Mastering Nonprofit Financial Statements: A Step-by-Step Guide (+ template)

Nonprofits are critical in making the world a better place for the communities they serve. Advancing your mission and doing change-making work is about managing how funds flow from supporters to impact.

Four key financial statements are essential for nonprofits to master for strong decision-making. Beyond the IRS requirement for tax-exempt organizations, efficient reporting opens the door to stakeholder trust and strategic decision-making.

Learn everything you need to know about nonprofit financial statements below, including:

• What are nonprofit financial statements, and why are they necessary?

• A deeper look into the four major nonprofit financial statements

• Sample nonprofit financial statements

• Tips to create financial statements for your nonprofit

• How to choose software to simplify the process

What is a nonprofit financial statement?

A nonprofit financial statement summarizes financial information for a given year. Nonprofits must complete four financial statements, which we'll detail below.

These documents fulfill tax requirements but have many additional benefits for nonprofits who want to stay organized. A more detailed view of how funds are utilized can support financial planning.

Each financial statement offers a unique view into how a nonprofit operates today and what opportunities exist for the future. The outcome is real-time data to inform strong decision-making that best serves the mission.

Why are nonprofit financial statements necessary?

You may wonder why nonprofits have a designated set of financial statements and what other purposes they serve. The following reasons will help you see the benefits before we dig into the statements themselves.

IRS requirements

Form 990 is a required document that all tax-exempt organizations must file with the IRS annually. It pulls information directly from the four financial statements we're discussing today.

Staying on top of your financial statements throughout the year can simplify tax season. More importantly, you'll maintain accuracy on these critical tax forms to avoid penalties.

Donor trust

Today's donors give as an extension of their identity to causes that mean a lot to them. They seek a deeper connection to nonprofits they'll continue supporting, and trust is paramount.

Your financial statements serve as a way to establish transparency among your donors. By showing the public exactly how donation dollars are being used and when you're involving them on a much deeper level.

You may share portions of your financial statements as part of your nonprofit annual report. That way, you can build momentum among current donors and recruit new supporters.

Stakeholder relationships

Donors aren't the only relationships that benefit from staying on top of financial statements. You can directly impact a few stakeholder categories by bringing that same level of trust and transparency through reporting.

• Board members: It's easier to retain and recruit board members when they can access accurate and organized financial reporting at any time.

• Grantmakers: When applying for a nonprofit grant, your financial statements will be a tremendous asset to showcase your operations and sound strategies.

• Corporate sponsors: Organizations are more likely to partner with your nonprofit and sponsor fundraisers when they clearly understand your financial stability.

Strategic decision making

Data-driven decisions can only benefit your nonprofit. Financial information broken out through various lenses will give you the most complete picture of fiscal health.

Whether you have an in-house leadership team invested in your finances or work with an external accounting firm, accurate statements will show you the best path forward.

Financial statements can contribute to decisions like:

• Annual fundraising goals

• Grant applications

• Timelines for critical projects and programs

• Major donor strategies

• Campaign diversification

• Growth projections

The 4 major nonprofit financial statements

Now, let's dive into these financial statements we've been referencing so far. Below, you'll learn about the value of each, what information to report, and how they work together to keep your nonprofit financially sound.

The Statement of Financial Position

The Statement of Financial Position is a nonprofit's version of the balance sheet. The goal is to summarize where your nonprofit stands financially at a certain point in time.

This snapshot will give you the best look at what you own, owe, and what's available today.

Key reporting criteria:

• Assets: Consider any resources you own with economic value. Current assets are cash and anything you expect to convert into cash to use within the year, such as inventory or e-commerce merchandise.

You should also include non-current assets on your Statement of Financial Position. That includes long-term investments, property, equipment, and anything else you expect to convert into something other than usable cash within the year.

• Liabilities: Think about anything your nonprofit may owe or upcoming payment obligations. You can see liabilities as current and non-current, just like you did for assets.

Current liabilities, such as short-term loans or accounts payable, are due within the year. Non-current liabilities are any long-term debt or payments owing after the current year you're reporting on.

• Net assets: This is where you can see your assets' residual interest after you deduct any liabilities. Essentially, net assets will show you where you stand after you earn revenue and pay off debts within the year.

There are a few different types of net assets to understand:

• Unrestricted net assets: No donor restrictions, and can be used by your nonprofit immediately

• Temporarily restricted net assets: May have donor-imposed restrictions that limit how and when funds can be used

• Permanently restricted net assets: Donor restrictions exist and significantly limit how your nonprofit uses funding

The Statement of Activities

The Statement of Activities examines revenue and expenses in a specific period to evaluate program effectiveness. You'll also track changes to the net assets you reported in your Statement of Financial Position.

This is similar to a for-profit income statement, with elements tailored to suit nonprofit accounting principles. The goal is to see how you're generating revenue, spending funds, and operating to maintain a healthy net asset ratio.

Key reporting criteria:

• Revenue: Look at any source of income for your nonprofit, including:some text
  • Donations: Any monetary contribution from individual donors, corporations, and foundations
  • Grants: Any funding you receive as a gift from private and public foundations, government entities, and other grantmaking organizations
  • Program service revenue: Any income you receive from services your nonprofit provides
  • Membership dues: Any income you receive from membership fees
  • Investment income: Any money you earn from gains or losses on investments and their associated dividends and interest
  • Other income: Anything that doesn't fall into a category above
  • Expenses: The cost of operating across various nonprofit activities, including:some text
    • Program services: Costs incurred to execute programs, campaigns, and other mission-driving activities for your nonprofit
    • Supporting services: Costs incurred to manage and operate your nonprofit, such as accounting, marketing, legal, or other administrative functions
    • Change in net assets: A demonstration of the impact revenue and expenses have on net assets, broken out by unrestricted, temporarily restricted, and permanently restricted
    • Beginning and end of period net assets: A look at where net assets began and where they land after subtracting changes

    The Statement of Functional Expenses

    The Statement of Functional Expenses details expenses you report on your Statement of Activities by the function they serve. This document is vital to building trust with stakeholders who can easily view how you're utilizing resources.

    A window into how each function of your nonprofit generates expenses will help you budget accordingly. You'll also be able to demonstrate compliance with nonprofit accounting regulatory requirements.

    Key reporting criteria:

    • Program or supporting services: The first step to completing your Statement of Functional Expenses is to classify costs by program services (directly related to carrying out your programs and mission) and supporting services (not directly related to a specific program, but supporting operations like fundraising and staffing).
    • Further classification: After determining program and supporting service expenses, you can classify each line item into highly-specific categories such as:some text
      • Salaries and wages
      • Rent and utilities
      • Supplies and materials
      • Professional service fees
      • Travel and meetings
      • Depreciation of assets
      • Office expenses

      The more specific you can be, the more accuracy you'll offer through your statement to inform decision-making and stakeholder transparency.

      The Statement of Cash Flows

      The Statement of Cash Flows zooms into how cash flows in and out of your nonprofit in a specific period. The goal is to understand how your nonprofit uses available cash and determine your liquidity, solvency, and financial health.

      Nonprofits use a format similar to the cash flow statement on which for-profit organizations rely.

      Key reporting criteria:

      • Operating activities: A summary of cash inflows and outflows. some text
        • Cash inflows refer to donations, grants, membership fees, and other revenue sources.
        • Cash outflows refer to money paid for rent, employee salaries, utilities, supplies, and other program expenses.
        • Financing activities: Here, you'll detail any cash your nonprofit gains from loans and how you use money to borrow funds or repay debts.

        Statement formatting: The Statement of Cash Flows can be filled out using two methods.

        • The direct method includes details of cash receipts and payments.
        • The indirect method reports on net cash by examining the change in net assets and adjusting for any non-cash transactions or changes to working capital.

        How to create financial statements for your nonprofit

        We've underscored the importance of accuracy in each financial statement. Below are some tips to help you feel confident and run effective nonprofit accounting practices.

        6 tips to prepare your nonprofit financial reports

        • ‍1. Maintain accurate and detailed records: Don't wait to dig into transaction details until you file your financial reports. Keep meticulous records of every transaction your nonprofit encounters with organized receipts, bank statements, invoices, and contracts.
        • ‍2. Know the latest accounting standards for nonprofits: Get familiar with any updates to the Generally Accepted Accounting Principles (GAAP) and Financial Accounting Standards Board (FASB). This way, you'll know exactly how to comply and avoid surprises that throw off your workflow.
        • ‍3. Be diligent about categorization: Nonprofit financial statements thrive on detail. The more you can place various expenses, cash flows, and revenue into categories, the more insight you can gain.
        • ‍4. Have a support team in place. Know which roles and responsibilities within your nonprofit are involved in preparing your financial statements. Feel free to tap into external and agency support to add multiple layers of approval and efficiency.
        • ‍5. Create internal solid controls: Conduct internal audits or hire a firm to audit your financial practices to confirm you're prepared in the event of an unexpected check-in. Understanding the risk of fraud and errors on your nonprofit's reputation and budget is extremely important.
        • ‍6. Be open to improvements: Like any process, each round of reporting can introduce gaps and opportunities to tighten things up. Embrace a culture of evolution and encourage forward thinking about making financial statements a simple yet highly efficient part of your operations.