Cash vs. Accrual Accounting for Nonprofits: A Beginner’s Guide

Capturing the ins and outs of cash flows is important for any organization. For nonprofits, choosing between the cash or accrual method of accounting is a decision contingent upon both the size and complexity of the organization and the unique financial reporting parameters required of nonprofit organizations. Cash-basis 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 necessary for nonprofits that must comply with US 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 accounting 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 allow 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’re received, and expenses are recorded when they’re 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-size 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’s earned, not when payment is received—and expenses are recorded when they’re incurred, which is not necessarily when they’re paid. Accrual accounting adheres to GAAP, which most nonprofits follow in preparation of their financial statements, and these statements, in turn, provide information required for their annual IRS Form 990 filing.

It’s 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’s received and expenses are recorded when they’re 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 isn’t 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 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. Nonprofits choose cash accounting because it:

• Simplifies accounting
• Is 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. Cash accounting poses disadvantages because it:

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

What Is Accrual-Basis Accounting?

Accrual-basis accounting records revenue when it’s earned or pledged and expenses when they’re 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 US National Council of Nonprofits encourages nonprofit bookkeepers and accountants to use specialized software 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 revenue 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. Nonprofits opt for accrual-basis accounting because it:

• Offers an 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. Accrual-basis accounting presents challenges because it:

• Is more complex than cash-basis accounting
• Requires specialized software and expert staff
• Involves complex transactions and reversals
• Involves estimates and reversals that add to complexity
• Requires cash flow statements for accurate cash position
• Needs adjustments if donors don’t fulfill pledges

Cash-basis accounting is simpler than accrual-basis, but, pragmatically, only the smallest nonprofit organizations should consider using it.

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, 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’s in hand, not when it was pledged; likewise, expenses when using cash accounting are recorded when they’re 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’s 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 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 United States, 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 functional expenses, and a statement of cash flows. The numbers shown on these statements will vary, based on the accounting method used:

• Statement of financial position is 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 because nonprofits don’t have owners. With the cash method, a nonprofit’s SOFP is simpler—current assets would consist primarily of cash and short-term investments, and liabilities would be limited to obligations, such as loans, that exist independent of the timing of revenue and expense recognition. Accounts payable and accrued expenses that arise from the timing differences that define accrual accounting wouldn’t appear. 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 is 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 is a further breakdown of expenses that’s 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 with 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 is 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.

Compliance and Reporting Factors to Consider in Choosing a Method

In addition to operational fit, a nonprofit’s choice of accounting method is typically dictated by regulatory requirements and funder expectations. Three compliance factors frequently influence this decision.

GAAP Requirements

Nonprofits that need to be GAAP-compliant, such as those seeking independent audits—whether voluntarily or because funders require them—must use the accrual method of accounting. GAAP-compliant statements are presented in a standardized format that makes it easier for boards, donors, and rating agencies to assess a nonprofit’s financial health. Because GAAP requires accrual-basis accounting, nonprofits seeking an unqualified or “clean” audit opinion on GAAP-compliant financial statements must use the accrual method.

IRS Requirements

The IRS allows nonprofits to use either cash or accrual accounting on Form 990, so long as the chosen method is applied consistently throughout the return. In practice, most nonprofits that file Form 990 use the accrual method. The specific form required depends on the organization’s size. Nonprofits with gross receipts of $200,000 or more—or total assets of $500,000 or more—must file the full Form 990. Smaller organizations that fall below both thresholds can file Form 990-EZ. The smallest nonprofits—those with gross receipts of $50,000 or less—can file Form 990-N (e-Postcard), which requires only basic identifying information.

Funder Requirements

Foundations, government agencies, and major donors often request audited financial statements before committing funds. Because audits require accrual-basis accounting, nonprofits pursuing grants or large gifts may find the accrual method a practical prerequisite. Organizations receiving more than $1 million in federal funding per year are required to undergo a Single Audit, which likewise mandates accrual-basis financials. Even when funders don’t explicitly require a particular method, accrual accounting makes it easier to track restricted funds and demonstrate that donor dollars are being used according to their stated purpose.

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 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.

Transitioning From a Cash-Basis to an Accrual-Basis Accounting Method

Common triggers for transitioning to accrual-basis from cash-basis accounting include hiring full-time employees, applying for foundation grants or government funding, planning a capital campaign, and preparing for an independent audit. In each case, accrual accounting provides the structure needed to track payroll liabilities, restricted funds, and complex revenue streams.

The timeline for transition varies significantly. For smaller nonprofits with clean records, the changeover may take just one to three months, and it’s easiest when starting at the beginning of a fiscal year. More complex organizations usually have a longer transition process—up to six months or more. This is particularly the case when historical records require reconstruction or when multiple restricted funds are involved. Accurate cash-basis accounting records are the starting point. Using these documented transactions, an accountant can restate them under the accrual method. The process usually involves identifying outstanding receivables and payables, recognizing pledged donations and in-kind contributions, and adjusting prior-period balances. Some nonprofit accounting systems can generate accrual-basis reports even if day-to-day books are maintained on a cash basis, making the conversion easier.

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 for Nonprofits 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. NetSuite then generates 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’s 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 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 helps 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?

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 US Generally Accepted Accounting Principles.

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?

Midsize and large nonprofits typically choose accrual-basis accounting. In fact, US Generally Accepted Accounting Principles 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’re using, and then use that method consistently throughout the form. While cash or accrual accounting are both acceptable, it’s preferable for the 990 to be prepared using the accrual method.