Most people go to work for a charitable organization because they want to spend their time serving their community. They hardly ever do it with dreams of spending their time managing nonprofit compliance.
We get it. While it isn’t the most exciting thing you’ll do as a nonprofit executive director or manager, nonprofit compliance is hugely important to your organization’s accounting. Proper accounting practices are vital for maintaining legal and regulatory compliance.
Beyond that, financial transparency is essential for building trust with your donors…the economic lifeblood of your operation.
Nonprofit compliance doesn’t have to be a headache. In this post, we’ll help make it easy by unpacking what it is, its role in your organization, and several ways to stay on top of it so you and your team can focus on doing what you love.
Understanding Nonprofit Compliance
Nonprofit compliance is the process of making sure that a nonprofit organization follows federal, state, and local laws as well as all regulations and agreements it enters into.
Compliance for a nonprofit not only ensures that an organization is meeting all of its legal requirements, but it helps demonstrate that they are operating according to good ethical standards as well. When the government trusts you, they allow you to continue to operate. (And you get to keep your tax-exempt status.) When the public trusts you, they are more likely to support your mission and help you grow. Both are key components of running a successful nonprofit.
The Role of Nonprofit Accounting Practices in Compliance
Everyone needs good basic accounting to manage their money well…personally and professionally. Nonprofits, however, have to operate at a different level. As we point out in another post we did on “Accounting For Nonprofits: A Complete Guide To What You Need to Know”, because you are stewarding other people’s money, you are held to a higher standard of accuracy and accountability.
Accurate nonprofit accounting practices lay the foundation for compliance when it comes to the IRS, laws in your state, and standards specific to your industry. When you manage your money well, it becomes much easier to accomplish your mission. If you don’t…it can get ugly really fast.
Financial Recordkeeping for Nonprofits: The Key to Compliance
The first place to start in ensuring good nonprofit compliance is with recordkeeping. If your files are a mess, the rest of your finances will be too.
Proper financial record keeping is a necessity when it comes to your tax filing and donor reports. Having good bookkeeping practices helps you track income, expenses, grants, and donations accurately. Then you are able to produce accurate reports that you need to properly run your operation.
Here is a quick list of the key documents that you need to maintain for nonprofit compliance purposes:
- Permanent Records – Articles of Incorporation, by laws, board meeting minutes, IRS determination letter
- Financial statements – Statement of Activities (Income Statement), Statement of Functional Expenses, Cash Flow Statement, Statement of Financial Position (Balance Sheet)
- Financial Records – Bank statements, checks, invoices, receipts (Keep up with receipts like a pro with these 3 simple tips.)
- Tax returns – For the last 3 years
- Program Activity Records – event details, funding sources, participants, etc.
- Donor information/contributions – For the last 7 years
Nonprofit Financial Reporting and Compliance
Regular financial reporting makes it so much easier to stay in compliance with federal and state laws. If you wait until you need to verify some piece of information to go looking for it, you’ll be setting yourself up for trouble.
Your organization’s financial statements are the key to ensuring you’re operating within the legal parameters of a nonprofit as well as maximizing transparency (and trust) for your stakeholders. We briefly mentioned them a moment ago, but let’s look at them in more detail here.
- Statement of Activities – Also known as an “Income Statement” in the for-profit world, this document shows all of your revenue and expenses for certain time periods.
- Statement of Functional Expenses – This is a more detailed version of the expense section of your Statement of Activities. It allows you to better show how your spending is spread out across your organization.
- Statement of Cash Flows – With this, you can see which activities generate the most cash and which are using the most resources.
- Statement of Financial Position – Commonly referred to as a “Balance Sheet” in traditional businesses, this nonprofit report includes a “Net Asset” section (instead of “Equity”) to show your total assets minus liabilities.
Read more: “Unraveling Nonprofit Financial Statements To Help Your Organization Do Even More Good”
Internal Controls in Nonprofits: Preventing Fraud and Ensuring Compliance
Unfortunately, not everyone wants to work with nonprofits for honorable reasons. Many people see opportunities to take advantage of the generosity of others and commit fraud.
Some common types of nonprofit fraud include:
- skimming cash donations
- fake or inflated expense reimbursement reports
- payroll fraud
- deceptive fundraising
- credit card abuse
Internal controls are important in nonprofit compliance because they help prevent fraud and financial mistakes. Different types of internal controls include requiring two signatures on checks, background checks on volunteers, locking doors to deter theft, and segregation of duties (for example, the person who receives checks isn’t the one who deposits them).
For more on this topic, the Council of Nonprofits wrote a good article on “Internal Controls for Nonprofits.”
Nonprofit Budgeting and Compliance: How to Stay on Track
Staying on track financially requires having (and using!) a budget. When your nonprofit budget aligns with your compliance goals and you discipline yourself to operate within that framework, it becomes a tool that helps create long-term sustainability and financial transparency.
A good nonprofit budget covers 3 basic categories:
- Revenue – income from any source (donations, membership fees, item/service sales, investments, etc.)
Note: Revenue that is “restricted” can only be used for the project/category the donor (or grant) specifically designated. Your budget must reflect that. - Fixed Expenses – salaries, rent, utilities, insurance, etc.
- Variable Expenses – supplies, fuel, raw materials, hourly wages, etc.
Read more: “Top Strategies For Building A Nonprofit Budget That Supports Your Mission”
Audit Preparation for Nonprofits: Ensuring Compliance and Accuracy
Every nonprofit needs to be prepared for an audit. The IRS selects organizations for a review for various reasons, and the audit may involve a simple questionnaire, a request for documentation, or an on-site audit.
The scope of audits and compliance checks by the IRS include:
- Timely filing of tax returns
- Completeness and accuracy of required forms
- Whether or not the organization’s activities are consistent with its stated mission
- Proper payment of employment taxes and unrelated business income taxes
To prepare for an audit, a nonprofit must ensure that all necessary documents are organized and easily accessible and that financial statements are current and accurate. (That’s why we stress how important good recordkeeping is.)
A nonprofit can choose to have an independent audit done anytime they wish…and we believe they should. They can help with nonprofit compliance and strengthen your organization’s credibility. As the Council of Nonprofits states in a post on why a nonprofit might conduct an audit even when the law doesn’t require it, “A nonprofit can build its reputation for integrity, transparency, and professionalism, by having a regular independent audit conducted and making it available to stakeholders and the public.”
You should consult with your board of directors and your CPA to weigh the cost/benefits of an independent audit to see if it is a smart move for your organization.
Partner With A Pro To Ensure Your Nonprofit Compliance
Ensuring nonprofit compliance is a vital role that every nonprofit executive must play. Following the law and building trust with your donors is essential to your organization’s ability to continue serving your community. Make sure you have strong accounting practices in place by scheduling a call with one of our experienced pros today. We specialize in nonprofit financial management and have worked with countless organizations over the past 40+ years, so we understand what it takes to keep you compliant and moving forward.
