Time for your nonprofit to hit the booksPublished: January 2017 | Last reviewed: June 2018
Every business, nonprofit or otherwise, must decide whether to practice cash or accrual accounting.
The basic distinction between the two systems is simply when you register income and record payments to others — or when income and expenses "hit the books." In the cash method, income and payments are recorded when they occur. In the accrual method, transactions are recorded when orders are made or services are rendered, regardless of when payment changes hands.
Cash accounting (also known as accounts for receipts and payments) tends to be simpler and more straightforward. However, accrual accounting may provide a more complete picture of a nonprofit's finances due to the nature of typical nonprofit sources of income.
Here's help understanding the two systems — and knowing when you may need to switch from one to the other.
Cash (or receipts and payments) accounting
How it works
Cash accounting works very much like personal accounting. The organization records transactions the way a person records payments and deposits in a checking or current account. Income is "booked" when it's received, such as from the sale of goods or services or from the disbursement of a grant. Similarly, an expense is "booked" when a bill is paid.
Who should consider it
Cash accounting is typically recommended for smaller organizations. In the U.S. that means those with an annual income of less than $500,000. In the U.K., cash accounting may be adopted by unincorporated charities and charitable incorporated organizations (CIOs) with a gross income less than £250,000. Charitable companies are not permitted to use cash accounting.
In general, cash accounting works best for organizations that:
- Spend or otherwise utilize all the income they receive in a given year
- Receive most funds from individual donors, short-term grants or simple fees for service (so no government or foundation grants)
- Have no, or very few, restricted donations
- Aren't required to submit annual audits
In reality, only the smallest of charities tend to use cash accounting. Any organization that's paying employees and advance costs — such as rent and insurance — is likely to choose accrual accounting.
How it works
The accrual system records obligations rather than payments. As soon as funds are legally yours (in other words, any conditions attached to the funds have been met) or you agree to pay an expense, the obligation hits the books as an income or expense. It doesn't mean that any money has changed hands. Instead, you and another party have agreed that a transaction is going to take place. This allows you — and your stakeholders — to see a complete picture of known income and expenses.
Who should consider it
Accrual accounting is recommended for larger organizations (and in the U.K., required for some types or sizes of organizations). It tends to be preferred by accounting professionals in general. If you're bringing an accountant onto your team, you'll probably want to convert to the accrual method (if you haven't already).
In general, accrual accounting is preferable when:
- Your organization receives grants from many different sources (say, state or local authority grants as well as private foundation grants)
- Those grants have different terms or donor restrictions
- You receive funds from government reimbursements (for U.S. organizations)
- You receive funds from individual donors over time (either from income on investments or from pledges)
- Payments are received before contracted services are delivered
- Funding is classified on your balance sheet as temporarily or permanently restricted
- You have significant capital assets (beyond standard office equipment and furniture)
- You're required to submit annual audits
While transactions hit the books at different times in the accrual method, cash intake and outflow during the year are reflected on the statement of cash flows (part of the year-end financial statements). It's also important to keep an eye on how much actual cash you have on hand, as opposed to funds that have been promised or pledged to your organization but not yet delivered or disbursed.
Know the audit requirements where you operate
Audit and reporting requirements may influence which form of accounting you use.
In the U.S.
Many states require nonprofits registering an annual income of $500,000 or more to submit annual audits to the state. In some states, fundraising is permitted only by organizations that submit audited financial records. Specific funders may require annual audits as well. Such audits typically require use of the accrual system — although small nonprofits might find it simpler to use the cash system day-to-day, and then convert to the accrual method when preparing financial statements.
In the U.K.
Audit requirements depend on the type and size of organization, but all charities are required to produce annual accounts. The format will depend on, among other things, whether you use cash (receipts and payments) or accrual accounting. Requirements and full advice are detailed here by the Charity Commission.
This article draws on the expertise of Andy Nash Accounting & Consultancy. Based in Cardiff, Wales, the firm offers specialized accounting and financial consultancy services to small and medium sized nonprofits.