Nonprofit accounting: basics, methods and reporting

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?
• Accounting methods for nonprofits: Cash vs. accrual
• Understanding fund accounting and restricted funds
• How to set up your nonprofit accounting
• Recording nonprofit revenues and donations
• Essential financial statements for nonprofits
• Nonprofit reporting and compliance requirements
• Choosing accounting software for your nonprofit
• Xero simplifies nonprofit accounting
• FAQs on nonprofit accounting

Key takeaways

• Implement fund accounting to track restricted and unrestricted funds separately, ensuring you use donated money exactly as donors intended and maintain compliance with legal requirements.
• Choose accrual accounting if your nonprofit has over $250,000 in annual revenue, as it's required by Generally Accepted Accounting Principles and provides a more accurate picture of your financial health.
• Prepare four essential financial statements regularly: Statement of Financial Position, Statement of Activities, Statement of Cash Flows, and Statement of Functional Expenses to demonstrate accountability to donors and maintain transparency.
• Select accounting software designed specifically for nonprofits that includes fund tracking, donation management, and automated generation of required financial reports rather than adapting for-profit business tools.

What is nonprofit accounting?

Nonprofit accounting involves recording, tracking, and reporting financial transactions for tax-exempt organisations like charities, clubs, and community groups.

Unlike for-profit businesses that aim to generate returns for owners, nonprofits exist to serve a mission. Any surplus funds get reinvested into that mission rather than distributed as profit.

Despite this difference, nonprofits still need to track money coming in and going out, pay employees, and manage day-to-day operations. The law requires you to account for all of this properly.

This guide covers what you need to set up nonprofit accounting and keep your organisation compliant.

How nonprofit accounting differs from for-profit accounting

While both nonprofit and for-profit businesses track money, their accounting practices have different goals. For-profit accounting focuses on profitability and returns for owners, while nonprofit accounting focuses on accountability and mission success.

Key differences include the financial statements you prepare and the terminology you use. For example, nonprofits report on net assets instead of equity and must often track funds based on donor-imposed restrictions. This focus ensures you meet legal requirements and maintain the trust of your supporters.

Is your business really nonprofit?

Not every organisation qualifies for nonprofit status. Ask yourself these questions to determine if your organisation fits:

• Purpose: Does your organisation exist to provide charitable services, run a social club, or serve a community need rather than generate profit for owners?
• Revenue sources: Will your income come primarily from donations, membership fees, fundraising events, grants, or investment income rather than product sales?
• Similar organisations: Do other nonprofits with a similar structure already exist, which can help establish precedent for your application?

Check your local regulations for specific requirements, as rules vary by location. See the guide to starting a nonprofit for more details.

Accounting methods for nonprofits: Cash vs. accrual

Most nonprofits use accrual accounting because it provides a more accurate picture of financial health and is required by Generally Accepted Accounting Principles (GAAP) for organisations with over $250,000 in annual revenue. GAAP is a set of standards the Financial Accounting Standards Board (FASB) has been responsible for keeping up-to-date since 1973.

Here's how the two methods differ. Understanding these differences helps you choose the right approach for your organisation:

• Cash accounting: Records income when received and expenses when paid. It's simpler to manage but doesn't show money owed to you or bills you haven't paid yet.
• Accrual accounting: Records income when earned and expenses when incurred, regardless of when cash changes hands. It shows a complete picture of your financial position.

Smaller nonprofits with straightforward finances may use cash accounting. However, if you receive grants, have significant pledges, or need audited financial statements, accrual accounting is typically required.

Check with your accountant or local regulations to confirm which method your organisation should use.

Understanding fund accounting and restricted funds

Fund accounting is a system that tracks money based on restrictions placed by donors or grantmakers. Unlike for-profit accounting that focuses on overall profitability, fund accounting ensures you use donated money exactly as intended.

Nonprofits typically manage two types of funds:

• Unrestricted funds: Money you can use for any purpose that supports your mission, including general operations, salaries, and overhead costs.
• Restricted funds: Money designated for specific programmes, projects, or time periods. For example, a donor might contribute cash to a soup kitchen under the stipulation that they serve 500 meals to low-income families. You must track these funds separately and use them only as the donor specified.

Fund accounting matters for several important reasons. Here's why it's essential for your nonprofit:

• Donor trust: Donors need assurance their contributions support the causes they care about.
• Compliance: Misusing restricted funds can result in legal issues and loss of tax-exempt status.
• Accurate reporting: Funders and boards need clear visibility into how you use each fund.

Your accounting software should support fund tracking so you can generate reports showing balances and activity for each fund separately.

How to set up your nonprofit accounting

Setting up nonprofit accounting correctly from the start helps you stay compliant and track your finances accurately. Follow these steps to establish your accounting system:

1. Choose your accounting method: Select cash or accrual accounting based on your organisation's size and reporting requirements. Most nonprofits with over $250,000 in revenue need accrual accounting.
2. Set up your chart of accounts: Create account categories that track restricted and unrestricted funds separately. This structure supports accurate fund accounting and donor reporting.
3. Select accounting software: Choose software designed for nonprofit needs, including fund tracking, donation recording, and financial statement generation.
4. Create your budget: Build a budget that allocates funds across programmes, administration, and fundraising. Use your accounting software to model different scenarios.
5. Establish financial policies: Document procedures for approving expenses, recording donations, and reconciling accounts. Clear policies reduce errors and support compliance.
6. Consider professional support: Work with an accountant familiar with nonprofit requirements to review your setup and provide ongoing guidance.

Recording nonprofit revenues and donations

Nonprofits receive income from multiple sources, and each type must be recorded accurately for compliance and reporting. Here are the main revenue types to track:

• Pledges: Record promises to give money, noting any conditions such as matching requirements or future event triggers.
• Donations: Track all donations regardless of source or payment method, including cash, cheques, bank transfers, and online payments.
• In-kind contributions: Record donated goods, services, and volunteer time when they provide measurable value or specialised skills.
• Membership dues: Account for fees collected in exchange for access to facilities, services, or member benefits.
• Event revenue: Record entrance fees, ticket sales, and other income from fundraising events.
• Investment income: Track returns from investments such as shares or property, following applicable tax rules.
• Grants: Record all grant funding from government agencies, foundations, and private sector sources, noting any restrictions on use.

Essential financial statements for nonprofits

Nonprofits prepare four main financial statements to report their financial position and activities. These documents help you demonstrate accountability and transparency:

• Statement of Financial Position: Shows what your organisation owns (assets), owes (liabilities), and its net assets at a specific point in time. It's similar to a balance sheet but categorises net assets as unrestricted, temporarily restricted, or permanently restricted.
• Statement of Activities: Reports revenue and expenses over a period, showing whether your organisation operated at a surplus or deficit. It breaks down activity by fund type and functional area.
• Statement of Cash Flows: Tracks cash moving in and out of your organisation from operating activities, investing, and financing. It helps you understand your actual cash position.
• Statement of Functional Expenses: A financial statement unique to nonprofits, it allocates expenses across programme services, management, and fundraising, showing stakeholders how much goes directly to your mission versus overhead.

These statements give your board, donors, and regulators a complete picture of your organisation's financial health. Your accounting software should automatically generate these reports from your transaction data.

Nonprofit reporting and compliance requirements

Nonprofits must meet specific reporting requirements to maintain tax-exempt status and demonstrate accountability to stakeholders.

You must meet several key compliance obligations to maintain your status and credibility. These include:

• Annual information returns: Most nonprofits must file Form 990 (or 990-EZ or 990-N depending on size) with the tax authority each year. While only the full Form 990 requires a complete functional expense report, the 990-N, 990-EZ, and 990-PF all ask questions about your expenses, documenting your revenue and activities.
• State registrations: Many jurisdictions require nonprofits to register before soliciting donations and file annual reports to maintain registration.
• Donor acknowledgements: Provide written acknowledgement for donations over $250, including the amount, date, and whether goods or services were provided in exchange.
• Audit requirements: Larger nonprofits or those receiving significant grant funding may need annual audits by an independent accountant.

Staying compliant protects your organisation in several important ways. Here's why compliance matters:

• Tax-exempt status: Timely filing helps you maintain your tax exemption.
• Donor confidence: Transparent reporting builds trust with supporters and funders.
• Grant eligibility: Many funders require clean compliance records before awarding grants.

Work with an accountant familiar with nonprofit requirements to ensure you meet all deadlines and maintain proper documentation.

Choosing accounting software for your nonprofit

The right accounting software makes nonprofit financial management straightforward. Look for these features when choosing a solution:

Fund tracking and nonprofit-specific features

Choose software built for nonprofit needs rather than adapted from for-profit tools. Key capabilities include:

• Fund accounting support: Track restricted and unrestricted funds separately
• Donation management: Record contributions and generate donor acknowledgements
• Grant tracking: Monitor grant spending against restrictions and deadlines

Reporting and financial statements

Your software should generate the reports nonprofits need. Look for these reporting capabilities:

• Statement of Financial Position: Shows assets, liabilities, and net assets
• Statement of Activities: Tracks revenue and expenses by programme
• Custom dashboards: Monitor cash flow, receivables, and key metrics in real time

Cloud access and collaboration

Cloud-based software lets your team work from anywhere. Here are the key benefits of cloud access:

• Remote access: Update accounts without being in the office
• Multi-user support: Give your accountant, bookkeeper, and board members appropriate access
• Automatic backups: Protect your financial data with secure cloud storage

Automation and time savings

Reduce manual work with built-in automation. These features save you time:

• Bank reconciliation: Match transactions automatically
• Recurring entries: Set up regular donations and expenses once
• Invoice generation: Create and send invoices directly from the software

Xero simplifies nonprofit accounting

Nonprofit accounting comes with unique requirements, from fund tracking to specialised financial statements. But with the right approach and tools, you can manage your finances confidently and keep your focus on your mission.

With Xero's cloud-based accounting software, you can make nonprofit financial management straightforward. Track restricted and unrestricted funds, record donations automatically, and generate the reports your board and donors expect. Learn how to record accounting transactions.

Get one month free and see how Xero helps nonprofits stay organised, compliant, and mission-focused.

FAQs on nonprofit accounting

Here are answers to common questions about nonprofit accounting.

What accounting method do most nonprofits use?

Most nonprofits use accrual accounting because GAAP requires it for organisations with over $250,000 in annual revenue. Smaller nonprofits with simple finances may use cash accounting.

What are the main financial statements nonprofits need to prepare?

Nonprofits prepare four main statements: Statement of Financial Position, Statement of Activities, Statement of Cash Flows, and Statement of Functional Expenses. Together, these show your organisation's financial health and how you use funds.

What is fund accounting and why is it important?

Fund accounting tracks money based on donor restrictions, separating unrestricted funds from restricted funds. This ensures you use donations as intended and maintain compliance with donor agreements.

Do I need specialised software for nonprofit accounting?

Standard accounting software can work for basic needs, but nonprofit-specific features like fund tracking, donation management, and restricted fund reporting make compliance easier. Look for software that generates the financial statements nonprofits require.

How often should nonprofits prepare financial reports?

Prepare financial statements at least quarterly for board review and annually for external reporting. Monthly reports help you monitor cash flow and catch issues early.