The Art of Rows and Columns Continued…
Designing Your Nonprofit Accounting System
Part 2 – Defining Rows
When designing a nonprofit accounting system, the rows represent the chart of accounts – the various income and expense line items that you use to track the flow of resources in and out of your organization. Deciding which and how many line items (individual accounts) to include in your full chart of accounts is as much art as science. There are many suggestions to be found online, including the Nonprofit Unified Chart of Accounts that purports to be applicable to most nonprofits. We suggest a different approach aimed at building a chart of accounts specific to your organization’s needs.
Only Rows That You Really Use
Instead of starting with a long list of common line items used in a “standard” nonprofit chart of accounts, we recommend that you begin by imagining and listing the categories of resources you commonly deploy in getting your mission work done. The rows you choose to use (your accounts) are most useful when they match the actual day-to-day categories of resources you most often deploy.
When considering income for example, the most common high-level categories are Contributed Support and Earned Revenue. We call these out as two distinct headings or groups because each type of income requires different infrastructure, capacity, expertise, and strategies to acquire. Contributed Support requires staff and systems in place to conduct effective fundraising, grant writing, and donor solicitation. Earned Revenue requires staff and systems to provide services, promote those services, and charge for those services.
Underneath the category Contributed Support, you might find it necessary or useful to break out more detail. You might choose to include line items for Foundation Grants, Individual Contributions, and Corporate Sponsorships. The key is to create line items only for categories that are meaningful and large enough that they truly influence your organizational operations and/or strategies. If they do not, there is no need to create a separate line item for them.
The Three Line Item Test
To demonstrate why you may need fewer line items than you think on your financial statements, look at a recent financial report. Total the three largest income line items. In the following example, Grants / Foundations, Revenue Released from Restriction, and Government Contracts are the three largest income items.
Together, these three items add up to $2,731,833, which is 90% of the total income. At 90% of total Support and Revenue, these three items influence your financial picture significantly more than all the rest of the items combined. You could condense your income line items to highlight these largest items, maintain your overall categories, and still provide a meaningful picture of the types of revenue that matter most to your organization.
The more compact your financial statements, the more readable and understandable they are for your end users. You will be doing your board members and donors a huge favor by providing a more elegant view of how your organization operates financially, while keeping the presentation simple and accessible.
The Power of Roll Ups
Sometimes smaller line items are necessary or important to track for accounting and budgeting purposes. But you may not need to report them all to every audience. The way to maintain both the detail you need for accounting and the elegance you seek for reporting is to make smart use of roll ups. Roll ups are summary line items or group headers for a series of related accounts.
As an example, think of all the various expenses that make up the cost of having an office. You may have rent or lease expense, utilities, custodial services, and maintenance and repair costs. You may need or want to track these items to be sure your accounting and budgeting are accurate, but there is little value in sharing this level of detail with your board. Instead, you could create a roll up account called Occupancy that summarizes these items.
If you extend this thinking to your entire chart of accounts, you can provide a much simpler, more accessible view of what resources it takes to run your organization. By keeping the level of detail appropriate to each audience, you help everyone focus their energy on the right questions. We always joke that the highest and best purpose of your board members is not drawing them into a debate over whether you spent too much on postage. Instead, you can use your roll ups to provide just the right level of detail and draw your board members into larger conversations about strategy, planning, and future initiatives.
Using Roll Ups to Summarize and Condense
Elegance in Reporting – The “Just Enough Detail” Principle
Whatever line items you ultimately decide on, you can use the “Just Enough Detail” principle to guide your choices. The goal in designing an accounting system and your chart of accounts is to track and report on the use of your organization’s valuable resources – everything from staff time to office space to program materials. But the level of detail necessary is dependent on which audience is using the data. What we consider to be an elegant chart of accounts is:
As simple as it can be, while still being complete.
As informative as it should be, without being too dense.
As sophisticated as it needs to be, without being overly complicated.
If you are inspired by these concepts, it may be time to refresh your chart of accounts. You will only benefit by aligning your accounting system to better match and mirror how your organization most naturally accomplishes its good work.
For more information on this topic or others related to nonprofit accounting and finance, please contact us at Diverge at any time.
By Curtis Klotz, CPA, Co-Founder and Chief Learning Officer, and Shétu Rose, Co-Founder and CEO, Diverge Finance Cooperative.