4 Common Fund Accounting Mistakes and How to Avoid Them

Your nonprofit has different goals and purposes than businesses do, and your accounting should reflect that. Where commercial accounting focuses on profitability, fund accounting centers around accountability, ensuring your nonprofit can track designated funds and allocate them appropriately across different initiatives.

Keeping track of how you direct all your organization’s funds is key, especially when large-dollar funders and donors often place restrictions on how they intend for your nonprofit to use their money.

Managing these restrictions can be tricky at first, so let’s explore some of the most common missteps and how to prevent them at your organization.

1. Pursuing the Wrong Restricted Contributions

Some kinds of revenue are more likely to be restricted than others, including endowment contributions, grants, sponsorships, and major gifts. If you don’t pursue the right restricted funds, you can overfund some areas of your work and fall short on other expenses.

As a member of the finance team, you should work with your development team to be strategic as you seek restricted funds. Here is how you can ensure restrictions on different funding types align with your needs:

• Major and planned gifts: Conduct thorough research on prospective donors. If your organization receives a major gift with restrictions, you want to be sure that you can actually put it to use. Meet with prospective donors to let them tell you about their priorities, see if these values align with your nonprofit’s, and prioritize your donor cultivation efforts accordingly.
• Grants: When looking for grant opportunities, work with your grant team to read application requirements and review funding disbursement information carefully. The grant application and management process can be very involved, so only apply for grants that align with your current needs to ensure you’ll benefit from any funding you win.
• Sponsorships: Approach companies whose values align with the campaign you want them to contribute to and have backup plans in mind if they’d like to provide goods or services instead of fiscal support. For instance, if a local grocery store didn’t want to buy a fiscal sponsorship package for your nonprofit’s upcoming 5K, you might suggest that they donate water bottles and snacks for participants to enjoy.

Remember that fundraising and financial management should work side by side to further your organization’s mission.

2. Mixing Restricted and Unrestricted Funds in Accounting Records

Be careful not to combine different categories of funding in your financial records.Confusion between restricted and unrestricted funds makes you more likely to misallocate restricted contributions, which can have major consequences such as IRS fines, donor lawsuits, and broken trust with your donor base.

A few ways to keep restricted and unrestricted funds separated include:

• Use dedicated nonprofit accounting software. Because fund accounting differs from commercial accounting, you might run into trouble using conventional accounting software right out of the box. Seeking out a designated nonprofit accounting system will help you avoid mix-ups between various categories of funds.
• Maintain an up-to-date chart of accounts. A chart of accounts is a directory that organizes assets, liabilities, net assets, revenue, and expenses into a single table. Keeping an updated directory of all your organization’s financial accounts (including separate designations for restricted funding) allows you to effectively manage all funds and quickly generate financial reports.
• Work with financial professionals who have nonprofit experience. When hiring for your organization’s financial team, look for candidates who know their way around accounting for nonprofits. If your current financial management team lacks this expertise, consider supporting them by putting them through a nonprofit accounting course or bringing in other experienced professionals to help show them the ropes.

Another good rule of thumb to follow is to make sure to budget restricted funds first, so that you can be certain your organization is using them as intended. From there, you can move on to allocating unrestricted funds to cover any of your nonprofit’s other needs.

3. Keeping Restricted Fund Contributors in the Dark

Donors and funders restrict their contributions because they want their money to make a specific impact on your mission. It’s up to your nonprofit to keep them informed about how their support makes a difference. This transparency also assures donors and funders that their contributions are only going toward the designated initiative.

Show them you’re making that impact by:

• Publishing financial statements. These reports should detail restricted fund usage and appear in your annual report and on your website. Your essential nonprofit financial statements will be reports of your organization’s activities, financial position, cash flows, and functional expenses. Creating financial statements will also help your nonprofit comply with IRS regulations and the Generally Accepted Accounting Principles (GAAP).
• Providing personalized impact updates. In addition to general financial statements, you should directly contact contributors of restricted funds to share information about the progress of the initiatives they support. These check-ins help express that your nonprofit appropriately manages their contributions and uses them to make a difference.
• Taking mandatory grant reporting seriously. Many grantmakers ask for documentation about the use of their contributions. This especially matters when your nonprofit receives a grant with contingencies, where funding is paid out in installments based on whether your organization meets certain conditions. If the grantmaker requires you to submit reports to be able to submit the next installment of the grant, it is crucial that you update them thoroughly on your grant’s progress.

Financial transparency can lead to more funding down the line and a general reputation boost for your organization, since donors and grantmakers will know that your nonprofit respects their wishes.

4. Not Making Provisions for Temporary Restrictions

In addition to separating restricted funds from unrestricted revenue,you should differentiate between permanently and temporarily restricted funds in your fund accounting. This means staying on top of funds that are designated for a specific purpose in perpetuity versus those that have a set time frame. Even though FASB simplified its standards to only focus on restricted and unrestricted, some restrictions can still be temporarily restricted, and it’s important to track them.

Endowments are the most common type of permanently restricted fund. Generally, one or more donors make a large principal donation to your organization, which goes into an investment account. The interest that contribution generates then funds a designated ongoing initiative while the principal remains intact. As you manage endowment funds, you should provide reports and updates to build trust with all stakeholders involved in the endowment.

On the other hand, grants, major gifts, and sponsorships often fall under the category of temporarily restricted funds. Your organization must use these contributions for their intended purpose until the project specified by the donor ends or an agreed-upon timeframe elapses.

When you receive a contribution with temporary restrictions, some funds may remain after the donor’s designation ends. For instance, if your nonprofit receives a major gift to renovate its facilities and the work comes in under budget, you will have some of the previously restricted funds left over.

This is why it is important to discuss “leftover” scenarios when making temporarily restricted contribution agreements with donors or funders—they might:

• Want the extra money back. With strong fund accounting practices in place, you will be able to return any leftover money to the donor or funder at the end of the specified project or timeframe.
• Have another initiative in mind that they want to put the money toward. Speak with donors to learn what other programs align with their values. Agree upon the initiative where you would allocate any remaining funds ahead of time, so that you can redirect them there when the time comes.
• Release the funding from restriction so you can spend it freely. In this situation, your nonprofit’s primary concern will be seeing the initiative through to its completion or end date before allocating funds anywhere else. However, once leftover funding is released, you can put it toward any program that needs additional revenue or even spend it on overhead!

Making arrangements early will ensure you aren’t scrambling later, but keep in mind that you should try to use as much of a contribution as possible for the original initiative.

Effectively Navigate the Complexities of Restricted Funding

By strategically pursuing restricted funds, keeping restricted and unrestricted funds separate, updating contributors, and planning for temporary restrictions, your nonprofit can effectively navigate the complexities of fund accounting. To make sure that your organization is on the right track, review your current accounting practices, make adjustments and software updates wherever necessary, and ensure you have a strong team managing your finances.

Looking to dig into the details of fund accounting, such as reconciliation, reporting, and internal controls? Check out the Fund Accounting Best Practices Guide.