We See You, World Changers
In our many years as entrepreneurs, we’ve had the opportunity to meet so many incredible startups with mind-blowing vision, ready to change the world, but they lacked a good handle on their finances which created barriers for them to be the change they wished to see in the world. This is one of the reasons why we began Simple Startup in 2015, so we could give these amazing entrepreneurs the support they needed to change the world! Since we got our start, we’ve worked with businesses in nearly every industry including nascent industries like hemp and plant-based meat alternatives as well as various nonprofit companies. This brings me to the topic of our article today, the differences between nonprofit accounting and for-profit, and there are quite a few, so let’s begin.
Why Does a Nonprofit Organization Have Different Accounting Standards?
While a for-profit business may have many goals, including social objectives, ultimately they exist to make a profit. But a nonprofit, well that’s a different story! Nonprofit organizations exist for a multitude of reasons but all of them have one thing in common, they want to help the greater good by serving society and profit doesn’t really come into play. This means that not-for-profit organizations have a completely different financial structure than for-profit organizations which accounts for quite a few differences in their accounting. Nonprofits also have special state and federal regulations that they need to meet in order to operate within the law.
Key Differences Between For-Profit and Nonprofit Accounting
Though nonprofit and for-profit businesses often both come from humble beginnings, like an idea written on a napkin in a coffee shop, they grow up to be fairly different operationally from their tax status to their financial statements and beyond. The following article will take a closer look at some of the main differences in nonprofit and for-profit accounting that stem from their variance in operation and mission.
1. Tax Status
Let’s start with the difference many of you are most likely familiar with, tax status. Once a nonprofit is approved as a 501(c)(3) organization by the IRS then they are exempt from paying federal income taxes. Local and state tax requirements, however, do vary. For example, in Colorado, nonprofits are exempt from paying state-collected sales tax for purchases made while conducting business activities and nonprofits that have achieved 501(c)(3) status through the IRS will generally be approved for a Certificate of Exemption in Colorado.
Though both for-profit and not-for-profit businesses can be founded by someone, the commonalities in ownership end there because a nonprofit isn’t truly owned by anyone. In the case of a profit-based business, individuals or entities can own a percentage of the business, their shares or equity are accounted for on a balance sheet, and they can reap earnings or dividends from the success of the company.
In the case of a nonprofit, while a founder or board of directors can run the entity, they don’t own any percentage of it, or reap earnings beyond their salary, and the business is run as a public trust. This means that on the balance sheet there will be no shareholder equity listed.
3. Source of Revenue
For-profit companies generate revenue from the sale of products or services which are then accounted for in their general ledger alongside their expenses and these incoming funds can be used or invested in any manner business leaders prefer.
When it comes to generating revenue for a nonprofit, revenue will be made of donations and grants. Oftentimes these types of incoming funds have limitations on what they can be used for or their own budgets outlined by grant contracts. So while this revenue can still be accounted for in a general ledger, this doesn’t provide the full story and each fund will likely have its own budget to track (and prove) the nonprofit is allocating funds as they are permitted to do so.
4. Financial Statements
Another way in which for-profit and nonprofit accounting differs, as you might have already guessed from our discussion above, is in their financial statements. With a for-profit business, the accounting system is ultimately tracking net income for the company and thus they can develop a balance sheet that outlines a company’s assets, liabilities, and owners’ equity. And this statement can be distributed to shareholders to show retained earnings. A for-profit company also uses an income statement that shows the company’s revenue and expenses at a particular point in time.
For a nonprofit, the accounting system is ultimately tracking excess revenue when all expenses have been accounted for. So instead of using a for-profit balance sheet, nonprofits use a statement of financial position which lists the assets, liabilities, and net assets of the nonprofit. And instead of a for-profit income statement, they utilize a statement of activities that list their revenues with their expenses deducted.
We touched on this lightly above, but nonprofits and for-profit organizations are held to different reporting standards. Furthermore, private and public companies are also held to different reporting standards.
Starting with private companies, they are only required to provide reports internally to owners and stakeholders of the business and do not need to make them available to the general public. The one caveat being that if the private company becomes so large that they have more than 500 shareholders and $10 million in assets then they must file financial reports, as if they were a public company, with the Securities and Exchange Commission (SEC).
Public companies have quite a few quarterly, annual, and circumstantial reporting obligations with the SEC. On a quarterly basis, they will file audited financial statements, as well as company information including legal proceedings or payment defaults. On an annual basis, a public company will file an annual report and audited financial statements that include information like organizational structure, subsidiaries, and legal proceedings, etc.
Nonprofits are not required to file publicly accessible annual financial reports. However, oftentimes, they publish them anyways as a value add to show donors, the government, and other parties the capabilities of the organization and how they may compare to their for-profit counterparts.
Budgeting is key to the success and sustainability of all organizations whether they are nonprofit or for-profit, public or private. But budgeting can be especially complex for a nonprofit organization, where cash flow is limited and funds received are often earmarked for specific purposes.
Nonprofits require a high-level of expert financial oversight to ensure budgets and spending meet donor and grant organization expectations and that all funds are making the maximum impact toward the organization’s mission. In action, this often looks like a “break-even” budget which shows that every dollar received is accounted for and being used to meet mission obligations and there is no surplus of money not being used productively.
It is much more acceptable for a for-profit company to have a surplus forecasted or actual budget that they can choose to reinvest in the business at their discretion. For-profits often have several budgets in play including the master budget, operating budgets, division or departmental budgets, and so forth. And when times get tough they can offer sales or discounts to help boost their cash flow – something that is inaccessible to a nonprofit organization.
One final item to note is that accounting software can differ between for-profit and nonprofit businesses. For example, QuickBooks, the accounting industry standard for for-profit businesses, also offers a nonprofit variation of their accounting software that is as simple to get started with as toggling on “nonprofit” during setup. There is also accounting software made solely for use by nonprofits including Aplos, Blackbaud Financial Edge NXT, and NonProfitPlus.
Cheerleaders for Changing the World
Changing the world is a pretty big endeavor that you can’t do alone! We know you’ve got the volunteers covered, but we want to help you hit your service goals by instilling a good accounting foundation and ensuring your cash runway extends well into the future by providing budget support, financial forecasting, and even financial oversight. Give us a call, we can’t wait to hear how you’re changing the world!