Among the most important reports you’ll create each year are a set of four financial statements: the statements of activities, financial position, cash flows, and functional expenses. Each of these reports summarizes different financial data so you can draw unique, actionable insights from them.
In this guide, you’ll learn all you need to know about nonprofit financial statements, including:
- Why are nonprofit financial statements important?
- Breaking Down the Nonprofit Financial Statements
- Additional Financial Statement Creation Tips
Before we dive into the details of each statement, let’s get started by discussing why your organization needs to compile these reports.
Why are nonprofit financial statements important?
Your organization primarily needs to create financial statements to comply with nonprofit regulations. Not only will compiling your data in these formats help you accurately file your annual tax returns with the IRS, but financial statements are also required under the Generally Accepted Accounting Principles (GAAP), a set of regulations that standardize accounting practices across all for-profit and nonprofit organizations.
However, just because your nonprofit has to create these reports doesn’t mean they aren’t useful in other ways! Financial statements can also be helpful for:
- Internal decision-making. Analyzing your collected data systematically at the end of each fiscal year allows you to get a better sense of what you’re doing well and where you can improve your financial management going forward.
- Strategic planning. Financial statements should be a central resource in deciding how ambitious your strategic plans can be given your current situation and what realistic monetary goals will look like over the next two to ten years.
- Promoting transparency. Making these reports publicly available (for instance, by linking to them on your website or attaching them as appendices to your annual report) can reassure potential donors and funders that you’ll use their contributions wisely.
These additional benefits of financial statements are why it’s important for everyone at your nonprofit to have at least some understanding of the data they contain. When your organization’s leadership, fundraisers, program staff, and other team members are all financially literate and reference reports as they go about their daily tasks, financial management truly works alongside your other activities to further your mission.
Breaking Down the Nonprofit Financial Statements
Now that you understand the overall importance of financial statements, let’s look more closely at the individual reports. We’ve included a template in each section to help you create your own statements, plus links to examples from real nonprofits you can model yours off of.
Statement of Activities
The nonprofit statement of activities is similar to what for-profit organizations call an income statement or profit and loss report. It essentially outlines your organization’s major transactions for the year to provide a detailed overview of spending and revenue generation.
Each nonprofit financial statement has three major sections, and the three divisions of the statement of activities include:
- Revenue. This section encompasses all of the funds you bring in during the year, typically categorized according to sources like individual donations, corporate giving, grants, investment returns, and earned income.
- Expenses. Here, you’ll break down your expenditures based on whether they directly support your mission (i.e., program costs) or are part of your nonprofit’s overhead, which can be divided further into fundraising and management expenses (more on these categories later!)
- Net assets. Finally, you’ll subtract your expenses from your revenue to determine your organization’s change in net assets or equity over the year. Most nonprofits note their net assets at the beginning and end of the year here as well, and it’s a best practice in fund accounting to separate revenue and net assets with and without donor restrictions so you can see how much you actually have available to support various initiatives.
The line items in your revenue and expense sections of your statement of activities should match those in your nonprofit’s annual operating budget. Budgeting is the internal process where your statement of activities is most applicable, since you can compare your actual spending and fundraising numbers from the end of the year to your projections from the beginning of the year. Then, you can use this information to make more accurate predictions in next year’s budget.
For a strong real-world example of a statement of activities, check out the World Wildlife Fund’s 2024 annual report.
Statement of Financial Position
You might have heard the statement of financial position called a “balance sheet,” and the two terms are interchangeable in the nonprofit sector (businesses tend to prefer the latter). Either way, this report provides a snapshot of your organization’s financial health, growth potential, and general sustainability.
The three sections of a nonprofit statement of financial position include:
- Assets. This category covers everything your nonprofit owns, such as cash and cash equivalents, accounts receivable, investments, prepaid expenses, and property.
- Liabilities. This section includes everything your organization owes, like debt, deferred revenue, and accounts payable.
- Net assets. On your balance sheet, you’ll subtract your liabilities from your assets to get your net assets, or what your nonprofit is worth. Like in your statement of activities, you should again separate net assets with and without donor restrictions.
Your statement of financial position can help you determine several essential components of your nonprofit’s health and sustainability, such as:
- Whether you have enough cash and other liquid assets on hand to balance out your current liabilities.
- If you have sufficient savings to cover operating expenses during a planned organizational expansion.
- Which version of IRS Form 990 you need to file, as total assets are an important criterion for determining whether you have to complete the full 12-page return or are eligible for a shorter version (Form 990-N or 990-EZ).
Because of these applications, balance sheets play a central role in most financial audits, meaning you can learn even more about your financial health and position through them.
For a strong real-world example of a statement of financial position, check out The Nature Conservancy’s 2024 annual report.
Statement of Cash Flows
The statement of cash flows has the same name in both for-profit and nonprofit contexts, as well as the same general purpose: to show how cash moves in and out of an organization. Its three sections correspond to different types of spending and revenue generation activities as follows:
- Operating activities encompass most of your organization’s day-to-day cash transactions in both the overhead and program expense categories and from most revenue sources (individual and corporate contributions, earned income, and grants).
- Investing activities are related to long-term asset management, such as earning interest from a savings account or purchasing new equipment.
- Financing activities cover cash flows surrounding prolonged liabilities, like taking out and repaying loans or paying off credit cards.
Most organizations pull statements of cash flows each month instead of just once a year. This way, they’re more useful for keeping your spending and fundraising on track with your budget and letting you know where you might need to make adjustments. Plus, understanding regular movement of cash helps you avoid overdrafting your nonprofit’s bank accounts.
For a strong real-world example of a statement of cash flows, check out Habitat for Humanity’s 2024 consolidated financial statements.
Statement of Functional Expenses
The statement of functional expenses is the one financial statement that only nonprofits create. This is because it categorizes your organization’s spending according to how it furthers your mission, which ties back to the unique goal of nonprofit accounting—remaining accountable to stakeholders and your commitment to making a difference as you manage your finances.
The statement of functional expenses is usually laid out as a table or matrix. The row labels show natural expense categories, which describe the nature of each cost and are how you would typically record an expenditure in your accounting system (e.g., “mortgage payments” or “marketing material creation”). The column labels show the three categories of functional expenses, which are more mission-driven. They include:
- Program costs, which are directly associated with furthering your nonprofit’s cause. These vary widely from organization to organization, ranging from buying a new painting for an art museum’s permanent collection to purchasing food and litter for rescue cats at an animal shelter.
- Fundraising costs, which include all upfront expenses of revenue-generating campaigns, such as event planning, marketing, fundraising consulting fees, and software subscriptions.
- Management and general costs (also known as operational or administrative expenses), which encompasses various expenditures related to keeping your organization running, from utility bills and insurance payments to staff compensation and office supplies.
Functional expense categorization is required on IRS Form 990, so this report will be especially helpful come tax season. However, you can also use it throughout the year for evaluating how productively you’re using your resources.
In the past, the general rule was for at least 65% of nonprofits’ spending to be program-related and no more than 35% to go toward overhead. While it’s now understood that the exact breakdown will look different for every organization, you should still ensure that the majority of your expenditures directly further your mission. If you need to cut costs to balance your budget, always try to reduce overhead spending before taking funding away from programming.
Additional Financial Statement Creation Tips
While the overviews, templates, and examples above should provide a solid foundation for understanding the four core nonprofit financial statements, you might still be wondering about the best ways to create them. Here are a few tips to help you get started:
- Use your chart of accounts as a guide. Your nonprofit’s chart of accounts serves as a directory of its financial records, which are usually divided into five categories: assets, liabilities, net assets, revenue, and expenses. All four financial statements contain some combination of data from these categories, so use the chart to help you find what you need.
- Streamline financial recordkeeping. Depending on what accounting software you use, you may be able to automate some transactions and integrate other solutions like your CRM, fundraising tools, and grant management platform. By enabling these features, you can be confident that the data you need for your financial statements will be accurately recorded in your system.
- Modify templates for your organization’s needs. The templates we’ve included, like most options available online, are fairly broad. Your nonprofit might have more subcategories to include in each report or ones that you don’t use, so make sure to adjust as needed. If you include copies of your financial statements in your annual report or other donor-facing resources, you may also want to brand them for a professional, cohesive look (internal or auditor-facing statements can be simple and straightforward).
- Keep previous years’ reports on hand. Having past financial statements to refer back to when creating new ones is immensely helpful for choosing content and format. More importantly, you can compare your information from previous years to this year to determine your nonprofit’s trajectory and make even better decisions.
If you still have questions or need help creating and analyzing your financial statements, turning to nonprofit financial professionals—like our team at CFO Leverage—is your best bet. From everyday recordkeeping and restricted fund management to cash flow tracking and budgeting support, our affordable, comprehensive services will put your organization on the right track for effective reporting and decision-making. We also work exclusively with nonprofits, so we understand your statements well and can interpret them to develop effective financial strategies.
Wrapping Up: Additional Resources on Nonprofit Accounting
Financial statements are essential for effective nonprofit accounting and management, far beyond their compliance purposes. Keep accountability and transparency at the forefront as you compile your organization’s reports to ensure they’re as accurate and useful as possible, and make sure everyone at your nonprofit is on the same page about how to apply the information they contain for maximum effectiveness.
For more information on nonprofit accounting, check out these resources:
- Fund Accounting for Nonprofits: What It Is & Why It Matters. Dive deeper into the accounting system that forms the foundation of your nonprofit’s financial statements.
- Gifts-In-Kind aka Non-Cash Donations. Discover how to use, record, and report one of the trickiest (and most useful!) types of contributions your organization may receive.
- Avoid These 7 Common Audit Mistakes: A Guide for Nonprofits. Along with compiling accurate financial statements, explore ways to make your audits go more smoothly.
