges that come with it. Nonprofits with gross receipts of less than $200,000 and total assets under $500,000 can use a simplified version, called Form 990-EZ; smaller organizations with gross receipts of under $50,000 can use Form 990-N, which the IRS describes as an e-postcard.
For other taxes, such as sales tax, nonprofits may be exempt, depending on the locality. For example, under Colorado’s tax code, charitable organizations are exempt from state-collected sales tax if the purchases are made during regular charitable functions and activities. Unrelated business, however, may contribute to a nonprofit’s tax bill, even for federal income taxes. If a museum has a gift shop, for example, revenue generated through retail sales may be taxable. It is important to properly categorize all funding sources to ensure that accurate taxes are paid and filed with the government and with relevant regulatory agencies, especially for nonprofits operating in multiple regions with differing tax policies.
Manage Your Nonprofit Accounting With NetSuite
As nonprofit organizations grow, managing their unique financial needs requires specialized accounting processes. NetSuite’s nonprofit accounting software is a comprehensive solution designed specifically to address the intricacies of nonprofit financials. NetSuite streamlines financial operations, enhances transparency and helps nonprofit organizations more effectively achieve their mission. It simplifies fund accounting by providing a centralized platform that allows organizations to separately track and report on multiple funds and programs. With real-time visibility into revenue, expenses and fund balances, nonprofit leaders can make informed decisions on how best to achieve their goals.
NetSuite’s core cloud accounting software can be integrated with other essential systems, such as customer relationship management (CRM) and fundraising platforms. This integration enables nonprofits to enhance accuracy across all the systems to quickly respond to complex accounting challenges, such as changes in regional regulations. With a more detailed view of donor-focused financial metrics, such as retention rates and contribution trends, nonprofits can transform their organizations to cultivate stronger relationships with donors and more effectively drive fundraising efforts. NetSuite’s nonprofit accounting software empowers nonprofits with the tools they need to spend less time managing finances and more time focusing on their core mission.
Spending too much time in your books?
The differences between for-profit and nonprofit accounting go far beyond modified financial statements and tax exemptions — they reflect the fundamental distinctions in purpose, goals and financial obligations between the two types of organizations. While for-profit entities prioritize generating profits for owners and shareholders, nonprofits aim to serve the public good and fulfill their charitable missions — in other words, to make the world a better place. This divergence leads to unique approaches to nonprofit accounting methods, financial statements and tax preparation. By following accounting best practices and using specialized accounting software, nonprofits can increase transparency and accountability for regulatory agencies and potential donors who want to be certain their contributions will further the causes they believe in.
Nonprofit Accounting Differences FAQs
What is the difference between a for-profit and nonprofit balance sheet?
A for-profit balance sheet is similar to a nonprofit statement of financial position. Both list their respective organizations’ assets and liabilities. However, the for-profit balance sheet also lists owner’s equity. Because nonprofits do not have owners, equity is replaced by net assets on a nonprofit’s statement of financial position. Net assets are meant to be spent to further the nonprofit’s mission.
How different is nonprofit accounting?
Nonprofit accounting follows many of the same procedures as for-profit accounting and, also like for-profits, typically adheres to Generally Accepted Accounting Principles (GAAP) guidelines. Additionally, however, nonprofit accounting uses fund accounting, which establishes separate funds to track restricted contributions that can be used only for specific purposes. Also, some restricted contributions can be withdrawn only in certain amounts or at certain times, so maintaining detailed accounting practices is necessary to ensure compliance and accountability for nonprofits.
How does accounting serve the needs of nonprofit organizations?
By meeting additional accountability standards related to fund and program accounting, nonprofits maintain their nonprofit status and its associated tax privileges. Nonprofit accounting also provides the increased transparency needed to maintain donors’ trust that their contributions are being used as intended, i.e., in specific ways that aim to further the cause of the nonprofit. Furthermore, following accounting best practices can help a nonprofit operate more efficiently, identify wasteful areas and promote growth, freeing more money to fulfill its mission.
What are the key accounting challenges faced by nonprofit organizations?
A key accounting challenge faced by nonprofit organizations is effectively tracking restricted funds. Some donations can be applied only toward specific programs, so accountants must track incoming and outgoing cash, in compliance with local and national fund accounting regulations, to verify that funds are being spent as the donors intended. Additionally, nonprofit organizations must be transparent in accounting for their spending, so donors can be certain that their contributions are furthering the stated mission of the nonprofit, as well as meeting any restrictions that the donors specify.