What’s the Difference Between Nonprofit and For-Profit Accounting, and How Does it Impact the Fiduciary Duties of Board Members?
By Lee Klumpp, CPA, CGMA
There are many opinions on what the fiduciary responsibilities of nonprofit board members are. The National Council for Nonprofits discusses that boards should:
a) Take care of the nonprofit by ensuring prudent use of all assets, including facility, people and goodwill; and provide oversight for all activities that advance the nonprofit’s effectiveness and sustainability. (Legal term: “Duty of due care”)
b) Make decisions in the best interest of the nonprofit corporation; not in his or her self-interest. (Legal term: “Duty of loyalty”)
c) Ensure that the nonprofit obeys applicable laws and acts in accordance with ethical practices; that the nonprofit adheres to its stated corporate purposes, and that its activities advance its mission. (Legal term: “Duty of obedience”)
In light of several nonprofit failures in recent years, it has become even more vital for members of nonprofit boards to exercise the duty of due care as described above by understanding how their organization communicates its financial results and operations. Members of nonprofit boards tend to come from the for-profit world, where financial reporting is quite different. Below, we have highlighted some of the financial reporting differences between nonprofit and for-profit entities to help board members understand and fulfill their fiduciary responsibilities.
First, look at the spectrum of nonprofits to determine where the organization you serve falls.
Some nonprofits might land at one end of the continuum or the other depending on their mission, strategic plan or business model. You might even determine a nonprofit’s position on the continuum based on how they generate revenue—for instance, a nonprofit that raises most of its funds from fees for services might be a more business-like nonprofit (i.e., nonprofit hospital). Whereas a nonprofit that raises most of its revenue through fundraising or contributions might be a more charity-like nonprofit (i.e., homeless shelter). A college or university might fall in the middle of the continuum depending on its business model.
Most of the time when we talk about the difference between nonprofits and for-profits, we consider the differences between the two; however, it’s also important to account for similarities. The following are just of a few of the similarities:
- Both types of organizations can grow, transform, merge or fail. Success isn’t guaranteed for either.
- Cash is crucial.
- Good management and leadership really matter. Delivering quality service, motivating and inspiring staff and conceiving new areas for growth are vital.
- Planning, budgeting and performance measurement systems are crucial.
- Both add value to society via job creation and buying and selling goods and services in the market.
The Goals of Financial Reporting:
Due to the differences between nonprofit and for-profit entities, they also have differing financial reporting goals:
- Meet their obligation to communicate to the public and their donors how they acquired, managed and allocated financial resources to accomplish their mission.
- Present financial statements that are informative, transparent, reliable and adequately communicate financial position, results and accomplishments to stakeholders.
- Report profitability and cash flows so that shareholders and investors can project future dividends and return on investment.
To address these different goals, the financial statements of the two types of entities need to be different. This is where many board members and users of nonprofit financial statements encounter difficulty. The chart below identifies the different components of nonprofit and for-profit financial statements.
When Reviewing Nonprofit Financial Statements, Remember…
- Present net assets versus retained earnings;
- Present net assets as unrestricted, meaning no restrictions are placed by donors; or temporarily or permanently restricted, meaning restrictions are placed on these funds by donors;
- Show contribution revenue, which is a nonreciprocal transaction where the donor does not expect a good or service of similar value;
- Present quantitative information on how a nonprofit manages and deploys its resources through the statement of activities, statement of functional expenses (if required), and footnotes.
Understanding the differences between nonprofits and for-profits will aid board members in fulfilling their fiduciary responsibilities by allowing them to analyze the financial statement
This article originally appeared in BDO USA, LLP’s “Nonprofit Standard” newsletter (Winter 2016). Copyright © 2016 BDO USA, LLP. All rights reserved. www.bdo.com