Cash or accrual based accounting? Which is best for your nonprofit? Here’s the pros and cons of each system and tips to help you find the right fit for your nonprofit in your current stage or season.

     Choosing an accounting method isn't a one size fits all decision. Just like choosing a path to get to my grandmother's house in Colorado isn't always the same. Determining which route depends on variables, like weather, construction, and the priorities of our journey. Are we going for fun or do we need to get there right away? Evaluating the options and then committing to the route is what it takes to get there. 

     In that same way, choosing a nonprofit accounting method depends on the route you want to take. Here's some important variables to consider when making this decision. 

Cash Basis Accounting For Nonprofits

     How does it work? Well, it records transactions when cash actually changes hands. Revenues are recognized when the money is received, and expenses are recognized when the money is paid. 

Advantages of Cash Basis Accounting

• Simplicity- easier to understand and implement
•  Immediate- tracking provides a clear picture of cash flow

Disadvantages of Cash Basis Accounting

• Accuracy- doesn't account for those receivables and payables, which can give a skewed view of financial health.
•  Limited Insight-  may not reflect the true financial position if there are significant amounts of outstanding funds that either have been earned or owed but not yet collected or paid

Accrual Basis Accounting For Nonprofits

     So how does this work? Well, it records revenues when they are earned and expenses when they are incurred or owed regardless of when the cash is actually exchanged.

Advantages of Accrual Basis Accounting

• Accuracy- provides a more complete view of the financial status as it does include those receivables and payables
•  Better for Planning- facilitates budgeting and financial planning by reflecting all earned revenue and incurred expenses regardless of whether the cash has happened or not

Disadvantages of Accrual Basis Accounting

• Complexity- It’s obviously more complex to implement and maintain
•  Cashflow Management- additional budgeting and cashflow planning tools will be needed since the bank balance won’t reflect the true account status

Which Accounting System is Best for Nonprofits? 

     So which one should you choose? Well, in general, for smaller nonprofits, the cash basis might be sufficient if the organization has simple transactions and really wants to keep the accounting straightforward. 

     But, as you get larger or you have more complex revenue sources, the accrual basis is often preferred because it provides a more comprehensive view of your financial health and it complies with GAAP (Generally Accepted Accounting Principles), which is especially important for organizations that receive significant funding from grants or contracts. Furthermore, if your organization will eventually receive an audit, the audit will have to be done on an accrual basis.

What’s the Next Step For Your Nonprofit? 

1. Identify Your Accounting Requirements

     I want to inspire you to take some action with what you've learned today! Many nonprofits are required by their funding sources to use accrual accounting. Do you know if that applies to you? If not, it’s time to find out! It's also a good idea to consult someone who specializes in nonprofits to determine the best approach for your situation, whether you're changing accounting systems or just making this accounting decision for the first time as you get started. 

2. Evaluate Your Accounting Software

     This is also a good time to evaluate your accounting software. What capacity does it have to support the accounting method you choose? For more on this, check out my blog/video The BEST Accounting Software for Nonprofits

     If you need help getting positioned for growth, I invite you to consider our fractional CFO services for more strategic decision making!