Allocate this! Accounting, the necessary evil, doesn't have to be so.

Mission motivates, but money makes things happen.

Generating income from fees and fundraising is a challenge enough, while accounting for where it goes is a dreaded chore.

For most nonprofit executives, accounting and financial reporting are necessary evils. Federal reporting Form 990 is an arena where "good" program-related activities battle the "bad" cost centers of fundraising and administration. Ratios of these areas are used as a baseline rating of the efficiency and effectiveness of individual nonprofits and the sector as a whole.

Funders, especially the federal government, likewise bring their own requirements to reporting, further complicating an already convoluted undertaking. Financial reporting is often an afterthought undertaken solely to close one grant to make a new request.

Managers and boards that have access to detailed accounting information can make informed decisions and plans based on financial viability, as well as the impact a program has in the community. Funders are becoming more sophisticated in looking at an organization's financial statements and are asking harder questions about controis and allocations.

A better understanding of where the money goes helps an organization demonstrate that it is a good steward of public support and more likely to be compliant under new regulations bringing Sarbanes-Oxley-like standards to the sector. Good cost accounting and financial management practices can make overhead more understandable and show how all of the pieces fit together to advance mission.

RISKY BUSINESS

The 2004 Nonprofit Overhead Cost Study conducted by researchers at the Urban Institute's National Center for Charitable Statistics (NCCS)/Center on Nonprofits and Philanthropy and the Center on Philanthropy at Indiana University examined Form 990s from 220,000 nonprofits. Among the findings: 37 percent of nonprofits with at least $50,000 in contributions and 25 percent reporting $1 to $5 million in contributions show zero fundraising costs. Another 13 percent of nonprofits reported zero management and general expenses.

Grant writing costs are the most likely to be misclassified. The researchers examined two organizations claiming zero fundraising costs and found "one had more than $500,000 in actual fundraising costs, as shown on its audited financial statements. No one had noticed the zero until researchers asked about it, almost a year later. The other organization had a staff person who did nothing but fundraising, and they also did some direct mail fundraising. Despite this, both the audited financials and the Form 990 showed "zero fundraising costs," according to the study.

Irregularities between Form 990s and audited financial statements are an obvious place for regulators to look.

Funders often request financial statements with grant requests, and the availability of Form 990s on watchdog Web sites make it very easy to compare the two.

Frank Kurre, national managing partner, Not-For-Profit Industry Practice at Grant Thornton in New York explained that "more than 50 percent of the 990s are done by nonprofit staff themselves. If they're doing them themselves, they need training; or the forms should be given to an outside firm to complete."

In the November 20, 2006 report Fiscal Year 2006 Enforcement and Service Results, Internal Revenue Service (IRS) Commissioner Mark W. Everson reported that "We've placed renewed attention and added resources in the charitable arena to help protect the integrity and maintain faith in the charitable sector.... These results show we are taking important steps to combat abuse in exempt organizations." He went on to state that the IRS audited 7,079 exempt returns in FY 2006.

Even with increased IRS scrutiny "finessing your 990 is considered low risk" according to Dottie Johnson, CPA, former director of program services at the Nonprofit Financial Center (NFC) in Chicago. "They bow to the pressure to show good ratios, but they end up looking at best naive, and at worst liars. They need to understand that under reporting fundraising and administrative expenses is going to raise flags. Nonprofits are also going to have to look inward at their program expenses so that they can relate costs to impacts."

OVERHEAD ON THE STREET

Consistency in all venues of financial reporting is the first step in making accounting systems a productive management tool. A proper allocation of expenses not only makes reporting more accurate, but it aids an organization with internal examinations of organizational effectiveness. Ratios of program-to-administrative expenses are the traditional starting place.

When his firm takes on a new client, Grant Thornton's Kurre said, "We take a hard look at how they allocate expenses and that they're following all applicable guidelines. Program costs of 65 percent are a minimum, but some organizations like The Salvation Army are able to spend 92 percent of their income on programs." Good methodologies for spreading costs are key; a solid process leads to realistic data.

NFC's Johnson said, "it's not about what software they have in place, and while staff training is important, it's not even enough to have the right staff. What's important is that the board and executive director have a commitment to manage finances consistently and accurately. Once they do that, everything else can fall into place."

Greg Smyth, associate director at Greenlights for Nonprofit Success in Austin, Texas, connects accounting to management in stages. "There's the logistical side of being able to generate the reports to funders that can secure additional funding. There's the role it plays in building the confidence of existing and prospective donors, and then there's the real world application of using it as a management tool and as a guide to spending resources wisely and effectively."

Greenlights is a management support organization (MSO) that operates a program called Back Office Services, which provides financial management, human resource, and risk management services to nonprofits. Smyth, who directs the program, describes the process client organizations undergo. "When we first meet organizations, they are looking at very practical challenges--payroll, 990, audit--very technical things. Once we've worked with them for several months, the organization starts to appreciate the value of that information as a management tool."

St. Louis ARCHS (Area Resources for Community and Human Services) is one of 22 public-private partnerships established by the governor of Missouri in 1998 with the mission of making government money do more through private agencies than the state can by itself. ARCHS acts as an MSO, and through its for-profit subsidiary, Leveraged Resources Management (LRM), provides financial management and accounting services, as well as group healthcare, dental and life coverage for nonprofits and small businesses.

ARCHS Chief Financial Officer and LRM Chief Operating Officer Terry Blake said that sometimes there's resistance to making the finance department part of the program planning process. "Program staff view accounting as the people who say no--whatever is being proposed, the accountants will say 'Good idea, how are you going to pay for that?' or 'Do we have the reserves to fund it ourselves?' Asking those questions that help the organization stay in good shape and able to deliver services."

According to Kurre, "More nonprofits need to take a cost accounting mindset, and manage by cost center. One of our clients looks at everything by cost and income, and while they lose money, they know where to put fundraising and investment income."

He recommended that organizations divide costs into three primary areas:

* direct program:

* program administration;

* agency administration.

An example is an organization that has multiple programs, such as a meals-on-wheels and senior services. There will be direct program costs for food and staff specific to each program. On top of that are administrators managing several programs who, while 100 percent program, are part time on any program Finally, on top of that are the executive director and accounting manager, who would be allocated across all programs as well as across fundraising and general administration.

Planning for these kinds of allocations is often missing in many organizations. "What typically happens is that the accounting records--the general ledger and subsidiary ledgers--don't have enough detail" explained Kurre. "You need enough detail to look at salaries and other expenses across activities and programs. New software is an opportunity to rework the chart of accounts." In addition to getting the general ledger in place, many organizations have too maW banks. "You'd be surprised at the number of organizations with eight or 10 bank accounts because they have board members at various places," said ARCHS' Blake.

CASH FLOW BALANCING ACT

Integrating accounting and operations can help avoid crisis. Knowing where money is coming from, where it has to be spent, and when bills and cash are due are critical to a program's stability. Greenlight's Smyth recounted, "A very simple example is providing a cash flow projection--we had one client that was ahead of budget with money in the bank, but when we showed them the cash flow projections and the impact of biweekly pays and the forecasting of a payroll shortfall in those months where there were three payrolls, they were able to plan several months in advance and they felt in control of their destiny. They deferred some payments and accelerated a fundraising event and were able to meet payroll."

Blake advised, "You need a financial strategic plan: Is there a reserve fund? Is there an investment policy? Are there growth goals--and how are you going to get there? Look at cash owed--if you're on a cash basis, you won't know, but with an accrual system you'll know--even if you're going to defer payment."

THE BOTTOM LINE

There are numerous software tools capable of tracking the numbers, but the nonprofit sector is only beginning to look at how those numbers are organized to tell the complete story. Knowing where the dollars come from and where they go is important to managing existing services and planning for new offerings.

While there is a donor tendency to want to see every dollar go directly to program, overhead is an important part of service delivery and keeping an organization viable. Increased scrutiny of Form 990s and financial statements--not only by regulators and funders, but by investment-minded donors will make it harder to fudge the numbers.

According to Kurre, "What nonprofits need to do is make sure that there's a good understanding for the costs being incurred and how overhead and general and administrative costs are being managed. Nonprofits are under more scrutiny than every before." Self-appointed watchdog organizations are issuing analyst reports, "and we're asking clients if they have a relationship with these monitors," said Kurre.

CHARTING A PATH

Creating an allocation and reporting system that properly distributes costs and provides useful information requires a combination of good design and good tools. Experts agree that good design in your chart of accounts is the most important factor in creating an accounting system that is both useful and easy to use.

Differences in accounting software packages will play a major role in how your chart of accounts is organized. The biggest distinction in accounting packages is fund accounting and general or commercial accounting.

Fund accounting software is designed to help nonprofits and governmental bodies demonstrate that monies have been spent according to specific restrictions. Essentially, fund accounting software allows an organization to operate projects and programs as if they were independent organizations, each with its own bank account. The advantage of fund accounting is that all of the monies can move through a much smaller number of bank accounts--sometimes even a single checking account.

General accounting software can't restrict financial activity as closely as fund accounting solutions. However, many packages do have the ability to track income and expenses across departments, jobs, and customers and these features can be used to track nonprofit cost allocations. Government funding almost always requires a true fund accounting package to comply with reporting and auditing requirements. Commercial accounting software can meet the reporting needs of many nonprofits that rely on individual and foundation support as well as earned income.

In addition to looking at external reporting requirements, you should consider internal needs when choosing between commercial and fund accounting solutions. While your funders might allow for fairly broad functional allocations, your management team could want to look at costs and income from multiple perspectives and a true fund accounting solution may be the best choice. Keep in mind that the desire to track an expense (meals, for example) across multiple programs (Head Start, ESL, etc.) requires a commitment to data entry at an increased level of detail.

Getting staff on board will require additional training, both on why it is important to work at a higher level of detail as well as training on how to make specific entries.

A comprehensive cost allocation system will expand beyond the accounting software to other systems as well. Client or case management databases and time reporting software may also be called into play to make sure that allocations match the real world and that expenses can be linked to non-accounting activities such as hours of service and/or event attendance.

Consistent methods of allocating cost through time tracking, square footage, or other means have to make sense internally and externally. Executive and board commitment to putting those tools in place will give you the ability to track your agency's financial position and performance and comply with new financial disclosure requirements.

Software To Consider

AccuFund Inc. AccuFund Accounting Suite-Standard (single-user: $2,995; three-user: $6,495; add $895 for each additional user); AccuFund Accounting Suite-Professional (single-user: $6,595; three-user: $8,995; add $1,195 for each additional user) [phone] www.accufund.com

Blackbaud The Financial Edge, version 7.7 Starts at $2,000 for single-user [phone] www.blackbaud.com

Cougar Mountain Software Cougar Mountain FUND Revenue Center (single-user: $1,199; four-user: $1,449; unlimited: $1,449); Cougar Mountain FUND Suite (single-user: $3,199; four-user: $4,199; unlimited: $5,299) [phone] www.cougarmtn.cam

Deltek Deltek Costpoint (starts at $90,000 for 250-500 employee organization) Deltek GCS Premier (starts at $10,000 for 1-25 employees) [phone] www.deltek.com

Donor2/Campus Management Corp. Donor2 Accounting Starts at $2,655 per user [phone] www.donor2.com

Executive Data Systems Nonprofit Starter Kit (single-user: $400; unlimited: $600); Fund Accounting Software Series (single-user: $1,000; unlimited: $1,500) [phone] www.execdata.com

Fund E-Z Development Corp. Fund E-Z Starts at $695 for single-user; add $495 for each additional user [phone] www.fundez.com

Intuit Inc. Quickbooks Premier for Nonprofits (single-user: $399.95); Enterprise Solutions for Nonprofits (five-user: $1,499.95) [phone] www.quickbooks.com

Kintera FundWare Starts at $1,295 [phone] www.fundware.com

Microsoft Corporation Microsoft Dynamics-GP Starts at $2,250 per user [phone] www.microsoft.com/dynamics

Open Systems Inc. TRAVERSE not-for-profit Starts at $1,500; add $200 for each additional user [phone] www.traversenfp.com

Sage Software Sage MIP Fund Accounting Starts at $2,995 for single-user [phone] www.sagemip.com

Sage Software (small business) Peachtree Premium for Nonprofits Starts at $599 for single-user [phone] www.peachtree.com

Serenic Corporation Serenic Navigator Starts at $3,000 per user for Business Essentials; starts at $6,000 per user for Advanced Management (Offers grant management system) [phone] www.serenic.com