Running a nonprofit isn't just about mission and passion. It's also about managing the money that makes the mission possible. For many nonprofit leaders, the dream starts with helping others, not with spreadsheets and financial statements.
But as your organization grows, so does the complexity behind the scenes. What began with a few donations is now a patchwork of grants, contracts, restricted gifts, and multi-year funding.
The choice between cash vs accrual accounting for nonprofits isn't just about bookkeeping preferences – it's about having the financial visibility to sustain and grow your mission. While cash accounting feels familiar, accrual accounting provides the comprehensive view that complex nonprofit funding requires.
If you’re still using cash accounting, you may not see the real financial position of your programs (or the risks and opportunities ahead) until it’s too late. Keep reading to learn why accrual accounting can give you the clarity you need to manage the complexities of nonprofit funding.
Understanding cash vs accrual accounting for nonprofits
Before diving into which method works best for your organization, let's clarify what each approach means:
- Cash accounting records transactions only when money actually changes hands. When a donor writes a check and you deposit it, that's when you record the revenue. When you pay a bill, that's when you record the expense.
- Accrual accounting records transactions when they occur, regardless of when money changes hands. When you're awarded a grant, you record the revenue even if the funds won't arrive for months. When you receive an invoice, you record the expense even if you haven't paid it yet.
Some nonprofits start with cash over accrual accounting
When you’re a smaller nonprofit without the budget to hire a proper accountant, it’s understandable that you’ll opt for cash over accrual accounting. It’s a lot easier to manage when you lack accounting experience but are still the one in charge of managing your organization’s finances.
Cash basis accounting is similar to how you run your own personal finances, so it’s simple enough to treat your nonprofit's funds the same way. You can see exactly what's in your bank account and make decisions based on that balance.
However, when it comes to cash versus accrual accounting, there are a few reasons you’ll want to opt for the latter, even if it’s a bit more complicated.
Complex funding means complex financial challenges
Running a nonprofit comes with unique challenges that you’ll need to account for—ones that accrual accounting is much better suited to address. Let’s look at a few:
1. Timing challenges with grants and donations
When you’re awarded grant money or receive donations, you don’t always see that money right away. Grant money can take weeks to months to come in, depending on the conditions. But you still have expenses to cover in the meantime.
Cash-based accounting doesn’t give an accurate view of your real financial position. Without that insight, you could be funding programs with no way to cover those bills, or conversely, you might miss opportunities to expand programs because you can't see incoming committed funds.
2. Multiple funding streams with different rules
As a nonprofit, you can’t necessarily spend any money at your disposal however you want. You have to use fund accounting to track and manage restricted, semi-restricted, and unrestricted funds. You also need a way to properly track long reimbursement timelines from various grants.
Without an accounting method that supports those requirements, you can fall out of compliance or even lose future funding.
3. Compliance and audit requirements
Most nonprofits that receive federal funding or reach certain revenue thresholds (typically $25,000 annually) are required to use accrual accounting because it follows generally accepted accounting principles (GAAP).
Accrual accounting can help solve these issues. Keep reading to see how!
How accrual accounting makes a huge difference for nonprofits
While nonprofits are typically required to use accrual accounting for compliance reasons, there are several other benefits it offers for 501(c)(3) organizations that go beyond just meeting requirements.
1. Improved fund and grant management
Because accrual methods take a granular approach to your finances, you can more easily manage specific grants when you get access to them.
Converting to accrual accounting enables you to:
- Account for delayed grant reimbursement accurately
- Separate money into the appropriate funds automatically
- Track financial activities within each fund more precisely
- Monitor grant spending against award timelines
In doing so, you simplify how you manage individual donor requirements for various grants and funds, always remaining compliant with funding agreements.
2. Consistent audit-readiness
Auditors from government bodies, donor organizations, and other third-party agencies require nonprofits to prepare GAAP-compliant financial statements. Spoiler: Only accrual accounting supports GAAP.
If you’re already using accrual, you save yourself so much time during routine audit periods. In the event you’re slapped with a surprise audit, you’ll be able to quickly pull compliant documents, building credibility and trust with regulatory agencies and donors alike.
3. Strong financial forecasting for mission growth
Since accrual accounting accounts for revenue and expenses when they’re received and incurred, it more accurately shows future accounts receivable and financial obligations. With that financial data readily available, you can more effectively:
- Plan your programs (in terms of funding them)
- Create realistic budgets for the future
- Plan for the growth or expansion of your mission
- Make strategic decisions about new program launches
4. Data-supported financial decisions
Cash accounting doesn’t always deliver the best view of your financial position. Accrual accounting does, with both high-level and granular financial insights. It delivers a clear view of:
- Your projected cash flow
- Unrestricted vs. restricted funds availability
- The timing of income and obligations
That helps your board members and donors make decisions based on real-time accounting data, rather than static figures in the bank.
Cash vs accrual accounting for nonprofits: The bottom line
Complex funding doesn’t have to mean financial confusion. Accrual accounting brings order to the chaos, helping you track what’s been earned, what’s owed, and how your programs are truly performing.
While the transition from cash to accrual accounting can seem daunting, the benefits far outweigh the initial complexity. You'll gain financial clarity, maintain compliance, and position your organization for sustainable growth.
However, switching to accrual accounting can be a process. You need to be strategic about when to make the change. While many firms wait until you’ve crossed the IRS revenue threshold to talk about switching accounting methods, Hiline takes a more proactive approach. We don’t just react to compliance triggers. We anticipate them.
Whether it’s to stay ahead of IRS mandates, unlock tax planning advantages, or prepare for future funding and audits, we help you transition on your terms.
Frequently asked questions about accrual accounting for nonprofits
1. When are nonprofits required to use accrual accounting? Nonprofits must use accrual accounting when they have gross receipts averaging more than $25,000 over a three-year period, receive federal grants, or undergo financial audits. Many states also require accrual accounting for nonprofits filing annual reports.
2. Is accrual accounting more expensive than cash accounting? Initially, yes. Accrual accounting typically requires more sophisticated bookkeeping software and may need professional accounting support. However, the improved financial visibility and compliance benefits often offset these costs, especially as your organization grows.
3. Can small nonprofits use accrual accounting? Absolutely. While not required for very small nonprofits, accrual accounting can benefit organizations of any size by providing better financial planning tools and preparing them for future growth and funding opportunities.
4. How long does it take to switch from cash to accrual accounting? The transition typically takes 1-3 months, depending on your organization's complexity. It's best to make the switch at the beginning of your fiscal year to avoid mid-year complications.
5. What's the biggest challenge with accrual accounting for nonprofits? The most common challenge is tracking restricted vs. unrestricted funds and managing complex grant reimbursement timelines. However, proper fund accounting practices and the right accounting system can address these challenges effectively.
Ready to evaluate whether accrual accounting is right for your nonprofit? Hiline specializes in helping nonprofits navigate accounting method transitions while maintaining compliance and improving financial clarity. Let's work together to ensure you're using an accounting method that best supports your mission.
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