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Accounting

Apr 10
0

A Guide to Nonprofit Budgeting: Navigating the Essentials

By | Accounting, Accounting Software, Budget, Nonprofit | No Comments
A Guide to Nonprofit Budgeting, people at desk or table with tablet, spreadsheets, and ledger

Budgets provide the financial foundation upon which an organization must run all its activities. Without a budget, it is almost impossible to manage cash flow. Budgets provide structure, organization, and financial stability that helps you with strategic planning.

Although it’s possible to run a company or a nonprofit solely off cash flow without budgeting for specific activities, it makes planning for steady growth and new activities very difficult. Budgets serve as both guidelines and tools, helping organizations plan for activities, manage cash flow, and view expenses. Here, we’ll share with you the main types of budgets used by nonprofits, as well as discuss each section of the budget in greater detail. Lastly, we’ll talk about ways to manage nonprofit budgeting to make the process go smoothly.

Key Components of Nonprofit Budgets: Income (Revenue) and Expenses

We can break nonprofit budgets into two simple categories: income and expenses. Income refers to money coming into the organization, and expenses refers to the money the organization spends. All financial activities can be grouped under each category. The difference between income and expenses results in a surplus when the difference is positive (more income than expenses) or a loss or deficit (when expenses exceed income).

Source of Income

Your organization probably has several sources of income. Some of these income sources are unique to the nonprofit world. Typical sources of income include donations, program fees, membership fees, sales of products or services, grants, and special events.

Because nonprofits invest their income into their programs and services to fulfill their mission, they must track carefully where revenues come from and how they are spent. Sometimes, nonprofit income is tied to specific programs or activities. For example, donors may indicate they wish their donation to be used only for a specific program or added to the general operating fund. If the donation is intended for a specific program, the organization must ensure that they budget the funds or add them to the fund for that specific activity.

A good example is a nonprofit animal shelter. Many have “spay and neuter funds,” which are set up to pay for low-cost or free spay/neuter programs to address the surplus of homeless animals in the local community. If donors give to that program, the shelter must honor the donor’s wishes and ensure that the money is spent on that program. They cannot reapportion the funds for the general budget to pay for advertising, for example, or for salaries and wages; funds raised for a specific purpose must go to fulfill that purpose.

Another example of how nonprofit revenues must be tracked differently from for-profit income streams is grants. Grants are often given for highly specific purposes or to fund specific programs. Granting organizations often require careful accounting of how the funds are spent.

Importance of Diversifying Income

Although we spoke at length about two sources of income—donations and grants—nonprofits receive income from many places. They may sell products or charge a fee for services. They may receive donations of goods. Each of these income categories requires careful tracking and recording of the income received.

As in the for-profit world, smart nonprofits diversify their income as much as possible. It’s never a good idea to put all your eggs in one basket or rely solely on one channel for income. A nonprofit that relies on a single large grant to fund multiple program activities may be in deep trouble if the grant doesn’t continue, for example. A diverse income stream of donations, fees for services or goods, grants, and other sources of income ensures that even if trouble hits one category, it won’t jeopardize the entire budget.

Expenses

Expenses refers to everything your organization must spend money on to keep running: operational costs (overhead, utilities, telephone and internet expenses, professional fees, insurance), rents or licenses, fixed assets such as furniture and computers, marketing and sales, salary, and benefits. You must track all your expenses to ensure that you have a clear and detailed view of how your organization spends its money.

Once you track expenses, it becomes clear which categories are consuming the largest share of the budget. You can then take steps to either minimize this spend or manage it prudently. There are many areas where expenses can be cut without compromising the quality of the services you deliver. For example, you may be able to cut back on insurance expenses by shopping for and comparing different policies and coverages. Or you may find that hiring remote employees helps you keep rent costs low because you don’t need as large an office building. These are just examples of how expenses can be managed to keep them low.

The Most Common Types of Budgets Used by Nonprofits

There are many ways in which you can create a budget. If your organization has a budget in place, you may use that as a starting point each year and adjust income and expenses based on projections. You may also find that a new approach to budgeting is helpful.

The three most common types of budgets used by nonprofits include:

  1. Program-Based Budgeting: This approach is widely used by nonprofits as it aligns budget allocations directly with the organization’s programs and initiatives. It allows for clear tracking of resources allocated to each program, making it easier to assess the effectiveness and impact of those programs.
  2. Zero-Based Budgeting (ZBB): While not as prevalent as program-based budgeting, ZBB is still commonly used by nonprofits, especially those seeking to ensure maximum efficiency and accountability in resource allocation. ZBB encourages a thorough review of all expenses, promoting cost-conscious decision-making throughout the organization. Zero-based budgets start at zero each year, with budgets built from scratch. Each expense and income must be estimated from scratch based on current conditions.
  3. Outcomes-Based Budgeting: Nonprofits are increasingly adopting outcome-based budgeting to demonstrate the impact of their activities and investments. By linking budget allocations to desired outcomes or impacts, organizations can better prioritize resources and measure their effectiveness in achieving their mission.

Ready, Set, Budget! The Budgeting Process

Creating a good budget takes time. Leave at least several weeks to build your budget and, if you need to gain approval from your board or managers, time for review, feedback, revision, and final approval.

Depending on the type of budget you are building, there are several ways to begin the process. You’ll need to understand all the categories you have to account for in the income and expense areas. Gather the necessary information: previous years’ income statements and cash flows, sources of revenues, and the like, as well as expenses.

Determine a reasonable percent by which you think you can increase both income and expenses. It’s natural to hope for the best, but it’s better to conservatively estimate increased income. If you plan to increase income, will you need to spend more on specific activities, such as marketing and donor relationships, to achieve your goals? All of these must be considered as part of your strategic plan as well as the budgeting process.

Your organization’s accountant or bookkeeper is instrumental in the budgeting process. Schedule time to review income and expenses together. Then, connect with staff as needed to gather additional input.

A budget is a living document. Like a good strategic plan or marketing plan, adjustments should be made to it as the year progresses (it’s not a once-and-done activity). Schedule periodic budget reviews and make necessary adjustments to income projections or expenses as you need to ensure an end-of-year surplus that can be invested back into the organization’s mission. A quarterly review may be sufficient. Some organizations conduct budget reviews monthly, others quarterly or twice a year. At a minimum, an annual budget review and budgeting cycle are necessary for a healthy financial picture.

Tools to Make Budgeting Easier

There are several types of accounting software that can make nonprofit budgeting easier. Spreadsheets are frequently used but have several drawbacks. They must be manually updated and can grow to be quite complex depending on the number of programs you’re managing. They also lack good reporting functions.

Many small business software packages seem like they would be a good step up, but these also have several drawbacks. While they can automate many tasks and produce good reports like balance statements, cash flows, and similar reports, they may require extensive customization to track income and expenses by program, or track donation information. They are not built for the unique requirements of nonprofit accounting.

Nonprofit accounting software is built specifically for nonprofit budgeting. There are packages for nonprofits and government accounting, so you start with a system designed with your specific income and expense needs in mind. Some offer cloud or browser-based versions, which make it easy for remote employees and auditors to log into the system to perform the work.

Welter Consulting

Whether you are new to nonprofit budgeting or highly experienced at it, if you need assistance choosing your budgeting method, selecting nonprofit accounting software, or moving from spreadsheets or another software to a new nonprofit-specific accounting platform, contact Welter Consulting. We are happy to help.

Welter Consulting bridges people and technology together for effective solutions for nonprofit organizations. We offer software and services that can help you with your accounting needs. Please contact us for more information.

Feb 23
0

Can Artificial Intelligence Become an Accounting Expert?

By | Accounting, Nonprofit | No Comments
person using laptop computer with right hand and holding mobile phone in left hand with Artificial Intelligence screen overlay

An interesting debate has arisen among accounting professionals: Can AI become an accounting expert?

AI has been around for several years but exploded into the national consciousness in November of 2023 when Microsoft unveiled ChatGPT. This generative AI platform uses large language models and machine learning to produce natural-sounding text quickly and efficiently.

While many hailed its advent as an exciting time in computer history, others were quick to curb their enthusiasm for GenAI. There are many good uses for it, for example, to summarize transcripts of calls or to create eye-catching headlines. However, AI makes mistakes—plenty of them. We do not believe that it is ready to take the place of an accountant. Here’s why AI makes a terrible accountant.

AI Makes (Sometimes Big) Mistakes

One of the most blatant errors made by ChatGPT was its insistence to a questioner that “no country in Africa begins with the letter K.” When the questioner pointed out that Kenya begins with a K, the response from ChatGPT was a veritable word salad of gibberish. It lacked logic. It lacked discrimination. Worse, the answer was wrong.

Accountants found out the same thing, as have many other professionals. AI’s answers can be wrong. It can draw erroneous conclusions or even “hallucinate.”

AI models return answers that are heavily dependent on how the input question is worded. Questions that are too complex can return poor answers. Ambiguity can also confuse the models and return incorrect responses.

AI also lacks the ability to distinguish source materials as good or bad. Instead, it may view all documents as equal—documents published by the Journal of Accountancy could be viewed with the same gravitas as documents published by Joe Blogger (no offense if that’s your name), who doesn’t have a CPA. The response might be fine, or it might be trained by Joe Blogger’s lack of in-depth knowledge of corporate finance.

Lastly, the models can hallucinate or return gibberish. No one knows why this occurs or even how often it does, but sometimes, question-and-answer sessions with an AI model devolve into peculiarly odd conversations.

AI Lacks Firsthand Experience

Consider how much knowledge and firsthand experience the average accountant possesses. Each human being is unique, and their background and special area of expertise make them well-suited for certain tasks. A nonprofit accountant has a very different background from someone who works for a large accounting firm; each person brings to their task a unique viewpoint or lens through which they see the problems and solutions at hand.

AI models have no such discrimination. They can produce information based on the inputs of their models and the ability to draw conclusions from their databases with newer GenAI models. But they cannot reach out beyond their databases to seek information, have flashes of inspiration, or remember something that can help with an immediate problem. All of these are human attributes, and an AI model cannot replace a human accountant’s flash of inspiration or memory of a similar problem encountered years ago.

Client Confidentiality

Another area that may be problematic is client confidentiality. AI models ingest and retain whatever data is fed into them. Therefore, if you input proprietary client information—say, asking the AI model to summarize the transcript of a client call—it will retain the information. It may use that information to inform a response to someone else. And, while it probably won’t mention your client by name, you certainly do not want confidential information floating around cyberspace forever. Never share anything confidential with an AI model.

What Can AI Do For You?

It seems like everyone is experimenting with AI, and that’s fine. Treat it like an experiment, but do not rely on it for accurate answers to accounting questions. AI may be evolving, but it has a long way to go before taking your place in the corner office.

Welter Consulting

Welter Consulting bridges people and technology together for effective solutions for nonprofit organizations. We offer software and services that can help you with your accounting needs. Please contact us for more information.

Jan 23
0

Best Practices and Tips to Prepare the Statement of Functional Expenses

By | Accounting | No Comments

In nonprofit accounting, the Statement of Functional Expenses is a financial statement that provides detailed information about how an organization’s expenses are allocated to different functional categories. This statement is a key component of the financial reporting for nonprofit organizations, offering transparency and accountability regarding the use of resources. It typically categorizes expenses into three main functional areas including program services, management and general expenses, and fundraising.

The purpose of the Statement of Functional Expenses is to provide stakeholders, such as donors, grantors, and the public, with a detailed breakdown of how the organization is utilizing its resources to achieve its mission. This level of detail helps in assessing the efficiency of the organization’s operations and its commitment to fulfilling its nonprofit purposes.

Nonprofit organizations are often required to include this statement in their financial reports, particularly for compliance with accounting standards and regulations. It contributes to the overall transparency and accountability of the organization’s financial activities.

We’ve put together a list of simple steps to help you prepare an effective, clear, and easily understandable Statement of Functional Expenses.

Step 1: Gather Relevant Data

Your first step is to gather the necessary data for the statement. Understand what you are trying to express, and what data you may need to gather. Identify the sources of data available both internally in your organization and possibly from third party sources. This may include reports available from your own systems as well as surveys, data reports from industry experts, constituent interviews, and more.

Step 2: Organize and Validate

Your next step is to organize the data and validate it. Organizing the data electronically into files and folders on a cloud-based system ensures that everyone working on the statement has access to the same information. Depending on how much information you have, consider various organization aids: a hyperlinked table of contents or spreadsheet to find documents can come in handy when working with a large number of files.

Additionally, you’ll need to validate the data. Check all the facts. Cross-reference data. And be sure that any third-party sources you cite are recent. A good rule of thumb is to use data that’s no older than two years, if possible.

Step 3: Analyze and Interpret

Next, analyze and interpret the data. This step may take the longest, and it should be conducted thoughtfully and carefully to ensure that no erroneous conclusions are drawn from the existing data. You may need to conduct statistical analysis, trend analysis, or draw conclusions from the findings.

Classifying Functional Expenses

Every business must classify expenses. Nonprofits face an added challenge because the classification of functional expenses assigns a “why” to every dollar spent. Consider how you classify expenses. A great way to begin is to reference your organization’s mission statement. By identifying the value of each expense as it pertains to your mission, you’ll naturally create direct links between expenditures and mission in an honest and accountable way.

If you organization is undergoing a nonprofit audit, you must present expenses by functional area as part of your accounting. A CPA must include a statement saying that the financial documents were prepared according to generally accepted accounting principles (GAAP).

Tracking functional expenses by category and preparing the statement of functional expenses is both a necessary compliance step and a further step for organizational transparency. By working with your CPA and helping prepare these statements, you’ll help ensure accuracy, transparency, and value for your constituents.

Welter Consulting

Welter Consulting bridges people and technology together for effective solutions for nonprofit organizations. We offer software and services that can help you with your accounting needs. Please contact us for more information.

Jan 16
0

The Art of the Close: Closing Best Practices

By | Accounting | No Comments
people using a laptop computer, calculator, and clipboard and pointing at screen

Like most accounting tasks, there are best practices pertaining to closing. In a recent presentation, we shared our experience with closing, as well as best practices. This article shares that information, and we’ll continue sharing more next month so that you too can have the latest accounting best practices.

Three Types of Closing

In accounting, there are various approaches to closing financial records, each serving distinct purposes.

The first method is the “No Close” approach, where the books are intentionally left open, allowing for adjustments to be made, as necessary.

Another technique is the “Soft Closing” or “Pre-Closing” of a fiscal year, which safeguards the integrity of account balances by restricting any transaction postings to that specific period. Soft closing permits the reopening of fiscal years or periods if needed.

“Hard Closing” involves permanently preventing any postings to a fiscal year. Lastly, a combination of both “Soft and Hard Closing” strategies may be employed to strike a balance between maintaining flexibility for adjustments and imposing more stringent closure measures for certain periods. Each type of closing method offers its own advantages and is chosen based on the specific requirements and preferences of the organization.

When Should You Close Accounts?

The frequency and due dates for closing procedures in accounting are flexible, allowing organizations to tailor their approach based on specific needs. Not every step in the closing process needs to be completed each month, offering adaptability. Organizations can opt for a monthly, quarterly, or annual close step, depending on factors such as the volume of transactions, the complexity of the organization, and the efficiency of the accounting system(s). This approach ensures that the closing process aligns with the unique requirements and operational characteristics of each organization.

Barriers to Effective Closing

Several potential barriers or hurdles may impede the completion of the closing process in accounting. One significant challenge arises from system or software limitations, where the existing tools may lack the necessary capabilities for a smooth and efficient closing. This can hinder the overall process and necessitate workarounds or additional manual efforts.

Another obstacle is the lack of time to set up a Close checklist. The demands of other priorities may leave little room for the meticulous planning and organization required for an effective closing procedure. This time constraint can result in oversight and errors during the process.

Adjustments pose another challenge in closing the books. Unforeseen changes or corrections may be needed and addressing these adjustments can be time-consuming and complex. Late invoices or receipts further compound the issue by introducing delays and potentially disrupting the entire closing timeline.

The existence of separate systems that do not interface and require manual entry creates a considerable barrier. This not only adds to the workload but also increases the likelihood of errors, as information must be transferred manually between systems.

Closing isn’t for perfectionists. Although you want to be as accurate as possible, perfection isn’t the goal, and striving for absolute accuracy may lead to excessive scrutiny and time spent on minor details, potentially delaying the overall completion of the books.

Moreover, a lack of understanding about reconciliations and closing procedures among team members can impede progress. Adequate training and communication are essential to ensure that everyone involved comprehends the importance and intricacies of the closing process.

Staff shortages or absences during key times can be a significant hurdle. The unavailability of essential team members can disrupt the workflow and lead to delays in completing the necessary tasks.

Finally, if it takes too long to close the books each month, it can become a substantial barrier. Inefficiencies in the closing process may result in a drain on resources and can hinder the organization’s ability to respond promptly to financial insights and changes. Addressing these potential barriers requires a proactive approach, including system improvements, time management strategies, and ongoing training to enhance overall efficiency in the closing process.

More Tips for Effective Closing

In our next installment, we’ll share best practices for effective closing. If you have any questions about closing your accounts, let us know. We’re here to help!

Welter Consulting

Welter Consulting bridges people and technology together for effective solutions for nonprofit organizations. We offer software and services that can help you with your accounting needs. Please contact us for more information.