CA's Budget & Nonprofits: Part Four
05.25.2023 | Linda J. Rosenthal, JD
Any expert in the philanthropy sector will tell you that it’s crucial for any and every charity board member to be actively involved in the affairs and activities of the organization. Regular attendance at board meetings is key, of course, as well as participation in decisions on mission and program activities, but it’s important, too, for every director to be aware of, and understand, the charity’s finances.
Under the law of California and all other states, a charity director has fiduciary duties of care and loyalty. California Corporations Code section 5231:
(a) A director shall perform the duties of a director,
including duties as a member of any committee of the board upon which
the director may serve, in good faith, in a manner that director
believes to be in the best interests of the corporation and with such
care, including reasonable inquiry, as an ordinarily prudent person
in a like position would use under similar circumstances.
In particular, each director should be given a copy of each year’s information return, Form 990 series, before it is filed with the Internal Revenue Service.
Tax-exempt, 501(c)(3) organizations come in all shapes and sizes. Similarly, board members range from novices with no prior experience in the nonprofit world or in business, to community leaders with many rounds of charity-board service under their belts.
But even successful entrepreneurs or business executives who sit on nonprofit boards may have little or no knowledge at all about the fundamentals of nonprofit accounting – which are different than regular business accounting.
And, just to let you in on a little secret, relatively few lawyers have a firm grasp of for-profit accounting principles much less nonprofit accounting concepts.
Many board members, then, regularly fail in their fiduciary duties because (a) they don’t know what they don’t know; accounting is just a big blur to them; or (b) they draw a blank when faced with nonprofit financial documents, but are reluctant to admit that they don’t understand the essentials of this branch of accounting.
Unlike in a business where the goal is to make money for shareholders, the purpose of a nonprofit is to carry out a charitable mission, and to raise funds to do that work.
Because of that distinction, the accounting system that will work well for one will not necessarily be adequate for the other. Here are some illustrations and examples.
Compare, for instance, the second item in each list. A business’ profit and loss statement shows income and expenses with either a profit or a loss as a result. The statement of activities for nonprofit organizations also shows income and expenses, but for nonprofits, income is not derived primarily from sales of goods or services, but rather it can be from sources of funds such as “fee for service”, gifts, grants, donations, and (hopefully) fundraising revenue. While nonprofit and for-profit businesses may have similar expenses — such as utilities, rent, payroll, and office supplies — nonprofit organizations also have something called “functional expenses,” where uses of funds are related to specific programs, with the net of sources of funds and expenses listed as either a surplus or a deficit.
Compare, also, the final item in each list. For-profits have a section for owner’s equity, but nonprofits (which do not have owners) have a net assets category instead. This net assets item “lists sources of funds and is broken down into three areas: unrestricted net assets, temporarily restricted net assets, and permanently restricted net assets.”
A board member who finds any of this unfamiliar or confusing will want to get up to speed. Resources like those below can help are a good starting point:
And if you’d like more information on nonprofit accounting, you can reach out to the experts at For Purpose Accounting.