9 Best Practices for Strong Nonprofit Financial Management
Smart money moves are vital for nonprofits. You’ve got to use funds wisely, aligning with your mission and honoring donor intentions. The laws—and the trust of your donors and funders—say so.
But staying financially solid while also being nimble enough to handle surprises like recessions and weather events is hard even for the most seasoned nonprofit.
Modern technology and clear rules are key to strong nonprofit financial management. They help your organization measure impact, follow regulations, and show donors you’re on top of the needs of your community.
But how do you perfect your nonprofit financial management? Here is what you need to know to strengthen your financial savvy and keep your nonprofit on a strong financial foundation.
What is Nonprofit Financial Management?
Nonprofit financial management is the process of managing the money that flows through your not-for-profit organization. It involves planning, tracking, and reporting on your income and expenses, as well as ensuring that you comply with the rules and regulations that govern your nonprofit status. Nonprofit financial management also includes the structures and workflows that enable your finance team to operate efficiently and effectively.
Strong nonprofit financial management includes:
- Planning and budgeting: setting your financial goals and allocating your resources accordingly
- Tracking income and expenses: recording and categorizing every transaction by fund so you can clearly show donor intent and grant compliance
- Accounts payable and vendor management: paying your bills on time and maintaining good relationships with your partners, such as pass-through grantees and suppliers
- Reporting and analysis: generating and reviewing financial statements and other reports that show your impact and stewardship
- Technology that supports it all: using software and systems that automate, integrate, and simplify your financial workflows
What Does Strong Nonprofit Financial Management Look Like?
In a perfect world, your budget will always be balanced. You will always get the grant and donors will never churn. While that’s not reality for any nonprofit, strong financial management enables you to plan for and weather just about any situation.
When your organization has strong financial management processes, you will have a clear understanding of how your money is spent and how your expenses align with your mission and strategy. You’ll be able to follow consistent and transparent processes for managing your income and your expenses and leverage technology to automate, streamline, and improve your financial workflows and data quality.
By following nonprofit financial management best practices, you will be able to proactively identify and plan for disruptive scenarios and mitigate their impact on your operations and programs. And you can clearly communicate your financial results and impact to your stakeholders with confidence.
Here are 9 best practices to help your organization develop strong nonprofit financial management.
1. Know Your Funding Types
One of the first steps to strong nonprofit financial management is to understand your funding sources and how they affect your financial planning and reporting. Depending on your organization’s focus and activities, you may have different types of funding, such as grants, contracts, donations, program fees, sponsorships, or merchandise sales. Each type of funding may have different restrictions, reporting requirements, and expectations from your funders.
Why this is important
Knowing your funding types will help you:
Manage restricted revenue: If you receive grants or donations that are earmarked for specific purposes, you need to track how you use those funds and report back to your funders. Failing to do so may result in penalties, loss of funding, or damage to your reputation.
Get detailed analytics: By tracking your income by funding type, you can see how each program or grant is performing, identify the costs and benefits, and see where there are the opportunities. This will help you make informed decisions and optimize your resource allocation.
Provide clear reporting: Different funders may have different expectations and formats for reporting. By knowing your funding types, you can tailor your reports to meet the needs and preferences of your donors and funders, from detailed reporting for government grants and contracts to showing impact in your annual report.
How to do it
Pull a list of your income sources from your accounting system or fundraising software. Identify if the sources are tied to strict reporting requirements and regulations, such as government grants or corporate sponsorships, or aligned more with meeting donor intent and highlighting general impact, such as individual donations and unrestricted gifts.
2. Track Your Revenue by Fund
As a nonprofit organization, you have a duty to your funding partners and your community to use your revenue to drive your mission. You can’t provide that transparency if all your funds are lumped together in one account. You need to track your revenue by fund, so you can see how each dollar is spent and how it contributes to your outcomes.
Why this is important
Tracking your revenue by fund will help you:
Ensure Compliance: Tracking your revenue by fund will help you avoid overspending or underspending on a program or grant and make sure that you comply with the terms of your funding agreements.
Make Data-Driven Decisions: You can get insights into your income and expense patterns, your cash flow, and your sustainability. You can see which programs or grants are generating the most revenue, which ones are costing the most, and which ones have the best return on investment. You can also identify any gaps or risks in your funding streams, and plan accordingly.
Show Impact: Tracking your revenue by fund will enable you to show how each fund is performing, how it aligns with your mission and goals, and what impact it has on your community. You can also customize your reports to meet the specific needs and preferences of each funder.
How to do it
Create a separate account for each fund in your segmented chart of accounts and assign each transaction to the appropriate fund. This will help you keep track of your income and expenses for each fund and avoid mixing restricted and unrestricted funds.
Use fund accounting software that can handle multiple funds and sub-funds. Integrate your fund accounting with your fundraising software to ensure data consistency and accuracy across your systems.
3. Streamline Your Expense Management
Managing your expense management can be time-consuming and error-prone, and it’s just as important as tracking your income. By streamlining how your team submits expenses and how you approve them, you can save time, minimize manual data entry, and have an audit trail for all your payables.
Why this is important
Streamlining your expense management will help you:
Save time: By automating your payments and approvals, you can reduce the amount of manual work involved in your expense management. You can also speed up the processing and reconciliation of your invoices and receipts, avoiding late fees and closing your books faster.
Minimize errors: When your expense management system integrates with your fund accounting, you can eliminate the need for double entry and reduce the risk of data entry errors. You can also ensure that your expenses are accurately categorized and allocated to the correct funds and programs.
Build a clear audit trail: Using a system that records and tracks every payment and approval gives you a complete and transparent history of your transactions. You can also attach supporting documents, such as invoices, receipts, and contracts, to your transactions, and access them easily when needed. This will help you comply with audit requirements and funder expectations.
How to do it
Use a system that makes it easy for your team to submit and approve expenses. Give your team members access so they can upload receipts directly. You can also create approval workflows that match your internal controls and send notifications and reminders to your approvers.
Integrate your expense management with your fund accounting to sync your data across your systems and avoid duplication and inconsistency. Use purchase cards or a system that creates credit card feeds directly into your expense management. Automatically allocate your expenses to the appropriate funds and programs based on predefined rules and criteria.
4. Use Scenario Budgeting
Nonprofits must withstand inflation, changing political policies, economic shifts, and the increasingly unpredictable climate. While all nonprofit budgets start with the best of intentions, it’s always good to have a plan B, C, and D to help account for the unexpected. Scenario budgeting is a technique that allows you to create different versions of your budget based on different assumptions and contingencies.
Why this is important
Using scenario budgeting will help you:
Plan for the unexpected: By creating different scenarios for your budget, you can anticipate and prepare for various situations that might affect your funding and spending. For example, you can create a best-case scenario, a worst-case scenario, and a most-likely scenario, and see how they differ from your original budget. You can also create scenarios based on specific events, such as a major grant award, a climate event, or an increased demand for your services.
Forecast and manage your cash flow: By using scenario budgeting, you can project your cash flow for each scenario, and see how it compares to your actual cash flow. This will help you identify any potential shortfalls or surpluses so you can adjust your plans accordingly. You can also use scenario budgeting to test the impact of different strategies, such as increasing your fundraising, cutting your expenses, or diversifying your revenue streams.
How to do it
If your fund accounting system allows for multiple budget scenarios, copy your original budget and modify it based on different assumptions and contingencies, or create a new budget from scratch for each scenario.
If your fund accounting software does not allow for budget scenarios, export your current budget to a spreadsheet and run scenarios on different tabs. It’s not as integrated and easy to manage, but it can still provide some planning benefits.
5. Build Detailed Reporting
At the core of every nonprofit organization is a mission. With clear reporting, you can understand how you are driving impact toward that mission, what is working, and what you need to change. Reporting is not only a compliance requirement, but also a communication tool that helps you engage and inform your stakeholders.
Why this is important
Building detailed reporting will help you:
Show your impact: Demonstrate how you are fulfilling your mission and delivering value to your community. You can also use reports to identify your strengths and weaknesses and evaluate your effectiveness.
Ensure compliance and stewardship: By creating reports that follow the standards and expectations of your funders and regulators, you can show that you are complying with funder restrictions. You can also use reports to show that you are using your funds according to the donor directive and the public trust.
Influence decisions and actions: Provide relevant and timely information to your internal and external stakeholders to help them make data-driven decisions. You can use reports to inform and educate your board, staff, donors, volunteers, and partners, and inspire them to support your cause and goals.
How to do it
Take advantage of pre-built reports to get quick details on your current financial position. These make for good dashboards, so you see your budget vs. actuals, statement of activities, and spending for a specific program right when you log in to your fund accounting system.
Learn how to build customized reports that give you complete control over the analysis you can get from your system. Whether that’s Insight Designer in Blackbaud Financial Edge NXT or plugging into PowerBI, understanding how to build these in-depth reports can elevate the information you get and the decisions you can make.
Link your financial data to your non-financial data, such as fund accounting software that has a performance management feature or an outcome measurement tool. You can use a system that lets you connect your income and expenses to your objectives, indicators, and outcomes so you can clearly show your impact and return on investment.
6. Create an Operating Reserve
Your operating reserve is your organization’s emergency fund. It is the amount of money that you have available to cover your expenses in case of unexpected events or situations that disrupt your normal operations. It’s also there to allow you to strategically capitalize on opportunities to grow or meet your mission. Having an operating reserve can help you manage the uncertainty and volatility that nonprofits often face.
Why this is important
Creating an operating reserve will help you:
Weather emergencies (climate and otherwise): Nonprofits have notoriously unpredictable funding streams and evolving community needs. Having an operating reserve can help you cope with unexpected events, such as a natural disaster, a funding cut, or a sudden increase in demand without disrupting your programs and services.
Take advantage of opportunities: Having an operating reserve can also help you seize opportunities that may arise, such as a bulk purchase of needed supplies to get a discount.
Build trust and confidence: An operating reserve can also help you demonstrate your financial stability and sustainability to your stakeholders, such as your board, staff, donors, funders, and regulators, and increase their trust and confidence in your organization.
How to do it
Understand how much you need. There is no one-size-fits-all formula for calculating your operating reserve, but a common rule of thumb is to have at least three to six months of operating expenses in your reserve. However, you may need more or less depending on your organization’s size, risk profile, cash flow, and goals.
Create a plan to fund it. There are different ways to build your operating reserve, such as setting aside a percentage of your annual surplus, allocating a portion of your unrestricted donations, or creating a designated campaign to fund your reserve. You can also seek external sources of funding, such as grants, loans, or investments, to boost your reserve.
Establish a policy for its use and replenishment. To ensure that your operating reserve is used wisely and effectively, you need to create a policy that defines the purpose, target level, sources, and uses of your reserve. You also need to specify the circumstances and criteria for drawing from and replenishing your reserve, and the roles and responsibilities of those involved in the decision-making process.
7. Build Strong Internal Control Policies
As a nonprofit, you need the trust of your donors, funders, volunteers, and staff. Internal controls help you ensure that your financial activities are consistent, accurate, and compliant, and that trust in your organization is warranted.
Why this is important
Building strong internal controls will help you:
Ensure accuracy and consistency: Strong internal controls help reduce the risk of errors, fraud, or mismanagement in your financial transactions and records. Your data is more likely to be reliable and complete, and your reports are timely and accurate. Strong internal controls also help mitigate fraud, either from bad actors or innocent staff mistakes.
Comply with regulations: When you have organizational buy-in of your internal controls, you can guarantee compliance with the standards and expectations of your funders, regulators, and auditors. You can also avoid penalties, fines, or sanctions that may result from non-compliance.
Protect your reputation: With strong internal controls, you can demonstrate your accountability and transparency to your stakeholders and increase their confidence in your organization.
How to do it
Create board policies for key areas, such as conflicts of interest, separation of duties, whistleblower protection, and gift acceptance. These policies should define the principles, rules, and expectations for your organization’s governance and oversight.
Create operational policies for key processes, such as budgeting, cash management, accounts payable, accounts receivable, payroll, and reporting. These policies should define the steps, roles, and responsibilities for your organization’s financial operations and controls.
Review and update your policies regularly, and communicate them to your board, staff, and other stakeholders. You should also monitor compliance with your policies and address any issues or gaps that may arise.
8. Establish a Strong Relationship with Your Auditor
With strong nonprofit financial management, audits are no longer a process to be feared but an opportunity to improve. A relationship with your auditor can help you get ahead of regulatory changes and provide a third-party perspective on potential updates to your financial processes.
Why this is important
Establishing a strong relationship with your auditor will help you:
Make your audits streamlined and (mostly) painless: Regular communication and collaboration with your auditor helps you prepare for your audits more effectively and efficiently. You can also avoid surprises and delays and resolve any issues or questions quickly.
Use their expertise to your advantage: Leveraging the knowledge and experience of your auditor for insights and recommendations. You can also use their feedback to improve your financial management and address any risks or challenges that may affect your organization.
How to do it
Choose an auditor that understands your organization and has a proven track record of working with nonprofits. You should also choose an auditor that is independent, objective, and has a good reputation among your peers.
Schedule regular check-ins throughout the year, not just during the audit season. You should also share any relevant information or updates with your auditor, such as changes in your funding, programs, policies, or systems.
Seek their input on any financial issues or questions that you may have, such as new accounting standards, reporting formats, or internal controls.
9. Leverage Technology for Greater Impact
Nonprofits have to do more with less. From automation to machine learning to integrations with your other systems, your software saves you time and gets you the information you need faster.
Why this is important
Leveraging technology for greater impact will help you:
Simplify workflows: By using software that automates, streamlines, and integrates your financial tasks, you can reduce the amount of manual work involved in your financial management. You can also improve your data quality and avoid duplication and inconsistency.
Show more accurate outcomes: You can use these technologies to generate better insights, predictions, and recommendations. The right technology will support your decision-making and planning.
Build more transparency: With view-only access, dashboards, and reports, you can increase your financial visibility and accountability. You can also share your financial information and impact with your stakeholders and engage them in your mission and goals.
Break down silos: By using software and systems that connect your core functions, such as fundraising, program management, and outcome measurement, you can break down the silos that often exist in nonprofits. You can also create a holistic view of your organization and align your strategies and actions across your departments and teams.
How to do it
Use fund accounting software that can handle all your nonprofit financial needs, such as planning, tracking, reporting, and analysis. Look for software that can integrate with your other systems, such as fundraising, and provide a seamless user experience.
Your software should constantly be improving and incorporating new technology, such as AI and machine learning. Similarly, there should be a way for current clients to suggest improvements and functionality they would like to see.
Strong Nonprofit Financial Management Starts with Fund Accounting Software
When you are just getting your nonprofit off the ground, you can manage with free software and spreadsheets. But as your organization grows, so does your chart of accounts, and suddenly you are drowning in Excel formulas and manual processes. Not sure if you are ready to make the jump to software built for nonprofits, check out our white paper, Why Nonprofits Need Nonprofit Accounting Software
