As a nonprofit professional, your days are likely filled with tasks such as developing programming, soliciting donations, and managing volunteers. Amid your mission-critical activities, it can be easy to overlook proper financial management—a key component of keeping your organization running smoothly.
Whether you’re new to nonprofit financial management or just pressed for time, you may fall into common mistakes that can jeopardize your organization’s stability and future. That’s why we’ve compiled this guide to help you identify common pitfalls and implement best practices to avoid them. Let’s get started!
1. Not Creating a Realistic Budget
Your budget is a roadmap that guides your organization’s financial decisions. An unrealistic budget (or, even worse, no budget at all) may cause you to overspend or misallocate resources.
How to Avoid This Mistake
- Review historical financial data. Base your budget on your organization’s past financial performance to accurately project your revenue and expenses. For example, YPTC’s nonprofit budgeting guide explains that “when comparing financial data points from the past five years, you may notice that your marketing costs have increased by about 2% annually, allowing you to predict another 2% increase for the upcoming year.”
- Incorporate flexibility. Keep your budget flexible to protect your organization from potential financial challenges. Build a contingency fund to cover unexpected expenses, and prioritize expenses so you’ll know which ones you can reduce in an emergency. You may also use scenario planning to develop different versions of your budget for different financial situations so you can easily pivot to the most realistic plan.
- Allocate to overhead as needed. Many organizations fall into the overhead myth, thinking they must allocate a specific percentage of funds to overhead expenses. In reality, you shouldn’t aim to limit overhead but optimize it based on your nonprofit’s age, size, geographic location, and specific needs. After all, overhead costs support your organization’s operations, laying the foundation to pursue your mission.
2. Failing to Keep Accurate Financial Records
Accurate financial records allow your team to understand your organization’s financial situation and allocate resources accordingly. Without sound financial records, it can be challenging to develop precise reports that support compliance with IRS regulations and stakeholder transparency.
How to Avoid This Mistake
- Use accounting software. Trade physical records and spreadsheets for dedicated accounting software built to track and organize financial records. Look for a nonprofit-specific solution geared toward your organization’s needs.
- Leverage automation. Automate donation tracking to streamline your financial records. For example, PairSoft’s Accounts Payable (AP) Automation tool “significantly alleviates administrative burdens and minimizes errors” by automating data entry, matching gifts to specific campaigns, and recording gifts within your financial system.
- Regularly reconcile accounts. Compare your internal financial records to external records like bank statements to verify their accuracy. By reconciling accounts monthly, you can identify and rectify errors before they snowball into larger issues.
3. Losing Tax-Exempt Status
To avoid losing their tax-exempt status, nonprofits must consistently follow several requirements. While you should review the full list of IRS exemption requirements, we’ll review some directly related to financial reporting.
How to Avoid This Mistake
- File Form 990 correctly and on time. After obtaining 501(c)(3) status, you must file Form 990 annually. To ensure it’s accurate, compile and audit nonprofit financial statements to supply the necessary data. A Statement of Functional Expenses is especially helpful here to help you report on the nature and function of your expenses.
- Make annual returns publicly available. Once you file Form 990, the IRS requires you to make it publicly available, along with your exemption application. Many organizations will also share their financial statements by including them in their annual reports.
- Provide donors with written acknowledgments. When a donor contributes a gift of $250 or more, you must provide a written acknowledgment of receipt to enable tax deductibility. This acknowledgment should include your nonprofit’s name and employer identification number (EIN), date of contribution receipt, cash contribution amount or non-cash contribution description, and a statement that no goods or services were provided in return for the contribution.
4. Lacking Internal Controls
Without internal controls, your organization is at a higher risk of financial errors and fraud. Establishing measures to maintain accuracy and security keeps your finances stable and helps you build trust and transparency with stakeholders.
How to Avoid This Mistake
- Create financial policies and procedures. Develop policies and procedures that guide team members in handling different finance-related scenarios. These should include an expense reimbursement policy, a conflict of interest policy, and a gift acceptance policy.
- Separate financial responsibilities. No one person should have complete control over your nonprofit’s finances. Have different team members lead different financial processes and clearly define their roles and responsibilities to establish checks and balances. For example, if one team member is responsible for recording financial transactions, another person should approve them.
- Conduct physical asset checks. You likely already have cybersecurity measures to protect sensitive financial information, but what about physical assets? Be sure to store cash and checks securely, maintain an asset register, schedule physical asset checks, and keep stock of valuable office equipment like computers and cell phones.
5. Neglecting to Plan for the Future
While you might be narrowly focused on your monthly, quarterly, or annual finances, you must consider the future. Otherwise, you won’t be able to lay the groundwork to secure your organization’s financial sustainability and longevity.
How to Avoid This Mistake
- Diversify revenue streams. Relying on a singular revenue stream may work for now, but if that source ever dries up, your organization won’t produce enough to support its mission. Prepare for uncertainty and safeguard against revenue fluctuations by leveraging as many funding sources as possible, such as individual donations, sponsorships, grants, membership dues, and program fees.
- Make strategic investments. Investing your nonprofit’s reserve funds allows you to build assets and maintain financial stability over time. Consider opening an automated investment account to streamline the process.
- Create a financial contingency plan. Develop a plan to overcome potential financial challenges. Identify potential financial risks ahead of time and develop response plans for different scenarios. You should also build an emergency fund for unexpected expenses.
Understanding common nonprofit financial management mistakes will help your team avoid these issues and keep your organization financially stable. If you need help implementing these practices, work with a nonprofit accounting firm for assistance.
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