Non profit accounting explained: basics and key steps

Published Monday 30 March 2026

Table of contents

• What is nonprofit accounting
• How nonprofit accounting differs from for-profit accounting
• Is your business really nonprofit?
• Key nonprofit accounting principles
• Nonprofit financial statements you need to know
• Six steps to get started as a nonprofit
• How to record nonprofit revenues
• Nonprofit compliance and reporting requirements
• Choose accounting software for your nonprofit
• Make the most of your nonprofit status
• FAQs on nonprofit accounting

Key takeaways

• Implement fund accounting to track money by its intended purpose rather than combining all funds, separating unrestricted funds from temporarily and permanently restricted donations to show donors exactly how you've used their contributions.
• Use accrual accounting as required by Generally Accepted Accounting Principles (GAAP) to record income when earned and expenses when incurred, providing a more accurate financial picture for grant reporting and audits.
• Produce nonprofit-specific financial statements including the Statement of Financial Position (instead of Balance Sheet) and Statement of Activities (instead of Income Statement) to demonstrate accountability and show changes in net assets rather than profit or loss.
• Maintain compliance by filing annual returns with tax authorities, tracking restricted fund spending against donor intentions, and ensuring your board provides proper financial oversight to protect your tax-exempt status.

What is nonprofit accounting

Nonprofit accounting is the process of recording, tracking, and reporting financial transactions for organisations that operate for a mission rather than profit. It follows specific rules that differ from standard business accounting.

Nonprofits include charities, foundations, clubs, and other organisations that reinvest surplus funds into their mission instead of distributing profits to owners or shareholders.

Like any organisation, nonprofits must:

• Track income and expenses: record all money coming in and going out
• Pay employees: process payroll and related taxes
• Meet legal requirements: file reports and maintain compliance with tax authorities
• Provide transparency: show donors and stakeholders how funds are used

Learn the basics of nonprofit accounting, from key principles to financial statements and compliance requirements.

How nonprofit accounting differs from for-profit accounting

Nonprofit accounting follows different rules and uses different terminology than standard business accounting. These differences affect how you set up your systems.

Key differences include:

• Net assets, not equity: nonprofits report net assets instead of owner's equity. Net assets show the organisation's financial position without implying ownership
• Fund accounting, not profit tracking: nonprofits track money by purpose or restriction rather than focusing on profit margins. This shows donors how you've used their contributions
• Restricted and unrestricted funds: donations may come with conditions on how they're spent. Nonprofit accounting separates restricted funds from general operating money
• Accountability focus: for-profit businesses report to shareholders seeking returns. Nonprofits report to donors, members, and regulators who want to see mission impact
• Different financial statements: nonprofits use Statement of Financial Position instead of Balance Sheet, and Statement of Activities instead of Income Statement

These differences affect how you record transactions, generate reports, and demonstrate financial health to stakeholders.

Is your business really nonprofit?

Not every organisation qualifies for nonprofit status. Before setting up your accounting, confirm your organisation meets the basic criteria.

Ask yourself these questions:

• What's your purpose? If your goal is to provide charitable services, support a community cause, or run a social or sports club, you may qualify as a nonprofit
• Where does your income come from? Nonprofits typically receive funding through donations, membership fees, fundraising events, grants, and investment income rather than sales of goods or services
• Do similar nonprofits exist? Having comparable organisations with nonprofit status can support your application

Regulations vary by location, so check with your local tax authority or government agency for specific requirements.

Key nonprofit accounting principles

Nonprofit accounting follows specific principles that ensure accurate tracking and transparent reporting. These fundamentals help you maintain compliance and build donor trust.

Fund accounting basics

Fund accounting tracks money based on its intended purpose rather than combining all funds into one pool. This lets you show donors exactly how you've used their contributions.

Common fund categories include:

• Unrestricted funds: money available for any organisational purpose
• Temporarily restricted funds: donations limited to specific projects or time periods
• Permanently restricted funds: contributions where only the investment income can be spent

Accrual vs cash basis accounting

Most nonprofits must use accrual accounting under Generally Accepted Accounting Principles (GAAP). This means you record income when it's earned and expenses when they're incurred, not when cash changes hands. The Financial Accounting Standards Board (FASB) has maintained these standards since 1973.

Accrual accounting provides a more accurate picture of your financial position, which matters for grant reporting and audits.

Chart of accounts for nonprofits

Your chart of accounts organises transactions into categories for tracking and reporting. Nonprofit charts typically include:

• Assets: cash, investments, property, receivables
• Liabilities: accounts payable, loans, deferred revenue
• Net assets: unrestricted, temporarily restricted, permanently restricted
• Revenue: donations, grants, programme fees, investment income
• Expenses: programme costs, administrative expenses, fundraising costs

Set up your chart of accounts to match the reports you'll need to produce for donors and regulators.

Nonprofit financial statements you need to know

Nonprofits produce specific financial statements that differ from standard business reports. These statements show your financial health and demonstrate accountability to donors and regulators.

Statement of Financial Position

This statement replaces the traditional Balance Sheet. It shows your organisation's assets, liabilities, and net assets at a specific point in time. Net assets are divided into unrestricted, temporarily restricted, and permanently restricted categories.

Statement of Activities

This statement replaces the Income Statement. It shows revenues and expenses over a reporting period, organised by how funds can be used. The bottom line shows the change in net assets rather than profit or loss.

Statement of Functional Expenses

This report is a financial statement that only nonprofits use. It breaks down expenses by both function and nature. Functions typically include programme services, management and administration, and fundraising. This helps donors see how much goes directly to programmes versus overhead.

Statement of Cash Flows

This statement tracks cash moving in and out of your organisation. It shows operating activities, investing activities, and financing activities. Cash flow reporting helps you manage liquidity and plan for future needs.

Most nonprofits need to produce these statements annually, though larger organisations or those receiving significant grants may need to report more frequently.

Six steps to get started as a nonprofit

Setting up nonprofit accounting requires you to complete several tasks to administer and plan your organisation. Follow these steps to establish your organisation properly.

1. Incorporate your business: file the required paperwork with your government agency. Complete this early to avoid tax liabilities from delayed registration.
2. Apply for tax exemptions: submit your tax-exempt application as soon as possible to get the most benefits. Note that while your organisation may be tax-exempt, employees still pay personal income taxes.
3. Create a business plan: use accounting software to model different financial scenarios. A solid plan helps you forecast income, expenses, and growth.
4. Plan your fundraising: develop a strategy for generating income through donations, grants, events, and membership fees. This keeps cash flowing without relying on product sales.
5. Look into financing: research grants and funding opportunities from government agencies and private foundations. Many offer specific programmes for nonprofits.
6. Structure your outgoings: set a realistic budget that keeps expenses below income. Accounting software helps you track spending and stay on target.

Consider hiring an accountant or bookkeeper to help with setup and ongoing compliance.

How to record nonprofit revenues

Recording revenue accurately is essential so you can account to donors, comply with tax rules, and be transparent about finances. Nonprofits receive income from multiple sources, and you must properly document each type.

Main revenue types to track:

• Pledges: record promises to give money, noting any conditions such as matching requirements. Track conditional and unconditional pledges separately.
• Donations: document all contributions regardless of payment method, including cash, cheques, bank transfers, and online payments. Record the date, amount, and donor details.
• Volunteer time: track donated time when it provides specialised skills like accounting or legal services, or when it creates or enhances assets. Accounting standards boards regularly update the rules for disclosing Contributed Nonfinancial Assets. Check local rules for valuation requirements.
• Membership dues: record fees collected in exchange for access to facilities, services, or member benefits.
• Special events: document entrance fees, ticket sales, and other income from fundraising events separately from regular donations.
• Investments: track income from shares, property, or other investments. Follow specific reporting rules that apply to investment gains and losses.
• Grants: record funding from government agencies, foundations, and private organisations. Note any restrictions on how grant funds must be used.

Nonprofit compliance and reporting requirements

To maintain nonprofit status, you must continually comply with tax authorities and regulatory bodies. Meet these obligations to protect your tax-exempt status and maintain donor trust.

Annual filing requirements

Most nonprofits must file annual returns with tax authorities. In the US, this typically means Form 990 or a variant based on your organisation's size. Other countries have equivalent requirements.

Key filing obligations include:

• Annual information returns: report financial activity, governance, and compensation
• State registrations: many jurisdictions require separate charitable registration
• Employment tax filings: submit payroll tax reports if you have employees

Transparency and donor reporting

Donors and grantors often require specific reports showing how you used their funds. Maintain records that let you:

• Track restricted fund spending against donor intentions
• Provide grant progress reports on schedule
• Share financial statements with stakeholders who request them

Maintaining tax-exempt status

Protect your exempt status by following the rules for your organisation type. Common requirements include:

• Operating exclusively for your stated charitable purpose
• Avoiding private benefit to individuals
• Limiting political and lobbying activities
• Keeping accurate financial records

Board oversight responsibilities

Your board has fiduciary responsibility for the organisation's finances. This includes ensuring compliance with accounting standards. Bodies like the Financial Accounting Standards Board often adopt these standards by unanimous vote. Good governance practices include regular financial reviews, independent audits for larger organisations, and clear policies for spending and conflicts of interest.

Choose accounting software for your nonprofit

The right accounting software simplifies how you manage nonprofit finances and helps you stay compliant. Look for features that specifically meet nonprofit needs.

Nonprofit-specific functionality

Choose software built with nonprofit requirements in mind. Generic business accounting tools may lack features to track funds, manage donors, and report in nonprofit formats.

Comprehensive reporting

Generate the financial statements nonprofits need, including Statement of Financial Position, Statement of Activities, and cash flow reports. Look for dashboards that show important numbers at a glance.

Cloud-based access

Access your accounts from anywhere with cloud-based software. This works well for organisations with remote staff, volunteers, or limited office space.

Scalability

Select software that grows with your organisation. Look for options to add users, connect apps, and expand features as your nonprofit grows.

Automation features

Save time by automating routine tasks like reconciling bank statements, processing invoices, and generating reports. This frees you to focus on your mission instead of manual data entry.

Make the most of your nonprofit status

Nonprofit status offers significant advantages that help you direct more resources towards your mission.

Key benefits include:

• Tax exemption: most nonprofits don't pay tax on net income, leaving more funds for programmes and services
• Reduced reporting requirements: governments often streamline paperwork for nonprofits, though you still need to maintain proper financial records
• Donor confidence: transparent accounting builds trust with donors, members, and stakeholders

To get the most from these benefits, focus on managing your finances well. Aim to keep revenues ahead of expenses so you can reinvest surplus funds into your mission. Track what you spend carefully and look for ways to reduce costs without compromising service quality.

With Xero accounting software, you can track donations, manage multiple funds, and generate the financial statements you need. Get one month free and see how Xero can help your nonprofit stay organised and compliant.

FAQs on nonprofit accounting

Common questions about nonprofit accounting:

What accounting method do most nonprofits use?

Most nonprofits use accrual accounting as required by GAAP. This method records income when earned and expenses when incurred, providing a more accurate financial picture for donors and regulators.

Do nonprofits need special accounting software?

Standard accounting software works for basic nonprofit needs, but software with nonprofit-specific features makes it easier to track funds, manage donors, and complete required reporting.

What's the difference between a Statement of Activities and an Income Statement?

A Statement of Activities shows revenues and expenses organised by fund restrictions, with the bottom line showing the change in net assets. An Income Statement shows profit or loss for business owners.

How do nonprofits track restricted funds?

Nonprofits use fund accounting to separate money by donor restrictions. You track each restricted gift in its own fund category, recording spending against that specific fund until you satisfy the restriction.

What is a nonprofit checking account and do I need one?

A nonprofit checking account is a bank account that you register in your organisation's name, typically with no fees or minimum balance requirements. You need one to receive donations, pay expenses, and keep organisational and personal funds separate.