Cash vs. Accrual Accounting for Nonprofits

Capturing the ins and outs of cash flows is important for any organization. For nonprofits, choosing between the cash or accrual method of accounting for those transactions is a decision contingent upon both the size and complexity of the organization and the unique financial reporting parameters required of nonprofit organizations. Cash accounting is straightforward and useful when a nonprofit is just starting out, has no paid staff and is working with limited funds. As a nonprofit organization grows, however, accrual-basis accounting can provide the structure and accuracy needed to record funding from a variety of sources, track expenses in alignment with donors’ intentions and allocate funds to multiple programs. Accrual-basis accounting is also necessary for nonprofits’ compliance with U.S. Generally Accepted Accounting Principles (GAAP) and is recommended for meeting IRS reporting requirements.

Key Takeaways

• Nonprofits can choose cash- or accrual-basis accounting to track their income and expenses, just like for-profit businesses.
• Cash-basis accounting is simple and ideal for smaller nonprofits with limited resources and minimal funding sources.
• Accrual-basis accounting is more complex, GAAP-compliant and used by larger nonprofits. It helps generate donor confidence and satisfies regulatory requirements.
• Both methods support the nonprofit accounting statements and reports that enable internal and external stakeholders to analyze the organization’s operational efficiency, as well as its adherence to its mission.

Cash vs. Accrual Accounting for Nonprofits Explained

Like for-profit businesses, nonprofits come in all shapes and sizes and have varied access to resources. And also like for-profit businesses, nonprofits can choose to use cash- or accrual-basis accounting to record the inflows and outflows of monies as they carry out their mission. While this choice often depends on the size and complexity of the particular organization, nonprofit accounting has additional, unique requirements that set it apart from for-profit accounting.

Some smaller nonprofits use cash accounting because of its simpler approach to record-keeping. Cash accounting is straightforward and always shows precisely how much cash is on hand at any point in time. In nonprofit cash accounting, contributions are recorded when they are received, and expenses are recorded when they are paid. But cash accounting is not GAAP-compliant and doesn’t necessarily paint the most accurate picture of an organization’s financial health, whether it’s profit-making or not.

Medium-sized and larger nonprofits typically turn quickly to accrual-basis accounting because it better accommodates the complex reporting requirements for nonprofit financial statements — as well any necessary compliance with government requirements, most notably tax-exempt status, which is overseen by the IRS. In accrual accounting, contributions are recorded when they are pledged or expected — in the same way that for-profit businesses recognize revenue when it is earned, not when payment is received — and expenses are recorded when they are incurred, which is not necessarily when they are paid. Accrual accounting adheres to GAAP, which most nonprofits follow in the preparation of their financial statements, and these statements, in turn, provide information required for their annual IRS Form 990 filing.

It is common for charitable organizations to start out using cash accounting and then transition to accrual accounting as they grow. Automating these processes, as the Legal Aid Society of Rochester did, helps channel resources back into the organization so it can focus on its nonprofit mission.

What Is Cash-Basis Accounting?

Cash-basis accounting is straightforward: Money is recorded at the time it is received and expenses are recorded when they are paid. Like for-profit companies, some nonprofits use cash accounting because it aligns with the ebb and flow of donations (aka revenue) and expenses. Cash accounting gives nonprofit board members and donors a good idea of how much cash is on hand for the organization to carry out its stated goals. Cash accounting is typically preferred by smaller nonprofits because its simplicity translates into more time to focus on the group’s mission.

Advantages for Nonprofits

Nonprofits use cash accounting for its ease of use — sophisticated accounting expertise is not necessary. Small nonprofits, especially those with no paid staff, use cash-basis accounting to record day-to-day donations and expenses. The nonprofit’s cash position is always evident, and money is handled like it’s a “checkbook” for the organization. The details of cash accounting can be expressed in a statement of activities — the nonprofit equivalent of a for-profit company’s income statement — giving stakeholders a simple view into the organization’s finances.

• Simplifies accounting
• Suitable for small nonprofits
• Offers clear visibility
• Makes money management easier
• Provides a straightforward financial overview

Disadvantages for Nonprofits

The downside of cash accounting for nonprofits starts with the fact that it doesn’t account for in-kind or pending donations that a nonprofit might receive. And just as it might at a for-profit business, cash accounting may not offer the most accurate picture of a nonprofit group’s overall financial health; for example, there could be pledges pending to fund future programs, but cash accounting has no way to reflect that. Nor can it signal that a major expense might be coming due for, say, an annual office-supply order. Another minus is that some state regulations require nonprofits to use accrual-basis accounting, so cash accounting isn’t an option.

• Excludes in-kind or pending donations
• Offers incomplete financial health picture
• Overlooks future financial commitments
• Cannot foresee major upcoming expenses
• Not allowed under certain state regulations

What Is Accrual-Basis Accounting?

Accrual-basis accounting records revenue when it is earned/pledged and expenses when they are incurred, as opposed to when money is actually received or paid. This gives nonprofits and profit-making businesses alike a more accurate picture of their financial health, which can be especially helpful for planning and budgeting purposes. Larger charitable organizations use accrual-basis accounting to record their more varied sources of funding, with each variation having a corresponding, separate account, according to the principles of fund accounting. Because accrual-basis accounting is more complex and labor-intensive — and that complexity is multiplied by the requirements of nonprofit fund accounting — the U.S.’s National Council of Nonprofits(opens in a new tab) encourages nonprofit bookkeepers and accountants to use software specialized for nonprofits to record their financial transactions.

Advantages for Nonprofits

The biggest advantage of accrual-basis accounting is that it provides nonprofits with a more accurate picture of the group’s finances than cash accounting does. Using accrual-basis accounting, nonprofits can see expected payables and receivables and get a “big picture” of their financial health that helps them more accurately analyze and plan for growth. Budgeting is easier with the accrual method because revenues and expenses can be more easily anticipated. The accrual basis of accounting also is the only method that complies with GAAP and, thus, facilitates larger nonprofits’ preparation of required financial statements. As nonprofits engage with large donors, foundations and government agencies, accrual-basis accounting is the only method that will support the audits and financial documents required by those funders.

• Offers accurate financial overview
• Shows expected payables and receivables
• Simplifies budgeting and planning
• Complies with GAAP for statement preparation
• Meets audit and document requirements for major funders

Disadvantages for Nonprofits

Accrual-basis accounting is much more complicated than cash-basis. Nonprofits that use accrual accounting need the support of specialized software and expert accounting staff in order to accurately track the many transactions and “reversals.” Reversals occur because, when a donor makes a pledge, for example, that amount is immediately recognized as revenue under accrual accounting — but the donor may actually send a different amount. When the monies are received the original estimate of the donation is reversed and the actual amount recorded, so that the books are accurate and nothing is counted twice. This continuous process of estimates and reversals is one of the main things that makes accrual-basis accounting so complex. And since the receipt of revenue or the payout of expenses may not sync with the organization’s cash on hand in this method, additional cash flow statements become necessary to get an accurate picture of the group’s cash position. Finally, should a large enough portion of donors fail to follow through with their commitments, the nonprofit will need to adjust any plans it made based on those pledges.

• More complex than cash-basis accounting
• Requires specialized software and expert staff
• Involves complex transactions and reversals
• Estimates and reversals add to complexity
• Cash flow statements needed for accurate cash position
• Adjustments necessary if donors don't fulfill pledges

Cash vs. Accrual Accounting for Nonprofits

As nonprofits solicit donations and other funding to support their mission, they must record those transactions using either the cash- or accrual-basis accounting method. Choosing which method to use is tied to the organization’s size, the types of financial transactions involved and the complexity of its programs. Smaller nonprofits use cash accounting to capture donations as they come in and pay expenses as they occur. Medium and large nonprofits use accrual-basis accounting to maintain a clearer picture of their more complex operations, because the accrual approach can account for anticipated funding, such as grants, and expenses/liabilities, such as office supplies purchased on credit.

Much of the difference between cash and accrual accounting comes down to the timing of revenue and expenses. Recording donations under the cash accounting method means revenue is recognized when it is in hand, not when it was pledged; likewise, expenses when using cash accounting are recorded when they are paid, not when they were incurred. This method of accounting gives the nonprofit an easier way to manage the day-to-day recording of transactions, but it may not give a true picture of outstanding payables or receivables.

Recording revenue under the accrual method, on the other hand, requires nonprofits to recognize funding when it is committed, such as a grant or large gift, even though the actual check may not arrive and be deposited for several months. The same is true for expenses, which are recorded as payables when incurred, such as for a supply order, even though the invoice may not be paid for 30 days. Account adjustments — aka reversals — are made when the money actually is received or paid. This method, while useful for planning and budgeting, presents a challenge for the organization as it tries to get an accurate cash flow picture, necessitating close monitoring of the cash flow statement.

Nonprofits that are looking to grow and that solicit donations from foundations, grants, and state and local governments should choose accrual-basis accounting. Some nonprofits use cash accounting for their day-to-day operations but have an accountant convert to accrual-basis for reporting their financial statements, which helps them position themselves better for the next level of growth.

Financial Statements Generated by Each Method

Depending on their size and other factors, nonprofits usually must generate four standard financial statements for regulatory compliance, regardless of the accounting method they use. In the U.S., these financial statements support required reporting on IRS Form 990, which nonprofits must file to maintain their tax-exempt status. Best practices dictate that a nonprofit generates a statement of financial position, a statement of activities, a statement of cash flows and a statement of functional expenses. The numbers shown on these statements will vary, based on the accounting method used.

• Statement of Financial Position, akin to a balance sheet in the for-profit world. But instead of following the “Assets – Liabilities = Equity equation, its simple equation is Assets – Liabilities = Net Assets. If the nonprofit uses cash accounting, cash and investments (or savings) would be the only items on the balance sheet. No liabilities would be present. The Net Assets balances would be the same as the cash balance, but would be shown as restricted or unrestricted. With the accrual method, a nonprofit’s accounts receivable and prepaid assets would populate the assets column, while accounts payable, accrued expenses and debt would populate the liabilities column. The SOFP is considered one of the essential statements for determining an organization’s financial health.
• Statement of Activities, similar to a for-profit business’s income statement. Nonprofit boards typically review this statement on a monthly, quarterly and yearly basis, and major donors check it to see how their contributions are being used. Small nonprofits may have “no strings attached” on donations they receive, but larger organizations often have restrictions that allow monies to be used only for specific purposes. Whether using cash-basis or accrual-basis accounting, the statement of activities relies on fund accounting as a way to show how restricted and unrestricted monies are spent, tying expenses back to donors’ intentions. Beyond that, the statement of activities shows whether the nonprofit is running at a deficit or a surplus.
• Statement of Functional Expenses, a further breakdown of expenses that is unique to nonprofits. This statement expands on information in the Statement of Activities. Expenses incurred by the nonprofit usually fit into three categories: administrative costs, program expenses and fundraising expenses. Reporting within these categories relies on a detailed chart of accounts, just as in a for-profit business. The statement of functional expenses allows for clear disclosure of how a nonprofit is distributing its expenses among different functional areas, providing transparency for donors and charitable rating agencies.
• Statement of Cash Flows, essentially the same as that prepared for any for-profit counterpart. It shows how monies are coming in and going out of the organization. Regardless of which method of accounting is used by the nonprofit, cash flows are divided into three categories: operating, financing and investing. Understanding historical cash flow is key to forecasting uses and sources of cash — in other words, future spending and how to pay for it — to better manage working capital needs.

Considering Stakeholders in Nonprofit Accounting

Nonprofits have a different relationship with their stakeholders than is typical of for-profit businesses. Just as profit-making companies need customers, nonprofits need donor support to fund their missions. But unlike business customers, donors and grantors can dictate how their gifts are used. Some funding sources, such as grants, foundations and large donors, request detailed financial statements before committing to their funding, to reassure themselves that the mission of the nonprofit will be carried out in the most transparent and efficient way possible and that their gifts will be used according to the restrictions they set.

Furthermore, due to GAAP and IRS reporting rules that nonprofits must adhere to, it’s crucial for charitable organizations to follow accounting best practices in the preparation of their statements. Nonprofits should select an accounting method that supports their operating needs, while satisfying the requirements of their donor and regulatory ecosystem.

Which Accounting Method Should Nonprofits Use?

The decision about which accounting method a nonprofit should use depends on the size and complexity of the organization. Small nonprofits with no paid staff and a simple donation model can survive just fine with cash accounting, assuming it meets all requirements for financial, operational and key performance indicator reporting to the board and other stakeholders. Maintaining the nonprofit’s funds as one single account — to receive donations into and write checks out of — works. To get a sense of how “small” a small nonprofit might be in practice, the IRS says organizations(opens in a new tab) that normally generate $50,000 or less in annual revenue are eligible to file an e-Postcard, which asks for no financial details at all, instead of Form 990-EZ or Form 990.

But the move to accrual accounting becomes a necessary next step as a nonprofit grows and diversifies its programming, services and funding sources. In particular, when a nonprofit adds its first full-time employees, the complexities of accounting for salaries, benefits, vacation and sick days make it a good time to move to accrual accounting. GAAP requires that most nonprofits filing an IRS Form 990 also must use accrual-basis accounting. And, if a nonprofit wishes to add the credibility of independently audited financial statements, it likewise must adopt the accrual method. In short, as nonprofits engage with larger donors, foundations and government agencies, accrual-basis accounting becomes necessary to support the audits and financial documents required by these entities.

Power Your Nonprofit With Accounting Software

No matter which accounting method you choose for your business, accounting software can help. With the power to automate time-consuming tasks like creating journal entries, calculating payroll taxes and generating compliant financial reports, accounting software gets your head out of the books and back to what matters: fulfilling your organization’s mission.

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Cash or Accrual, Handle Your Accounting With NetSuite

Nonprofits have unique accounting and reporting needs. Handling the tracking of nonprofit financial transactions, whether from cash donations or multiple funding sources, requires the support of an accounting software system designed for nonprofits, like NetSuite for Nonprofits. This specialized version of NetSuite Cloud Accounting Software provides a flexible and multidimensional chart of accounts that nonprofits can use to configure NetSuite software to accurately — and automatically — coordinate revenue sources and expense transactions, and manage fund restrictions and grant requirements. Then, NetSuite can generate financial statements that convey those details to interested stakeholders. NetSuite’s nonprofit product suite streamlines and standardizes income and expense entries, speeds report generation and supports the data required for regulatory compliance unique to mission-driven organizations. It provides real-time visibility and insight into the finances of the organization, assuring board members and donors that the mission is being carried out transparently and efficiently.

Nonprofits must choose cash- or accrual-basis accounting to track the income and expenses of their organizations. Smaller nonprofits can use cash accounting, which is simpler, while larger organizations generally must use accrual-basis accounting to capture their more complex transactions and support their more detailed reporting requirements. Nonprofits should study both accounting methods to determine which one best suits their situation and supports their donor and regulatory ecosystem.

Cash vs. Accrual Accounting for Nonprofits FAQs

What is the best accounting method for nonprofit organizations?

Each nonprofit has its own unique set of needs and resources required to carry out its mission. Smaller nonprofits may use the cash method of accounting to record the inflows and outflows of donations and expenses for their day-to-day operations. Medium-sized and large nonprofits have more varied funding sources and a more complex range of needs to meet, so they use accrual-basis accounting to support budgeting and planning. The best method of accounting is the one that best fits the organization, while supporting the unique reporting requirements of nonprofits.

Can nonprofits switch from one accounting method to another, and if so, how?

As nonprofits grow, the need to switch from cash accounting to accrual basis accounting becomes necessary. Tracking additional funding sources, meeting the demands of large donors and grant makers, and detailing the way expenses are allocated, based on donor-set restrictions, necessitates accrual accounting to capture the variety of transactions. And, as the organization expands, the need for accrual accounting becomes even greater, because it will help its board better understand the full scope of the organization’s finances. The transition from one accounting method to another requires meticulous record-keeping. As long as cash-basis accounting transactions are recorded fully, accurately and in detail, professional accountants can restate the information using the accrual method.

Which accounting method is preferred by donors, grantors and other stakeholders?

Nonprofits are required to provide transparency and accountability to their funders. Financial statements and tax filings provide the best way to show how their money is being used to accomplish the mission of the organization. While donors may have no hard-and-fast rules about which method of accounting must be used, nonprofits typically must provide them with financial statements that present an accurate picture of the financial health of the organization. These statements reassure donors and other funders that the mission of the nonprofit is being carried out and that their dollars are being used for their intended purpose. Such detailed financial statements usually require the accrual method, which is the only method that is compliant with U.S. Generally Accepted Accounting Principles (GAAP).

Should nonprofits use cash or accrual accounting?

Nonprofits can use cash or accrual accounting, depending on the complexity and size of their organization. Each method has pros and cons, and the requirements of each should be considered based on the resources available, funding sources and number of programs the nonprofit is administering. In general, though, smaller nonprofits use cash-basis accounting, but the larger the organization, the more likely it is to use accrual-basis accounting.

Do nonprofits use accrual accounting?

Due to their more complicated requirements, medium-sized and large nonprofits typically choose accrual basis accounting. In fact, U.S. Generally Accepted Accounting Principles (GAAP) dictate the use of accrual accounting, and some states have their own regulations for how nonprofits must report income. Accrual accounting is often required in order to receive funding from large institutions and grant-making organizations.

Should 990 be cash or accrual basis?

Nonprofits that file IRS Form 990 are required to check off which method of reporting income and expenses they are using, and then use that method consistently throughout the form. While cash or accrual accounting are both acceptable, it is preferable for the 990 to be prepared using the accrual method.