Raising Capital: Fund Accounting 101

Written by Amanda Bower    |    Published: August 31, 2023

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While most businesses and organizations conduct their accounting in similar ways, there’s a unique category of accounting that sets itself apart. Fund accounting is the go-to for nonprofits and other entities that need to track and manage their finances in a way that’s different from profit-driven businesses. For these organizations, decision-makers must know fund accounting inside and out to maximize their financial resources.

Nonprofits, government agencies, and churches are just a few of the entities that typically use fund accounting. Even though they don’t operate with a profit-driven mindset, they still need to keep track of their financial resources. 

It’s like this: Nonprofits focus on raising capital to fuel their causes. In the US alone, nonprofits report more than $2.6 trillion in revenue. These organizations must manage, disperse, and report on funds accurately, especially when they’re designated for particular projects or programs.

Now, if you want to make sure your finances are precise, well-managed, and up-to-date, here’s all you need to know about fund accounting.

The Basics of Fund Accounting

At their core, nonprofits function financially in ways different from a typical for-profit business. Because of this, they need distinct accounting practices. This is where fund accounting comes into play.

Fund accounting tracks and manages financial resources to ensure they’re used for specific purposes or activities. This system allows nonprofits to track funds, see how they’re managed, and where they are ultimately spent.

As the name might suggest, fund accounting operates by separating financial resources into different groups called funds. Several types of these groups are often used in nonprofit fund accounting (which we’ll dive into later). There are also many functional reasons nonprofits use fund accounting and many benefits when used correctly.

Organization of Financial Resources

One of the primary functions of fund accounting is to effectively organize all of the financial resources circulating within a non-profit. This is important for reasons including the effective management of resources. That’s because when funds are separated into groups based on their intended purpose, they’ll likely be put to work the way they’re intended to be. 

Accountability Rather Than Profitability

Another key reason for fund accounting in nonprofits is accountability. While they may have individual causes, they all aim to benefit society without generating profit.  People often donate money to these nonprofits, which also enjoy certain benefits (for example, they are exempt from certain taxes). 

For these reasons, nonprofits need to operate transparently and hold themselves accountable for where funds are spent. One study found that nonprofits lose 5% of annual revenue to fraud. With transparent accounting practices, nonprofits can ensure their money is being spent appropriately. 

Difference Between Fund Accounting and Traditional Accounting

Nonprofits’ financial decision-makers need to learn the ropes of fund accounting, which is a whole different ball game compared to regular business accounting. Some of the differences include:

  • Purpose: Fund accounting is designed to help nonprofits track and manage funds, as well as report on their use and source of revenue. Typical business accounting tracks and manages financial performance, profitability, and cash flow. 
  • Separation of funds: Fund accounting intentionally involves separating financial resources into different funds, each with its own revenue source, expenses, and financial statements, to ensure funds are used as intended. Typical business accounting does not involve separating funds and instead tracks all financial transactions to get an overall view of an organization’s financial health.
  • Reporting and compliance: Fund accounting emphasizes reporting to various stakeholders, including donors, grantors, members, and regulatory authorities. Instead, traditional business accounting focuses on generating financial statements that provide a comprehensive view of a company’s financial performance, including income statements, balance sheets, and cash flow statements.
  • Revenue sources: These are usually donations, grants, and contributions. When it comes to typical business accounting, for-profit businesses typically generate revenue by selling goods or services. 

What Are Considered Funds?

Funds can be considered in different categories or segments of financial resources. Those typically used by nonprofits include:

  • Unrestricted funds: These funds can be used for any purpose and are not designated for anything specific. For example, they might be used on daily expenses (such as salaries).
  • Restricted funds: These funds are designated to be used specifically. For example, if your nonprofit receives a grant for a specific purpose, those funds can’t be used for anything else.
  • Temporarily restricted funds: Within a certain time frame, the usage of these funds is limited to specific things. After that time lapses, they can typically be used at a nonprofit’s discretion.

The Role of Fund Accounting in Non-Profit Organizations

Fund accounting plays a large role in the operations of a nonprofit. For example, it can benefit donor relations because it enables nonprofits to track and report on the allocation and expenditure of specific funds. Fund accounting can also be useful for mission fulfillment, as it allows nonprofits to allocate funds to specific programs and ensure they’re directed toward activities that advance the organization’s goals. 

Ensuring Financial Accountability

One of the main roles fund accounting plays in nonprofit organizations is its facilitation of financial accountability. Nonprofits have legal, ethical, and moral reasons for being accountable for their revenue. When it comes to the law, there are legal requirements for non-profits when it comes to record keeping. 

For example, the IRS requires that tax-exempt organizations “must keep books and records needed to show that it complies with the tax rules.” Fund accounting can play a vital role in this record keeping process.

Ultimately, fund accounting is essential for operational transparency and ensuring that finances are always being spent accordingly. 

Advantages of Fund Accounting to Non-Profits

Fund accounting isn’t just practical for nonprofits: it also comes with some distinct benefits aside from financial accountability. Fund accounting plays a key role in transparency by providing clear tracking of funds, their sources and their designated uses. 

It also allows nonprofits to easily manage grants separately and evaluate individual programs’ financial performance. Fund accounting can also facilitate budgeting accuracy and help prevent the misallocation or misuse of funds.

The Fund Accounting Lifecycle

Fund accounting is an important process for non-profit organizations to keep track of their finances. When they receive cash donations, they need to determine which fund it belongs to based on factors such as its source, any restrictions on its use, and whether it can be added to an existing fund or requires a new one. Transactions within each fund are recorded, and budgets are used to ensure they stay on track. 

Nonprofits may also create financial reports for each fund to monitor its performance. However, they must also be vigilant to ensure that funds are not being wasted and consider closing funds when their goals have been met or they are no longer receiving contributions.

Common Hurdles in Implementing Fund Accounting

Fund accounting is crucial for nonprofits to master, but can also be challenging to implement, particularly at first. Firstly, it can be more complex than traditional business accounting because it’s particular and involves tracking separate funds simultaneously. Nonprofit staff also might need to be trained in proper fund accounting.

Additionally, nonprofits need to adhere to fund restrictions and requirements, which can add complexity to accounting. Fund accounting can also require transparent communication with stakeholders and budgeting and reporting processes for each fund.

Overcoming Fund Accounting Difficulties

Having a well-trained staff that is proficient in fund accounting is an excellent first step in overcoming the nuances of fund accounting. However, there are other steps that decision-makers can take to overcome the complexities and difficulties of fund accounting. 

For example, appropriate accounting software and technologies can be crucial for proper fund tracking, reporting, and compliance. Likewise, outsourcing certain accounting services can be a huge asset in fund accounting. Depending on your organization, you can outsource functions such as bookkeeping, accounting management, financial reporting, or cash management.

We Love Working With Nonprofits to Ensure That Their Accounting Is Always Up-to-Date

You’re part of a revolutionary nonprofit destined to shake things up in the spaces it operates in. With our substantial financial resources, we’re here to help you reach your most audacious goals. 

At hiline, we provide finance as a service that’s tailored to meet the unique fund accounting needs of nonprofits. From bookkeeping and finance to tax and HR, we’ve got you covered. And with our top-notch payroll services, you can free up your time and energy to focus on what really matters—making a difference in the world.

When it comes to your finances, we’ll take it from here. Contact us today to get started. 

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