Bookkeeping

The Complete Guide to Bookkeeping for Nonprofit Therapy Practices

Headshot of Bryce Warnes
September 24, 2022
September 24, 2022
Bryce Warnes
Content Writer
Senior woman talking with participants in a group therapy session

If you’re planning to start a nonprofit therapy practice, you should be prepared for your bookkeeping to look a little different than it does for a regular, for-profit practice.

In the business world, bookkeepers and accountants focus on tracking—and helping to maximize, where possible—profit. In the nonprofit sector, however, accountability is the number one priority.

Nonprofit bookkeeping follows a variety of practices for ensuring transparent bookkeeping, so there’s no difficulty proving funds have been allocated and used correctly throughout the organization.

This guide gives you steps you can take to get bookkeeping for your nonprofit therapy practice up and running.

What this guide doesn’t do is get into the details of setting up a business entity, or obtaining nonprofit status with the IRS. If this is your first time starting a business, check out our crash course on therapy practice business entities before you begin.

Understand for-profit vs. nonprofit bookkeeping

For the sake of transparency and accountability, most nonprofits have a particular individual who is responsible for financial matters. It’s not enough to have the owner or founder of the organization take responsibility—your nonprofit needs a treasurer or financial officer. 

The treasurer or financial officer is responsible for the financial activities of your practice. They have access to your organization’s bank account, and work one-on-one with your bookkeeper and accountant.

However, at the end of the day, it’s the CEO (who may or may not be the founder of your organization) who provides final approval for all payments and signs the checks.

Your treasurer may take on the role of bookkeeper for your practice. In that case, they’ll use accounting software to set up a general ledger for your organization and generate financial reports.

The financial reports your bookkeeper creates differ slightly from those created for a for-profit business. More on that below.

Set up a bookkeeping system

Your bookkeeping system consists of the tools—typically accounting software—your bookkeeper uses to create entries in the general ledger and generate financial reports.

Using accounting software, your bookkeeper creates:

  • A chart of accounts, listing all the categories for transactions recorded in the general ledger.
  • The general ledger, plus sub-ledgers (and sub-sub-ledgers) for tracking how money enters and leaves different parts of your organization.
  • Regular financial reports, in the form of statements of activities, statements of financial position, and statements of cash flow.

The bookkeeping system for your organization uses either accrual or cash basis accounting. Not sure of the difference? Learn more about the difference between cash and accrual accounting.

Typically, software used by regular, for-profit businesses cannot be used by nonprofits. Major accounting products, like Quickbooks, may offer special versions specifically designed for nonprofits. Heard software does not support nonprofit therapy practices at this time.

Open a separate bank account for your nonprofit

While it’s unwise, many small businesses—particularly ones where the owner is the only employee—use personal bank accounts to cover expenses and save retained earnings.

For nonprofits, this simply won’t fly. There needs to be a clear distinction between the funds held personally, by you, and those held by the organization. Before you can start accepting donations or allocating funds, you need a separate bank account for your nonprofit practice.

Learn more from our article on business bank accounts.

Get in the practice of creating budgets

Nonprofits hold meetings to create budgets, which serve as roadmaps for spending and earning. 

Any budget you create should:

  • Cover a specified period of time.
  • Include revenue as well as expenses. The budget for your nonprofit practice includes both income earned as donations, and the money you spend to keep your practice running.
  • Feature projections, as well as actual numbers. When you first create your budget, it will consist of projections. As time goes on, you’ll come in over or under budget for different income and expenses. These should be reported, so you can see how effective your budgeting is, and plan for improvements in the future.

Typically, a budget will include two types of expenses:

  • Fixed expenses remain the same month to month and quarter to quarter. Rent is a good example of this.
  • Variable expenses, true to their name, vary. They change on a quarterly and monthly basis.

For a complete guide and free template, check out our article on how to build a budget for your therapy practice.

Set up fund accounting, if necessary

For the sake of making sure donated money is used appropriately, nonprofits typically use fund accounting. 

Fund accounting effectively creates a fund, for which you track assets, liabilities, revenue, expenses, and total balance. That may sound like a lot of extra work, but it has an important purpose. 

How you use fund accounting

For example, if your nonprofit therapy practice receives a donation for $10,000 in order to provide counseling for children, you need to prove the money was used for its specified purpose. 

The fund you create for that $10,000 includes:

  • Assets: The remainder of the initial donation, and anything with cash value (like therapeutic tools) you purchase with the fund’s money
  • Liabilities: Debts owed by the fund, such as wages owed to counselors providing youth counseling
  • Revenue: Any earnings the fund generates, such as gains on investments you make using the fund
  • Expenses: Money paid out by the fund (for instance, as wages for counselors)
  • Total balance: How much cash is left in the fund

The 3 types of funds

Typically, any fund your nonprofit creates will fall into one of three categories:

  1. Unrestricted funds, which can be used for any valid purpose by your nonprofit. Often these come in the form of repeating monthly or annual donations.
  2. Permanently restricted funds, which are typically used to generate revenue by being invested. The principal cannot be spent (hence it is “permanently restricted”) but the revenue from the investment is used to support a specified program.
  3. Temporarily restricted funds, whose use is restricted within a specific timeframe. After that timeframe ends, the funds are either stopped, or may be spent by your organization.

In the case of permanently and temporarily restricted funds, it is up to your organization to work with an investment advisor to make sure the principal is invested in a way that generates the kind of revenue a particular program needs.

A final word on fund accounting

Fund accounting is essential if your nonprofit practice runs multiple programs and their performance needs to be tracked.

Not all nonprofits use fund accounting, however. Before deciding whether to use fund accounting, consult with an accountant who is familiar with nonprofits. Fund accounting can become incredibly complex, and there are many nuances to how it is used.

Record in-kind donations

Broadly speaking, in-kind donations consist of goods or services volunteered to your organization. They need to be recorded on the books as a donation with cash value.

If a therapist volunteers their time at your nonprofit practice providing counseling services, they’re providing an in-kind donation. Their time has a cash value, and must be reported as revenue in order to comply with IRS regulations.

What qualifies as an in-kind donation?

In order to qualify as an in-kind donation, any service volunteered must be:

  • Specialized. If a therapist volunteers three hours a week at your nonprofit practice, but that time is dedicated to doing set-up and take-down for events, their time does not count as an in-kind donation. During their time volunteering, they must be providing services they would otherwise provide through their own private practice (that is, volunteer therapists should do work for you as therapists, not as general purpose volunteers)
  • No strings attached. Any donation you receive (in-kind or otherwise) must come with no strings attached—there is no expectation (explicit or otherwise) that your organization will provide goods, services, or some other kind of benefit in exchange for the donation.
  • Ordinary. In-kind donations must consist of goods or services your nonprofit practice would normally use in the course of carrying out its mission. A catering company may donate an extravagant meal for your staff and volunteers, but unless the meal has a fundraising purpose, it won’t count as a donation.

How to value in-kind donations

Any in-kind donation your nonprofit practice accepts must be recorded on the books at its fair market value. According to the Financial Accounting Standards Board (FASB), “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.”

So, if a therapist volunteers three hours of their time per week doing one-on-one counseling, and their regular rate is $90 per hour, you record their donation as $270 revenue per week.

Providing donor receipts (gift substantiation)

The practice of officially acknowledging donations is called gift substantiation. The IRS requires you to officially acknowledge, in writing, any contribution of $250 or more. That includes in-kind donations exceeding a value of $250. 

Receipts should be sent out promptly after receiving a donation. The donor or volunteer will use it in order to claim their donation on their tax return. 

For more detail on gift substantiation, check out this guide to in-kind donations by Todd Kimball, a CPA who heads a nonprofit.

Get used to reconciling your bank accounts

Bank reconciliation is key to any effective bookkeeping system. When you perform a bank reconciliation, you confirm that your bank accounts and your general ledger match up, so you can be confident your records of revenues and expenses are true to reality. 

For more details on how to reconcile your bank account, check out our guide to cash basis vs. accrual accounting.

Learn how nonprofit financial statements work

For-profit practices use three main financial reports to track how they are performing:

Nonprofits used modified versions of these three reports. Respectively, they are:

  • The statement of financial position
  • The statement of activities
  • The statement of cash flows

They’re different because nonprofits, by definition, do not earn a profit and do not have owners. Otherwise, each nonprofit financial report and its for-profit cousin have a lot in common.

Like regular financial reports, nonprofit financial reports are generated based on information from your general ledger. Generating any kind of financial report is complicated—it’s best done with the help of accounting software, or (ideally) a professional accountant or bookkeeper.

Here’s how to read and understand each report.

The statement of financial position

Like the balance sheet, your statement of financial positions gives you a picture of what your finances look at a particular point in time.

Unlike the balance sheet, the statement of financial position does not record owners’ equity, since a nonprofit does not technically have owners. Instead, a nonprofit has net assets.

Assets - Liabilities = Net Assets

Here’s an example.

Jeff’s Nonprofit Practice

Statement of Financial Position

As of December 31, 2021

Statement of Financial Position
ASSETS
Cash/cash equivalents $30,000
Grants $4,500
Pledges receivable $2,000
Equipment $3,000
Total assets $39,500
LIABILITIES
Accounts payable $1,000
Long term debt $4,000
Total liabilities $5,000
NET ASSETS
Unrestricted net assets $30,000
Restricted net assets $4,500
Total Net Assets $34,500

This statement of financial position is very similar to a balance sheet.

One major difference you may notice: Net assets are broken up into “unrestricted” and “restricted” categories. This is in accordance with the different types of funds, as covered above in the section on fund accounting.

The statement of activities

Your nonprofit doesn’t make a profit, so a financial statement called “Profit & Losses” wouldn’t be much help.

It does, however, lose or gain assets. So, instead of profits, your statement of activities tracks changes in net assets.

Here’s an example.

Jane’s Nonprofit Practice

Statement of Activities

As of December 31, 2021

Unrestricted Restricted Total
REVENUES
Donations $10,000 $2,000
Fees $22,000 -
Other $1,000 -
Total revenues $33,000 $2,000 $35,000
EXPENSES
Fundraising events $1,000 -
Other fundraising $500 -
Management $12,000 -
General $300 -
Total expenses $13,800 - $13,800
CHANGE IN NET ASSETS $19,200 $2,000 $21,200

If you’ve ever glanced at a P&L, the statement above will look familiar.

One important difference: as with the statement of position, the balance sheet has “restricted” and “unrestricted” sections. In this case, it’s applied to revenues. Some money given to the organization goes into a restricted fund. Other revenues don’t.

The statement of cash flows

For the most part, a statement of cash flows does not differ from a cash flow statement for a for-profit business.

The only major difference is that, whereas a statement of cash flows may make adjustments based on capital gains from investments, a nonprofit statement of cash flows makes adjustments based on gains from restricted funds. That is, donations that are invested and managed by the nonprofit.

Here’s an example.

Jordan’s Nonprofit Practice

Statement of Cash Flows

As of December 31, 2021

Cash flow from operations
Increase in net assets $3,000
Additions to cash $500
Depreciation $100
Increase in accounts payable $800
Subtractions from cash
Increase in accounts receivable ($1,200)
Increase in inventory
NET CASH FROM OPERATIONS $3,200

Cash flow from operations
Increase in net assets $3,000
Additions to cash $500
Depreciation $100
Increase in accounts payable $800
Subtractions from cash
Increase in accounts receivable ($1,200)
Increase in inventory
NET CASH FROM OPERATIONS $3,200


Cash flow from financing
Proceeds from restricted donations $300
Debt repayments ($1,200)
NET CASH FROM OPERATIONS ($900)

Cash flow from operations
NET CASH FLOW FOR MONTH ENDING DECEMBER 31, 2021 $2,700

Comply with the IRS

An organization must keep books and records to show it complies with tax rules, and be able to substantiate this with documentation. Otherwise, your nonprofit may be unable to show that it qualifies for federal exemption and, as a result, lose its tax-exempt status.

The IRS wants to see if your nonprofit can:

  1. Monitor their specific programs 
  2. Prepare financial statements
  3. Prepare annual information and tax returns

Establish your bookkeeping practices

With few exceptions, an organization can pretty much choose any record keeping system, so long as it accurately presents your income and expenses.

At the very least, your system must include a summary of transactions, typically written your organization's books (accounting journals and ledgers), which should include: 

  • Gross receipts
  • Purchases
  • Other expenses
  • Taxes
  • Assets

If your nonprofit is small, a credit card statement or checkbook may be the sole source of bookkeeping entries.

Nonprofit accounting methods

The IRS expects you to choose an accounting method and stick to it. You do that by choosing an accounting method on your first annual tax return. Afterwards, that’s the accounting method you use to do all your bookkeeping.

Learn more about accounting methods from our guide to cash basis vs. accrual accounting.

The nonprofit tax year

Your nonprofit needs to keep financial records based on an annual accounting period called a tax year. Usually, it’s 12 months long. 

There are two kinds of tax years:

  • Calendar tax year: This is a period of 12 consecutive months beginning January 1 and ending December 31.
  • Fiscal tax year: This is a period of 12 consecutive months ending on the last day of any month except December.

Have a records retention procedure

Besides having an organized set of books, you also need to hold on to supporting documents and including. These are records of transactions such as contributions, purchases, sales, and payroll. These will help substantiate your transactions in the event of a tax audit.

Some common supporting documents kept by nonprofits:

  • Copies of grant applications and awards
  • Sales slips
  • Paid bills
  • Invoices
  • Receipts
  • Deposit slips
  • Canceled checks

For federal tax purposes, the statute of limitations for the IRS to challenge what you report on your tax return on these records is typically three years (from the date when you filed the return, or the date the return is due—whichever is later longer). So plan to keep them safely stored and labeled for at least that length of time, if not more.

Tax authorities other than the IRS—those on the state and local level—may require you to keep supporting documents longer.

There are a few types of supporting documents you should keep permanently:

  • Your application for recognition of tax-exempt status
  • The determination letter recognizing your tax-exempt status 
  • Organizing documents (such as articles of incorporation and by-laws, with amendments) 
  • Board minutes

Finally, you may need to keep some supporting documents for non-tax purposes. These include. For example, a grantor, insurance company, creditor or state agency may require you to keep records longer than the IRS requires.

Nonprofit accounting is its own area of expertise—there are many accountants and firms specializing in working with nonprofits. Your nonprofit will need to follow specific regulations, standards, and reporting requirements in order to maintain its nonprofit status. 

Before trying to start a nonprofit practice, meet with a qualified accountant. Learn more about how to hire an accountant for your therapy practice.

This post is to be used for informational purposes only and does not constitute legal, business, or tax advice. Each person should consult his or her own attorney, business advisor, or tax advisor with respect to matters referenced in this post.

Bryce Warnes is a West Coast writer specializing in small business finances.

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