Nonprofit accounting: How to manage finances and stay compliant

Published Thursday 29 January 2026

Table of contents

• What is nonprofit accounting?
• How nonprofit accounting differs from for-profit accounting
• Fund accounting basics for nonprofits
• Nonprofit accounting vs bookkeeping
• Is your business really nonprofit?
• How to set up accounting for your nonprofit
• Compliance and reporting requirements
• Record all revenues
• Think like a regular business
• Choose good accounting software to keep an eye on the numbers
• Get the most from your nonprofit status
• Manage your nonprofit accounting with Xero
• FAQs on nonprofit accounting

Key takeaways

• Implement fund accounting to separate restricted donations (which must be used for specific donor-designated purposes) from unrestricted funds that can support any mission-related activities.
• Complete your nonprofit setup within 90 days by incorporating your organization, applying for 501(c)(3) tax-exempt status with the IRS, and establishing proper accounting systems to avoid penalties.
• Choose nonprofit-specific accounting software that includes fund tracking, donor management, grant monitoring, and compliance reporting features rather than adapting general business accounting tools.
• Maintain detailed records for all revenue sources including pledges, donations, grants, and volunteer time to ensure compliance with reporting requirements and preserve your tax-exempt status.

What is nonprofit accounting?

Nonprofits operate differently from traditional businesses in several key ways:

• Primary purpose: Focus on mission fulfillment rather than profit generation
• Revenue sources: Donations, grants, membership fees, and fundraising events
• Legal structure: Tax-exempt status with specific compliance requirements
• Financial oversight: Mandatory reporting to maintain nonprofit status

Despite these differences, nonprofits still handle daily operations like payroll, expenses, and financial planning. Legal compliance requires detailed record-keeping and regular reporting to government agencies.

How nonprofit accounting differs from for-profit accounting

While both nonprofit and for-profit accounting track income and expenses, their goals and methods are different. For-profit accounting focuses on generating profit for owners, while nonprofit accounting focuses on accountability and mission success.

Key differences include:

• Financial statements: Nonprofits use a Statement of Financial Position and a Statement of Activities, following guidance from the Financial Accounting Standards Board's (FASB) 2016 Accounting Standards Update, which modernized the financial statement presentation for not-for-profit entities.
• Fund accounting: Nonprofits use fund accounting to separate money that is restricted for specific purposes from unrestricted funds.
• Focus on mission: Success is measured by how well the organization achieves its mission, not by how much profit it makes.

Fund accounting basics for nonprofits

Fund accounting is a core part of nonprofit financial management. It's a system for tracking resources that have specific restrictions on their use. This helps you show donors that their contributions are being used as they intended.

Funds are typically categorized as:

• Unrestricted funds: Money that can be used for any purpose to support the mission.
• Restricted funds: Donations or grants that must be used for a specific purpose designated by the donor, such as a new program or building project.

Proper fund accounting is essential for maintaining donor trust and ensuring compliance.

Nonprofit accounting vs bookkeeping

It's easy to confuse accounting and bookkeeping, but they play different roles in your nonprofit's financial health. Both are important, but they handle different tasks.

Bookkeeping is the day-to-day process of recording financial transactions, like donations, payments, and expenses. It's about keeping accurate and organized records.

Accounting is more high level. It involves analyzing, interpreting, and summarizing that financial data to create reports and provide insights. An accountant helps you understand the bigger picture and make strategic decisions.

Is your business really nonprofit?

Nonprofit eligibility requires meeting specific criteria. Evaluate your organization using these steps:

1. Assess your mission: Confirm your primary purpose serves public benefit, not private profit.
2. Identify revenue sources: Ensure income comes from donations, grants, membership fees, or fundraising.
3. Research similar organizations: Find comparable nonprofits in your field to validate your structure.
4. Review legal requirements: Check local regulations for nonprofit formation in your jurisdiction.

Organizations focused on charitable services, education, religious activities, or community benefit typically qualify for nonprofit status; in fact, about 60 percent are public charities or foundations, also known as 501(c)(3) organizations.

The regulations vary depending on where you set up your business, so check local laws for guidance.

How to set up accounting for your nonprofit

Setting up nonprofit accounting requires completing these essential steps:

1. Incorporate your organization: file formation documents with your state agency to establish legal entity status.
2. Apply for federal tax exemption: Submit IRS Form 1023 or 1023-EZ to obtain 501(c)(3) status.
3. Register for state tax exemptions: Apply for state-level tax exemptions where applicable.
4. Obtain required licenses: Secure necessary permits for fundraising and operations.
5. Set up accounting systems: Implement fund accounting to track restricted and unrestricted funds.
6. Establish governance: Create board oversight and financial controls.

Timeline: Complete incorporation and tax applications within 90 days of formation to avoid penalties.

Create a business plan

Use this nonprofit business plan template to run through different forecasts and scenarios. Nonprofit accounting software can help you see which plan works best for you.

Nonprofit accounting software can help you run different forecasts and scenarios. Play with the numbers and see which plan works best for you.

Plan your fundraising

You'll probably have no products or services to sell, at least at the beginning. So how will you raise money? A well-thought-out fundraising plan will help keep cash flowing in.

Look into financing

Nonprofits can apply for various grants and other forms of finance, from the public and private sectors. An online search can be helpful here. Check your government's business website for details.

Structure your outgoings

How much can you afford to spend? Your business was set up to provide a useful service, but you'll need to budget carefully to make sure expenditure doesn't exceed income. Again, accounting software can help here.

You might need some assistance with all of this, so consider hiring an accountant to help you.

Compliance and reporting requirements

Staying compliant is critical for any nonprofit. Meeting reporting requirements helps you protect your tax-exempt status.

Your organization must file an annual information return with the IRS, typically Form 990, to provide the IRS with information required under section 6033 of the tax code.

Record all revenues

Revenue tracking requires recording all income sources with specific accounting methods:

• Pledges: Promises to donate that may include conditions or matching requirements, such as a challenge grant, which is a common form of a conditional promise to give.
• Donations: Direct contributions from individuals, corporations, or foundations
• Grants: Funding from government agencies or private foundations for specific programs; in fiscal year 2004 alone, the federal government spent an estimated $317 billion on nonprofit organizations.
• Membership dues: Regular payments from members for access to services or benefits
• Special events: Income from fundraising activities, galas, or community events
• Investment income: Returns from endowments, stocks, or other financial investments
• Volunteer time: In-kind contributions valued at fair market rates for skilled services

Documentation requirement: Maintain detailed records for all revenue sources to ensure compliance and accurate reporting.

Think like a regular business

When you run a nonprofit business, you can still aim to make it as successful and efficient as possible. The more efficiently you run your organization, the better the service you'll be able to provide, which is why the sector has seen a significant increase in specialized nonprofit management programs at the graduate level. Here are some ideas:

Hire the right employees

A nonprofit organization doesn't technically have an owner. But it does still have people in positions of responsibility, such as the secretary or treasurer. These people need to fulfill their roles well so your nonprofit runs smoothly. Find guidance on hiring well.

Strive to earn more than you spend

Your goal is not to make a profit for owners. If you collect more in revenues than you spend, that extra money can be reinvested or used to offer extra services or facilities.

Look for business opportunities

Network with business owners, talk to advisors and your peers. Learn about opportunities to raise money for your nonprofit business or improve the services you offer.

Talk to your "customers"

The people receiving your business's services can be considered as customers. Whether it's the members of the club you run or the recipients of your charitable services, talk to them. Find out what they really need from you, then tailor your organization to match.

Choose good accounting software to keep an eye on the numbers

Nonprofit accounting software helps you streamline financial management and stay compliant with nonprofit requirements, so you can focus more on your mission and less on the numbers. Choose software with these essential features:

• Fund accounting capabilities: Track restricted and unrestricted funds separately
• Donor management: Record contribution history and generate tax receipts
• Grant tracking: Monitor grant requirements and spending restrictions
• Compliance reporting: Generate required forms like Form 990 and state reports
• Budget management: Create program-specific budgets and track variances
• Integration options: Connect with fundraising platforms and payroll systems

Selection criteria: Prioritize software designed specifically for nonprofits rather than adapted business accounting tools.

Full reporting

You might want to track things like accounts receivable ratios, liquidity graphs, monthly timelines of income and expenditure, and other useful statistics. High-quality accounting software will let you do this, with a "dashboard" of key numbers that you can access quickly and easily.

Collaborate from anywhere, at any time

Many nonprofit organizations are tight on money. In 2004, 73 percent had annual budgets of less than $500,000, and many may lack fixed office space, making remote work for employees a necessity.

Cloud-based software makes perfect sense here and lets your accountant or bookkeeper update the accounts from anywhere.

Tools for growth

Your business might stay small, or it might grow as you reinvest revenue to help people. Choose nonprofit accounting software that scales for more users and connects with add-on apps as your needs change.

Automate those manual time-consuming tasks

If you're running a nonprofit business in your spare time, you'll want software that can handle all the important tasks for you in one place. That way you'll get more done in less time.

Get the most from your nonprofit status

Nonprofit status provides significant financial and operational advantages:

• Tax exemption: No federal income tax on mission-related revenue
• Donation deductibility: Donors can claim tax deductions for contributions
• Grant eligibility: Access to foundation and government funding restricted to nonprofits
• Reduced reporting: Simplified financial statements compared to for-profit businesses
• Public trust: Enhanced credibility with donors and community partners

Maximizing benefits: Reinvest savings into program expansion, staff development, or reserve funds. Maintain transparent financial practices to preserve donor confidence and regulatory compliance.

Mission focus: Direct all financial decisions toward advancing your organization's charitable purpose and serving your target beneficiaries effectively.

Manage your nonprofit accounting with Xero

Xero's online accounting software for nonprofits simplifies your accounting, from tracking cash flow and paying employees to sharing financial reports. You’ll have more time to set up and manage a successful nonprofit.

Get one month free and try Xero for nonprofits today.

FAQs on nonprofit accounting

Here are answers to some common questions about nonprofit accounting.

What kind of accounting do nonprofits use?

Most nonprofits use fund accounting, which is a specialized method of accrual accounting. It helps track financial activity across different funds, like grants or restricted donations, to show how money is used based on donor intent.

What are the main financial statements for a nonprofit?

Nonprofits typically prepare three key financial statements: the Statement of Financial Position, the Statement of Activities, and the Statement of Cash Flows. These reports provide a clear picture of the organization's financial health and activities.

How much does an accountant cost for a nonprofit?

The cost of an accountant for a nonprofit varies widely based on the organization's size, complexity, and location. Costs can range from a few hundred dollars for a simple tax filing to several thousand for ongoing bookkeeping, payroll, and advisory services.