4 Financial Considerations Before Starting a Nonprofit (2024)

Nonprofits are formed because passionate individuals recognize a philanthropic need in their communities and want to provide the answer. Filing taxes, registering with the IRS, and managing yearly finances go hand-in-hand with running a nonprofit, but few feel excitement for setting up effective accounting and bookkeeping systems.

However, for your nonprofit to have long-term, sustainable success, you must research and create a financial plan in advance. Aspiring organizations should be able to spell out their rough financial plans before they launch their first program. Otherwise, they risk over-spending and crashing before they’ve even gotten started making a difference.

In addition to your nonprofit’s mission statement, begin drafting a list of steps you’ll need to take to get your nonprofit’s finances in order before opening its doors. In this article, we’ll go over four areas of consideration that most of your financial planning will fall under:

1. Documentation
2. Budget
3. Organization
4. Dedicated Accountant

As you create your financial plan, you’ll also need dedicated individuals to take on both bookkeeping and accounting duties for your nonprofit. Most organizations start off with their executive members managing these and other financial duties, but quickly find that it can become overwhelming. Keep this mind as you design your management plan so that your finances are not just in order, but also well-managed over time.

Without further ado, let’s dive into the financial considerations that are top-of-mind as you get your start.

Starting a Nonprofit Documentation

The majority of nonprofits fall under the umbrella of 501(C)(3) organizations, meaning they have filed for tax-exempt status from the IRS under that specific article of the tax code. The IRS can take anywhere between two and twelve months to process your 501(C)(3) application, and the necessary paperwork (the form 1023) to apply for a 501(C)(3) can also take months of preparation.

While it might take some time, filing for tax exemption is the most economically efficient practice. Don’t put this step off in your creation of a nonprofit. Otherwise, you’ll find that you’re paying taxes and wasting your hard-earned finances unnecessarily.

After you’ve filed your Form 1023, keep track of a copy of the form. Some of the information on this form will carry over to future tax paperwork. For example, retaining your nonprofit status requires your organization to file a 990 form at the end of each fiscal year. There will be some information, such as the official name of your organization, EIN, mission statement, etc. that will carry over from form to form. When you have an organized system to track each of these forms, you’ll be able to ensure each of these sections matches exactly from year to year.

Financial documents become easier to understand and file the more experience you have with them and the better you know your nonprofit. However, it always helps to have an expert on your side. They’ll be able to ensure all of your tax forms are filled out just right and on time so that you can avoid pesky fees or unnecessary taxes.

No matter if you’re going at accounting alone or hiring an expert to help you, here are some tips to help manage your legal financial documents, be sure to:

• Create a calendar of due dates. Deadlines can sneak up on you, especially when you have a full list of tasks to juggle. Make a timeline for your tax forms and regular financial check-ins to monitor your progress and adjust future deadlines accordingly. Get into this habit early because while self-imposed deadlines may not have specific penalties associated, late filing of your annual tax forms can result in them.

• Understand what forms you need to file. Filing a 501(C)(3) usually requires filling Form 1023. However, smaller nonprofits with less than $50,000 in projected revenues can apply for the Form 1023-EZ, which is shorter and takes less time to process. Your nonprofit can also be incorporated or unincorporated when you file. Being incorporated grants your nonprofit certain legal protections, so consult with a lawyer ahead of time to decide which choice makes sense for your nonprofit.

• Create report templates using your software. Many of your ongoing forms, from 990s to 1099s will require reference to other aspects of your nonprofits’ finances. Creating templates for commonly used reports (cash flow statements, statement of activities, etc.) will ensure your financial information is organized the same way from year to year, ensuring consistency and form accuracy.

Creating good documentation management habits early will benefit your nonprofit in the long run as you grow to manage donation forms, employee contracts, and vendor invoices.

Nonprofit Budget

Your budget rests at the heart of your nonprofit’s financial plan. Treat your budget as a living document as you continuously monitor and update various known and predicted revenue and expenses throughout the year.

Nonprofit budgets consist of two components: your expected revenue and your expense budget. Both of these numbers are calculated using data from previous years. This means your budget for your first year will require educated guesswork and regular check-ins as you experiment with new fundraising strategies and program activities. This guide goes into more detail about calculating your expected revenue and expense budget, which should be your first priority once you have the data to do so. In the end, your budget might look something like this:

You can make certain inferences about your organization’s budget during your first year as a nonprofit based on the industry averages for various expenses. For example, your mission programming should account for approximately 65% of your expenses, while overhead costs may rest right around 35%. You may need to allocate a larger portion of your budget during your first year to overhead costs as you get established, but 35% is a good goal to shoot for.

Overhead costs tend to have a bad reputation, but they are vital for creating and maintaining any sustainable organization. A few overhead costs that you’ll encounter right off the bat and will need to account for in your budget include:

• Marketing costs. New nonprofits need to get their name out to potential supporters. Email service providers, direct mail service providers, social media managers, graphic designers, and content writers all require money. Fundraising events and the necessary software to support them also need to be factored into your budget.

• Employee salaries. Many nonprofits say that lack of staff is a major factor that holds them back from fulfilling their mission, applying for grants, or completing other tasks vital to their nonprofit’s financial health. Your employee compensation rates will determine how many employees you should factor into your budget and how much you’ll rely on outsourced services and volunteers.

• Administrative and office expenses. Bills, office space rent, and management software all cost money and need to be paid on a regular basis. Your expenses are likely to fluctuate (especially during your first year of operations as you figure out what your nonprofit needs to function), but most office expenses are fixed costs that will stay the same from year to year. This makes them a constant that you’ll need to account for in your budget.

When you prepare your budget, look for the opportunities that you have to save funds, but don’t be afraid of spending necessary funds to stay afloat. Because your first year might be a little pricier than other years, consider the small things you can do to make the most of your budget. For example, you set the office thermostat lower in the winter and warmer in the summer to reduce heat and air conditioning costs, lowering your constant utility expenses.

Nonprofit Accounting

As your nonprofit grows, you’ll need to answer questions about your nonprofit’s finances such as who gets to make purchasing decisions? Or, who approves payroll?

Nonprofit finances run on accountability. Nonprofit annual tax forms are public so that any donor can look to make sure you are living up to your mission. Additionally, donors and grant-giving foundations can set restrictions on what their money can be used for, and your nonprofit has to follow through with their requests.

As you establish your internal financial practices, ask the following questions:

• How much oversight does your board have? Your board should be independent from your nonprofit to provide insight with minimal bias. Determine ahead of time how often you’ll meet with your board and what spending choices will require board approval in addition to your final budget sign-off.

• Are there checks and balances on spending? Setting effective internal controls for your financial system is absolutely necessary for maintaining a secure and accountable structure. Proper security ensures your donors feel safe providing their payment information to your organization and that you’re using the funds you’re given in a respectable manner, according to supporters’ wishes.

• What financial software are you using and how is it maintained? Accounting software helps your nonprofit track your various funds all in one system. The solution you choose should be designed for nonprofits to ensure it’s set up with the necessary fund accounting features. Then, assign access to that system for your bookkeeper, accountant, and other financial department employees, spelling out very specific maintenance protocols for effective data hygiene.

As you get started establishing your nonprofit’s structure, consider hiring a consultant. Use resources like Aly Sterling’s list of nonprofit consultants to both find consultants and understand different roles and responsibilities you’ll need to account for as you set up your nonprofit. Your exact organizational structure may be unique to your nonprofit, but consultants with years of experience can be an invaluable source of knowledge to ensure all of your bases are covered.

A Dedicated Accountant

Nonprofit accounting is a full-time job. Nonprofits have unique financial restrictions and don’t manage expenses and accounts like for profit businesses. Your nonprofit will need a dedicated bookkeeper and a dedicated accountant to record, analyze, and help adjust your financial plan.

Essentially, your bookkeeper is the one who does the day-to-day financial input and record-keeping for your nonprofit. Meanwhile, your accountant dives deep into financial analysis, finding improvement opportunities and options for organizations. Jitasa’s guide to nonprofit bookkeeping vs accounting provides an in-depth explanation as to the differences between the two roles:

• Bookkeepers’ responsibilities include:
  • Entering data. Your bookkeeper records expenses, donations, and any other financial transactions into your financial software system.
  • Writing checks and making deposits. As they record transactions, bookkeepers tend to all make deposits and handle payments before recording the transaction.
  • Allocating costs. Bookkeepers help organize your expenses by deciding how to divide costs between different aspects of your nonprofit.

• Accountants’ responsibilities include:
  • Reconciling all accounts. Accountants resolve discrepancies between the totals in your bank accounts and the totals on your bookkeeping sheets. Ensuring all discrepancies are resolved is necessary for meeting compliance standards and passing your nonprofit audit.
  • Comparing actual expenses and income against your budget. Your accountant will help you understand and explain variances between your budget and your projected income and spending. Additionally, by explaining why and how your expected vs. actual expenses differed, your accountant can help your nonprofit create more accurate future budgets.
  • Filing your 990 form. As mentioned, your Form 990 ensures your nonprofit keeps its tax exempt status from year to year. This form reports your financial information to the government to prove you’re handling your finances responsibly and according to your philanthropic intentions.

While an executive, employee, or experienced volunteer can handle bookkeeping duties, accountants are trained and CPA certified professionals. Most small nonprofits don’t have the resources to hire full time in-house accountants and rely on outsourcing accounting duties to accounting and bookkeeping consultant firms.

Nonprofit finances are complex and can be overwhelming when you first get started. However, the more you understand your nonprofit’s financial situation, the more you can control the direction of your organization (and the easier filing accurate financial documents will become).

Many nonprofits regularly seek out help from third-party experts by outsourcing their accounting and bookkeeping needs when they first get started. Do your own research, but don’t be afraid to reach out as it’s better to solve financial problems when they first come up rather than close to a deadline.