Nonprofit accounting is fund accounting. Instead of tracking one pool of money toward a profit figure, you track money according to the restrictions donors attached to it, and you report spending by function as well as by type. Ratios sit on top of that structure. They only mean something once the structure underneath them is right.
Most small organizations get the ratios wrong because they got the bookkeeping wrong first. A program expense ratio calculated from a chart of accounts that never separated program from administration is a number with no content. Start with the structure.
What makes nonprofit accounting different
A business asks one question of its books: did we make money. A nonprofit has to answer two questions at once. Did the organization live within its means, and did each restricted dollar go where the donor said it should. That second question is why the whole system exists.
Net assets, not equity
Where a company reports equity, a nonprofit reports net assets, and the Financial Accounting Standards Board requires them to be split into two classes: net assets with donor restrictions and net assets without donor restrictions. That two-class presentation came in with FASB’s Accounting Standards Update 2016-14, which replaced the older three-way split of unrestricted, temporarily restricted and permanently restricted funds. If your financial statements still use the old labels, they are out of date and a funder’s auditor will notice.
The practical version: a $20,000 grant for a summer reading program is not $20,000 you have. It is $20,000 you owe the reading program. An organization can be sitting on a healthy bank balance and still be unable to pay the electric bill, because almost all of it is restricted. That single misunderstanding closes more small nonprofits than any ratio.
Expenses by function, not just by type
Nonprofits report what they spent by natural category (salaries, rent, supplies) and also by function: program, management and general, and fundraising. ASU 2016-14 made that functional analysis mandatory for every nonprofit rather than optional. It is also the raw material for every ratio a watchdog or a funder will later calculate about you, which means the allocation decisions you make in your own accounting software determine the numbers strangers will judge you by. Write your allocation method down, apply it consistently, and be able to defend it.
The four statements, and what each one is for
| Statement | The for-profit equivalent | The question it answers |
|---|---|---|
| Statement of Financial Position | Balance sheet | What do we own, what do we owe, and how much of what is left is actually available |
| Statement of Activities | Income statement | What came in and what went out this year, split by donor restriction |
| Statement of Functional Expenses | No equivalent | How much of our spending went to program, management and fundraising |
| Statement of Cash Flows | Statement of cash flows | Where cash actually moved, as opposed to where revenue was recognized |
Small organizations often produce only the first two and wonder why grant applications keep asking for something they do not have. The functional expense statement is the one funders read closest.
What you file, and what happens if you do not
The IRS sorts the annual return by size. Organizations with gross receipts normally at or under $50,000 file the Form 990-N electronic postcard. Organizations with gross receipts under $200,000 and total assets under $500,000 may file the Form 990-EZ. At or above either of those figures, the full Form 990 is required. Private foundations file the 990-PF regardless of size.
Miss it and the consequence is severe and automatic. An organization that fails to file its required return for three consecutive years loses its tax-exempt status without a hearing, a warning letter or an appeal. Reinstatement means reapplying and paying the fee again, and every gift received in the gap is exposed. Diarize the deadline the way you would diarize payroll.
Your Form 990 is also a public document. It is republished by Candid, by ProPublica’s Nonprofit Explorer and by the IRS itself, and it is the first thing a serious donor, a corporate sponsor or a prospective board member reads about you. Treat it as the annual report it has become rather than a compliance chore, and answer the narrative questions in Part III as though a stranger will judge the organization on them, because one will. A separate impact report is a communications document; it does not replace this one.
The ratios that matter, and what each really tells you
Every ratio below is a question, not a verdict. Calculate them quarterly, look at the direction of travel rather than the single value, and be ready to explain any number that looks unusual, because an unusual number is not automatically a bad one.
| Ratio | How it is calculated | What a board should ask about it |
|---|---|---|
| Program expense ratio | Program services expenses / total expenses | Are we underinvesting in the systems that keep programs running? |
| Management and general ratio | Management and general expenses / total expenses | Is this low because we are efficient, or because we are running on unpaid overtime? |
| Fundraising efficiency | Fundraising expenses / contributions raised | Which appeals are carrying the cost, and which are subsidized by the rest? |
| Current ratio | Current assets / current liabilities | Can we pay what is due in the next twelve months? |
| Months of cash on hand | Unrestricted cash and liquid investments / average monthly expenses | How long could we operate if the largest funder stopped tomorrow? |
| Liabilities to assets | Total liabilities / total assets | Is debt rising faster than the asset base behind it? |
| Operating margin | (Total revenue – total expenses) / total revenue | Are we replacing the equipment and reserves we are consuming? |
| Revenue concentration | Largest single funder / total revenue | How much of the budget disappears if one relationship ends? |
Two of those deserve emphasis because they are the ones small organizations skip. Months of cash on hand is the number that predicts whether an organization survives a bad year, and it should be calculated on unrestricted cash only. Revenue concentration is the one nobody wants to look at, because for a great many small nonprofits the honest answer is that a single grant or a single family is most of the budget.
Where the published benchmarks come from
The BBB Wise Giving Alliance Standards for Charity Accountability set two figures that are widely quoted: Standard 8 asks a charity to spend at least 65 percent of total expenses on program activities, and Standard 9 asks it to spend no more than 35 percent of related contributions on fundraising. Charity Navigator scores program spending on a sliding scale whose full-credit threshold varies by the organization’s size and type rather than a single sector-wide number. Neither system claims a ratio measures whether a program works.
This is where the overhead myth does real damage. In 2013 the chief executives of GuideStar, the BBB Wise Giving Alliance and Charity Navigator jointly published an open letter to American donors arguing that overhead ratio alone is a poor measure of a charity’s performance, and asking donors to stop using it as the primary test. Their point was that an organization starved of accounting, evaluation and technology spending eventually stops being able to deliver the program. For a fuller treatment of how those percentages get read from the outside, see what the percentage-to-cause figure actually measures, and for who publishes the ratings, the charity watchdogs and what each one misses.
Read with that caution in mind, one ratio still repays understanding on its own terms: the fundraising efficiency ratio asks how much of each dollar raised reaches the cause rather than going to raise the next dollar.
What the numbers look like on a fund held in Paola
Miami County Community Foundation, a 501(c)(3) community foundation established in 2007 and serving Miami County, Kansas, holds and administers charitable funds on behalf of individuals, families, businesses and churches. Its own fund terms are a compact worked example of how restriction and spending policy shape what money is actually available.
An expendable fund opens at $1,000. It can be spent all the way down, and when it is spent the fund closes. An endowed fund opens at $10,000 and the balance cannot fall below what was contributed; only earnings are spendable, under a 5 percent spending policy, so a $10,000 endowed fund makes roughly $500 available for its purpose. On a statement of financial position, the first sits with net assets that carry a purpose restriction; the second behaves like a permanently restricted corpus with a spendable earnings layer above it. The Foundation charges a total fee of 2 percent, made up of a 1 percent administrative fee and a 1 percent community support fee that funds the Foundation’s own operations. Establishing a fund takes seven to ten business days, and the Foundation’s funds are held care of First Option Bank.
For an organization that has neither an investment policy nor a finance committee, that structure is worth understanding before building either one. The list of funds held at the Foundation shows what the arrangement looks like in practice across a small county.
Where to start if you are the one keeping the books
- Fix the chart of accounts before anything else. Program, management and general, and fundraising need to be separable without a spreadsheet reconstruction at year end.
- Write down your allocation method for shared costs, including how staff time is split, and have the board approve it once rather than argue about it annually.
- Track restricted balances by fund, not as one line called restricted. You need to be able to answer what is left in the reading program grant on any given Tuesday.
- Report months of unrestricted cash to the board at every meeting, alongside the budget-to-actual.
- Calendar the 990 deadline and the state charitable registration renewal in the same place you calendar payroll.
If your board wants one number to watch each month, make it months of unrestricted cash on hand. It is the only ratio that answers the question a board is actually there to answer. The wider set of operating pressures behind those numbers is covered in the challenges facing nonprofit organizations and how to manage them, and if the terminology itself is still unsettled, start with nonprofit versus not-for-profit. Tax treatment varies by organization and by year, so confirm anything with a bearing on your filings with your own accountant.
