No one likes preparing for audits. Or doing their taxes. It’s easy to spend hours — if not days — sorting through Excel spreadsheets and analyzing business costs. If you’re a nonprofit, what matters most is achieving your mission. But you can’t achieve your mission without having accurate operational data about your business. Not only is it critical for board and donor transparency, it’s required by the Federal government.
So we’ve put together a quick guide to help you.
Statement of Functional Expenses is a requirement for compliance when filing Form 990 Part IX
Gain key insights into operations and performance when you report on functional expenses
Increased transparency and employee accountability when you record functional expenses
All organizations exempt from income tax must report on their total expenses. That should be fairly straightforward. But businesses with 501(c)(3) or 501(c)(4) status must also report on three additional categories: Program, Administrative, and Fundraising.
Internal controls are financial management rules designed to deter the misuse of funds. They also prove to the IRS and your donors that your nonprofit has a system of checks and balances to stay in compliance. Internal controls can be as simple as requiring two signatures on a check to ensuring that expenses are reasonable (i.e., within the range of recent industry norms). The National Council of Nonprofits has a wealth of information readily available to assist you.
Labor is often the single biggest expense in an organization, so its accurate allocation is critical to understanding the breakdown of expenses. Employee time tracking allows the board, the IRS, and your donors to understand the employee costs of a given program.
Time should be tracked by activity, service, or project, and signed off by a supervisor. Any changes to timesheets should be tracked, as they can be audited. Guidestar has some great overview of nonprofit time tracking.
| Program |
|---|
| Costs that result in the organization fulfilling its mission |
| Administrative |
|---|
| Costs necessary for the operations of an organization that are not identifiable with a specific program, fundraising or membership activity |
| Fundraising |
|---|
| Costs that involve seeking, soliciting or securing contributions |
This is where things get a touch tricky. While timesheets simplify the allocation of employee time and cost by function, other expenses — such as renting office space — require a bit more work, as certain programs may occupy a greater percentage of the office than others.
For example, if you have three programs in the office Reducing Ocean Pollution, Improving Veteran Health, and Educating Underserved Children, as well as a small administrative and fundraising team, you’ll want to allocate your rent and utilities proportionately across these groups.
| Program Name | Reducing Ocean Pollution | Improving Veteran Health | Educating Underserved Children | Administrative | Fundraising |
|---|---|---|---|---|---|
| Percentage of office space | 15 | 25 | 40 | 5 | 15 |
| Percentage of program allocation | 15 | 25 | 40 | 5 | 15 |
Or, some costs — such as cell phone bill — may be split across Program, Administrative, and Fundraising. A similar methodology would be applied here:
| Executive Director Cell Phone | Calls related to Programs | Calls related to Administrative | Calls related to Fundraising |
|---|---|---|---|
| Percentage of cell phone use | 10 | 30 | 60 |
| Percentage of functional expense | 10 | 30 | 60 |
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