Accounting Best Practices for Nonprofits Receiving Grants
We run into this question a lot with nonprofits we’re helping achieve major growth. Which is better, cash or accrual accounting? While cash accounting has historically been the preferred method for nonprofits’ financial reporting, we strongly recommend accrual accounting because it offers several significant advantages when it comes to managing grants, especially reimbursements. Broadly, accrual accounting provides nonprofits with a more accurate and comprehensive depiction of their financial health, enhances transparency, improves decision-making, and ensures compliance with reporting standards and regulations. Specifically, it takes a lot of headaches out of figuring out what to file on which reimbursement.
Accuracy and Comprehensive Financial Reporting
Accrual accounting provides nonprofits with a more accurate picture of their financial status compared to cash accounting, which only records transactions when cash is exchanged. It allows organizations to account for all income and expenses, including those that occur but are not immediately paid for. Grants often come with specific obligations or restrictions that require nonprofits to make expenditures at specific times or in relation to specific activities. Accrual accounting ensures that these obligations and expenditures are accurately reflected, providing a more holistic understanding of financial performance.
Transparency and Stakeholder Confidence
Accurate and transparent reporting is crucial for maintaining stakeholder trust and attracting future funding. Accrual accounting provides a more comprehensive view of financial transactions and obligations, enabling nonprofits to better document the use of grant funds. Accurate financial reporting not only strengthens relationships with grantors but also enhances transparency and accountability to donors, beneficiaries, and the public. By using accrual accounting, nonprofits can clearly showcase their financial health, making them more appealing to potential donors and grant-making organizations.
Improved Decision-Making
Accrual accounting offers valuable insights into the long-term financial position of nonprofits, enabling better decision-making. By recording revenue and expenses when they are incurred, accrual accounting provides a more accurate representation of an organization's financial stability. Nonprofits can assess their cash flows over time, identify trends, and make informed decisions based on comprehensive financial information. This helps organizations plan effectively, allocate resources efficiently, and make informed financial choices to enhance long-term sustainability.
Compliance and Reporting Standards
Adopting accrual accounting ensures that nonprofits comply with accounting standards and reporting requirements. Many accounting and financial reporting frameworks, such as the Generally Accepted Accounting Principles (GAAP) and the International Financial Reporting Standards (IFRS), favor accrual accounting over cash accounting due to its superior accuracy and transparency. By using accrual accounting, nonprofits can align their financial reporting with these standards, further enhancing their credibility and consistency.
Consistent Evaluation and Comparison
Accrual accounting enables nonprofits to compare their financial performance over different periods using consistent criteria, facilitating performance evaluation and benchmarking. This consistency improves the interpretation of financial data, allowing nonprofits to identify strengths, weaknesses, and trends more accurately. Grantors and stakeholders can also evaluate the cost-effectiveness of nonprofit programs and services with greater clarity and confidence, encouraging informed decision-making and resource allocation.
Financial Planning and Sustainability
Accrual accounting provides nonprofits with a better foundation for financial planning and long-term sustainability. By capturing both current and future financial obligations, accrual accounting allows organizations to forecast cash flows accurately, plan budgets, and project funding needs more effectively. This improves financial stability and reduces the risk of unforeseen financial challenges that may hinder mission fulfillment.
In Practice
While cash accounting has traditionally been favored by nonprofits, the adoption of accrual accounting brings numerous benefits for organizations receiving grants. By recording expenditures, including payroll costs and purchases, when the expense happens rather than when it is paid, the accrual method provides a very clear picture each month throughout a grant project period of all costs incurred that month which gives much greater clarity to the grant budget status. It also reduces the lag and delay on preparing, submitting and receiving reimbursements which is already a slow enough process as it is, especially with large federal programs. So, why aren’t all nonprofits using the accrual method?
Most nonprofits start small and grow. Cash accounting can be a lot easier to implement in startups and it can be a beast to convert from cash accounting to accrual once a method is established. Is the hassle of converting worth it? Yes, we think so. But, there is a workaround. Many common accounting software platforms provide the ability to run reports on an accrual basis, even if the overall accounting method in use is on a cash basis. While the accrual method is best for grant recipients which is why pretty much all large institutions like colleges and universities and governmental agencies use the accrual method, in the interim, growing nonprofits can make savvy use of sophisticated reporting to take a hybrid approach.
If your nonprofit only wishes to have these sorts of growing pains, you should probably get in touch with us. There’s a reason we’re intimately familiar with this problem.