Fund accounting basics and best practices
Fund accounting basics and best practices
What is fund accounting?
Fund accounting is a way for organizations like foundations to track accounting for multiple funds with one chart of accounts. The best way to visualize accounts for fund accounting is to think of them as a dresser. The account is the whole dresser, and each fund has a drawer in that dresser. The drawers are different sizes and shapes; each represents the portion of the dresser that the fund owns.
Fundamental principles of fund accounting:
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One chart of accounts for multiple funding sources
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Segregation of funds or funding sources
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Fund accounting vs. traditional accounting
The main difference between fund accounting and traditional accounting is the ability to easily track and report on each fund individually or together. In traditional accounting, for example, all assets are owned by the entire entity; by contrast, in fund accounting, assets can be owned by different entities. This allows for the maintenance of fewer real-world bank or investment accounts, easy reconciliation of these accounts, and allocation of investment revenue or expenses on an asset to each individual fund based on their portion (or drawer) of the account.
Why is fund accounting important?
Foundations often hold many different funds: Donor-Advised, Designated, Field of Interest, Agency, etc. Fund accounting reduces the need to keep separate books for each fund or type of fund. The organization can use the same revenue and expense accounts for all funds but easily pull an income statement for each fund. Fund accounting helps to reduce the need for physical transfers between bank and investment accounts.
Often, a foundation or nonprofit will have projects or departments for which it wants to track a budget. Using fund accounting, they can easily track the budget, report on revenue expenses, and understand any assets allocated to the project or department. Each fund can be created as a sub-fund of a parent fund, so they can easily report on each fund and the parent and sub-funds.
Agency funds present their own reporting needs because they are a liability to the foundation. After all, the agency funds' assets are owned by the Agency rather than the foundation. With this type of fund, the foundation wants the ability to report the liability on a consolidated balance sheet and the fund balance on each agency fund. In CommunitySuite, a contra fund makes this reporting easy with simple filtering.
Organizations that use fund accounting
Nonprofits and foundations
Foundations use fund accounting to track funds contributed to the foundation by individual donors and organizations.
Nonprofits may use fund accounting to record specific projects, departments, or grants they received. Rather than adding to their chart of accounts, they can utilize a fund to segment the different areas they want to track.
Example: While at a nonprofit organization, we had access to funds from governmental grants, privately funded grants, specific fundraising activities, and various departments within the organization. These funds enabled us to allocate revenue and expenses to particular categories and report this information to our board.
Churches and religious organizations
Churches may use fund accounting to track specific areas, such as a cemetery or school fund. Donors can contribute directly to these funds, or the church may allocate them a specific amount. These funds are part of the organization, but the church board monitors them closely to ensure adequate funding and no overspending on changes or upgrades.
Governments
Governments use fund accounting to segregate resources into categories for specific activities or objectives according to laws, regulations, or restrictions. This accounting method is crucial for public sector entities because it helps ensure and demonstrate compliance with legal and financial guidelines.
Educational Institutions
Educational institutions utilize fund accounting much like other organizations that have to manage various sources of funds earmarked for specific purposes. This method allows them to segregate resources into categories for departments or projects, ensuring funds are used in accordance with donor restrictions or institutional priorities.
For example, a university may receive donations specified for scholarships, research, building expansions, or departmental support. Fund accounting enables the institution to track these funds separately, ensuring that money designated for a research project isn't inadvertently used for facility maintenance
Types of funds
Unrestricted funds
Unrestricted funds are funds from which contributions can be used for any purpose that aligns with the organization's goals. These funds often do not track a principal or corpus balance or have a prescribed spending policy. They can be used for salaries and operating expenses.
Restricted funds
Restricted funds are set up with a specific purpose or beneficiary. These restrictions can vary from a specific purpose or field of interest to supporting specific organizations in the community.
Temporarily restricted funds may be restricted for that purpose through a specific time frame.
An example is a Donor-advised fund that the donor designates where to grant until the donor becomes incapacitated or dies. Once the contingencies of the restriction are satisfied, the remaining funds can be used as the foundation sees fit.
Designated funds
Designated funds are just that. The contributions are defined for a specific purpose.
Example: a fund created to provide scholarships for nursing students. The contributions can only be spent on scholarships for students going to school for nursing.
General funds
General funds are usually unrestricted. Contributions can be used for anything that aligns with the organization's goals.
Special revenue funds
These are used mainly by governmental entities. They are established for a specific project and can receive donations from governmental entities, individuals, and organizations.
Debt service funds
These are used to track the revenue and expenses for long-term obligations. Governmental entities may have deferred debts for public improvements that they are collecting payments through taxes to repay the debt in the future. A hospital may have a fund like this to collect a portion of all patient payments to support a long-term debt for improvements.
Common fund accounting reports
Balance sheet (Statement of financial position)
In fund accounting, a balance sheet is helpful for showing the overall financial standing of the organization and individual funds. The balance sheet shows the assets, liabilities, and fund balances, showing the net worth of a foundation or fund as of a specific date.
Income statement (Statement of activities)
Ability to track revenue and expenses at the fund level. This is a big part of using the consolidated chart of accounts. You can use the same revenue account across funds and use the fund groups, subgroups, divisions, and segments in reporting to slice and dice your financial reports.
Statement of functional expenses
A statement of functional expenses categorizes an organization's expenses according to their purpose, such as program services, management and general operations, and fundraising. This classification helps to provide transparency and accountability by showing how funds are being used directly to support the organization’s mission, manage its operations, and raise additional funds. This report is essential for donors, grantmakers, and regulatory bodies to assess the effectiveness and efficiency of the nonprofit in utilizing its resources.
Fund accounting best practices
Separate funds
Segmenting funds based on specific criteria is critical for reporting needs. The organization’s board will want to understand what they have in endowed funds that should permanently provide administrative fee income to the organization. They will also want to know what the cost of funds, like pass-through, unrestricted, and agency funds, are to determine if the administrative fees being charged cover the costs. Also being able to identify funds that are interested in granting to certain fields of interest is helpful when requests for funding arise.
Best practices for separating funds
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Start with grouping the funds to the largest buckets of similarity.
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Then splitting those funds into sub groups for more granularity. Organizations should write definitions for each segmentation to make it easy to know where they fall and why. When they begin writing definitions often they find they are duplicating and this activity helps them to find those areas and reduce any duplication.
Foundant's Fund accounting system has divisions which help to segment when an organization has funds that are separate legal entities. These will report their own separate 990 so the ability to identify them with a division is helpful especially when a fund from the separate entity gives a grant to a fund that the foundation owns. Grants like this are reported for each division’s 990 where grants that are owned by the same entity aren’t reported on the 990 because they are just movement between funds.
Maintain internal controls
When organizations have turn over they need written documentation to help with consistency year over year. Relying on team members to store processes in their memory sets you up to fail. I’ve seen organizations lose team members and spend hours trying to figure out how to reproduce work that team member did. To consistently report to the board, the processes that get you there need to be documented and followed. Documenting workflows will make onboarding of new team members easier, reduce fraud potential, and reduce the stress of period-end reporting.
Best practices for establishing and maintaining internal controls
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Write it down and update it when things change. I’ve seen organizations create documentation and then abandon it when changes are made.
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Setting a regular cadence of reviewing documentation and processes can help the team improve efficiency. It’s a small contribution of time for a longer-term payoff. I recommend reviewing processes at least once per year; quarterly is better to keep on top of changes. Often, software is changing throughout the year and a quarterly review will identify areas to improve efficiency.
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Split up the work, if several team members do the same processes have them take a section to review. Setting up a review schedule and documenting each time something is updated will make the process go quickly.
Keep accurate records
Auditors, fund holders, board members will all appreciate your efforts for accurate and organized record keeping.
Best practices for keeping accurate records
Purchase good software that helps you stay organized. Fund accounting and CRM software can make all the difference in your record keeping. Store everything in one place and adopt as much functionality as possible. Take the time to learn the software so you can enter everything in and ditch the spreadsheets.
Conduct regular financial reporting
A monthly financial reporting review is necessary to help you fix errors before moving too far ahead. We all make mistakes at times, but catching those mistakes shouldn’t be difficult. Set up reports that help you quickly catch any oddities and dig into them. Reconciling your reports each month will help you understand what is happening in the organization and whether a team member needs additional training.
Best practices for consistent financial reporting
Save the reports you need to pull each month with the filters saved (don’t reinvent the wheel because it won’t always come out the same), create a schedule of reports to review and how often to review them, reconcile reports and bank accounts before running revenue share allocations to ensure accuracy of the allocation.
Budget and forecast for funds
Budgeting and forecasting are most done only for organization-owned funds. For the organization, this helps to determine whether investing policies are correct for the current markets, whether administrative fee revenues are covering expenses, and how they are spending. Tracking this information will help drive future initiatives for the organization.
Best practices for budgeting and forecasting
If you’ve never set budgets before start, it doesn’t have to be fancy just start. Don’t stress over it the first couple times you do it, you will get better at forecasting and budgeting for the future as you review how it’s gone in the past.
For those who have tracked a budget, start looking at year over year to determine where you have growth and where most of your expenses are going. If you are seeing trends, start documenting them and what is happening in the communities you serve. Documentation will help you understand five years down the road why your growth has changed.
Leverage fund accounting software
The software can build efficiencies in your processes, freeing up time for your team to focus on fund development.
Key features to look for in fund accounting software (integration capabilities, compliance features, usability and support.
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Integrated CRM
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Custom reporting
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Financial reporting
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Visibility into general ledger transactions associated with records
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Cash management functionality (biggest efficiency you will find)
Learn more about fund accounting software
Many qualities define a community — let CommunitySuite provide the right tools for the work you do in yours.
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Cash management process is easy and visible.
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Integrations with Grant Lifecycle Manager and Scholarship Lifecycle Manager for consistency across the organization.
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CRM & Fund accounting are in a single solution, so you are working in the same place and don’t need to do duplicate entries or worry about an integration breaking
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Easily correct errors and system log changes so auditors can see the full picture
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