While your nonprofit’s mission is driven by its programs, its people, and its commitment to community impact, the fuel that powers all of these efforts is sound financial management.
Unlike for-profit institutions, your nonprofit has to manage funding that often comes with donor restrictions, adhere to unique regulatory standards, and prioritize public transparency. This additional complexity requires specialized expertise and a proactive approach.
By adopting a few fundamental best practices, your organization can move beyond merely tracking income and expenses to strategically managing its resources for maximum impact. Let’s explore some essential nonprofit financial management best practices to help you get started.
1. Establishing a Foundation: Team, Policies, and Controls
The cornerstone of financial health is a well-defined structure for handling your organization’s funds. This structure must address both the personnel responsible for financial management work and the internal controls that safeguard assets.
Assemble a Competent Financial Team
Sound financial management requires a dedicated team with clearly defined roles. This team typically includes a board treasurer for oversight, a CFO for strategic financial planning and forecasting, and an accountant and bookkeeper responsible for day-to-day transaction recording and reporting.
To fill the roles of CFO, accountant, and bookkeeper, you can either hire in-house or outsource these functions to a nonprofit-specific financial management firm, depending on your needs and budget.
Each member of this team provides a crucial layer of expertise and accountability, improving efficiency and minimizing the risk of human error by incorporating systems of checks and balances.
Implement Strong Internal Controls
Financial health is synonymous with security and preparedness. Establishing clear financial policies and procedures is a critical step in providing day-to-day oversight, ensuring that everyone who handles your nonprofit’s funds does so correctly. These policies should cover topics like gift acceptance, expense reimbursement, and conflicts of interest.
Alongside policies, your organization should also develop robust internal controls, which are smaller, specific guidelines designed to prevent unintentional errors, financial malfeasance, or even data security threats. A common internal control, for instance, is requiring two team members to sign off on payments over a specific threshold.
These controls are an integral part of comprehensive risk management, which Jitasa’s risk management guide defines as “the process of identifying, evaluating, mitigating, and preventing negative situations that could impact your nonprofit.”
2. Mastering Compliance and Transparency
Compliance and transparency are non-negotiable for nonprofits. They are key drivers of public trust and are legally required to maintain tax-exempt status.
Maintain Timely Tax Filing
Filing an annual tax return via IRS Form 990 is perhaps the most critical compliance obligation for 501(c)(3) organizations. Depending on its size and status, your nonprofit may complete the full Form 990, the private foundation-specific Form 990-PF, or one of the shorter versions designed for smaller organizations (Form 990-N or Form 990-EZ). Ask your accountant if you’re unsure about which one to file.
Timely annual filing offers crucial benefits, chief among them the retention of your tax-exempt status. Losing this status by failing to file a federal tax return for three consecutive years not only requires a time-consuming re-filing process but also removes the powerful tax-deductibility incentive for donors (and often lowers their confidence in your organization).
Communicate Openly With Stakeholders
Transparency is a powerful tool for cultivating donor trust. Form 990s are a great starting point for financial transparency because they’re required to be publicly available for at least three years after filing. Therefore, they allow supporters to see your nonprofit’s most important financial details.
Additionally, comprehensive financial statements can provide deeper insight to your nonprofit’s key stakeholders when you’re willing to share them. These documents communicate essential information about your financial health, help to establish long-term viability, and demonstrate that you’re using funding responsibly to fulfill your mission.
Consider sharing these four statements via your nonprofit’s website or annual report:
- Statement of Financial Position: A snapshot of your organization’s assets, liabilities, and net assets (equity) for a given year.
- Statement of Activities: An overview of your organization’s revenue, expenses, and annual change in net assets.
- Statement of Cash Flows: A report that details the flow of cash into and out of your organization over a specific period (either monthly or annually), explaining the change in its cash balance from the beginning to the end of the reporting period.
- Statement of Functional Expenses: A detailed table that organizes all expenses by both their function (how they support your nonprofit’s mission) and their natural classification (the type of expenditure).
Conduct Independent Financial Audits
While it’s only required in some cases, conducting an independent financial audit of your nonprofit is one of the most powerful ways to validate your organization’s financial reporting and demonstrate integrity to funders and the public. An independent audit is an objective examination of your financial data and reports by a third-party professional to ensure adherence to regulations and effective overall financial management.
Preparation is key to a successful audit. Maintain clean, organized financial data, including resolving discrepancies ahead of time. Post-audit, your nonprofit should use the findings to improve accounting practices, increase reserve funds, and inform future budgeting.
3. Strategies for Long-Term Financial Sustainability
Financial health requires a continuous, evolving strategy focused on stability and growth. Two essential pillars are revenue diversification and reserve fund management.
Diversify Revenue Streams
Relying too heavily on a single funding source leaves your nonprofit vulnerable to economic shifts or changes in philanthropic trends. A diversified funding model is a hallmark of effective financial management and promotes stability by incorporating individual donations, grants, corporate philanthropy, investment returns, earned income, and other sources.
For example, your nonprofit likely brings in most of its individual donation revenue from major donors. To ensure continued support from these high-value supporters, consider promoting non-cash giving options such as stock or real estate donations, while expanding your planned giving program alongside major gifts. Through this diversification, you give donors more flexibility when contributing large amounts, making them more likely to give.
Build and Manage Operating Reserves
Financial flexibility is crucial for navigating unexpected challenges, such as economic downturns or unanticipated expenses. A healthy operating reserve provides your nonprofit with this flexibility, since it allows your nonprofit to keep covering basic costs if regular revenue streams are temporarily disrupted.
Double the Donation’s guide to nonprofit operating reserves recommends keeping three to six months’ of basic expenses on hand. This helps ensure your organization is resilient enough to continue its work without interruption.
Beyond reserves, proactive cash management is key to achieving true financial stability for your nonprofit. This involves practices like strategically managing a nonprofit investment portfolio and simplifying complex non-cash donations like stocks and cryptocurrency to maximize resources and grow long-term assets.
Sound financial practices are essential for maximizing mission impact. By focusing on strong internal controls, transparency, compliance, and strategic revenue diversification, your nonprofit can build the resilience needed to serve your community for years to come.
