If you’re running a nonprofit organization, one of the most important financial decisions you must make is which accounting method to use: cash vs accrual?

Established nonprofits generally use the accrual method (aka “accrual basis”) for preparing and issuing financial statements. Smaller or startup organizations often choose the cash method (aka “cash basis”).

But what do you do if you fall somewhere in between?

It helps to compare cash vs accrual accounting side by side, so that you can decide which one is right for your nonprofit.

Cash basis accounting
  • Revenue is recognized when money is received from contributors and customers;
  • Expense is recognized when amounts are paid to your employees, vendors and contractors.

With cash basis accounting, it’s easy to manipulate your financial statements in order to show a rosier (or less rosy) picture, depending on whether you want to look needy or well-off.

If you’re approaching the end of your fiscal year, you can “improve” the bottom line simply by delaying payment of expenses until the new year.

Accrual basis accounting
  • Revenues and expenses are both ‘matched’ to the period when the underlying economic event takes place.

This generally presents a more accurate picture of your financial position and activities:

  • Revenues from program services are recognized when they are earned;
  • Contributions are recognized when they are promised to you, regardless of when payment occurs;
  • Expenses are recognized when they are incurred (typically when you enjoy the benefit of the expense), regardless of when the bill is paid;
  • Required for organizations that follow generally accepted accounting principles (GAAP), which typically includes California nonprofits with annual revenues in excess of $2 million (per the California Nonprofit Integrity Act).

Accrual basis accounting is generally considered the superior method of the two. Because net income cannot be manipulated by the timing of payments, it’s likelier to show what’s really going on in your organization.

Example: cash vs accrual accounting

Consider a nonprofit that performs program services under a cost reimbursement contract with a government agency.

Say it invoices the government agency on January 2nd for services performed in December.

Using accrual basis accounting, the organization would recognize the revenue in December, when the services are performed; with cash basis accounting, the organization would wait and recognize the invoiced revenue later when the payment is ultimately received.

When does cash basis accounting work best?

The main disadvantage of accrual basis accounting is that it requires judgment and analysis. This can be time consuming.

That’s why smaller nonprofits (e.g. those with annual budgets less than $100k) often choose the cash method. Such organizations are less likely to find themselves in situations that would create significant differences between cash and accrual basis, such as pledges and multi-year grants.

They’re also less likely to engage professional accountants to prepare their financial statements, and therefore need to keep the accounting process simple.

What is modified cash basis accounting – and should you consider it?

You may have heard the term ‘modified cash basis accounting’.

Some organizations want to keep things as simple as possible but also see the value in at least some aspects of accrual basis accounting.

For example, a church with significant investments in land and buildings may wish to capitalize and depreciate its property and equipment (instead of recognizing them as expenses in the year of purchase); but it does not wish to show unfulfilled member pledges as assets and revenues in the financial statements.

Such an organization may adopt accrual based accounting for certain things and cash basis for others.

Year-end accrual basis accounting

If you’re a small but growing nonprofit organization, another option to consider is maintaining your books on the cash basis throughout the year and then doing a cash-to-accrual conversion at year-end.

This would allow you to issue annual financial statements in accordance with GAAP (which grant makers and other funding sources like to see), without having to deal with all of the additional work on a month-to-month basis.

Depending on your staffing structure, you could have your internal accounting people perform the conversion, or outsource it to an external accountant.

Cash vs accrual accounting: which is best for your nonprofit?

Whichever option you choose, it should not be at the expense of the other.

If you elect cash basis accounting, you should still have mechanisms in place to track pledges and other receivables, as well vendor payables that are in the pipeline.

Conversely, if you use accrual basis accounting, it is advisable to prepare cash flow statements and projections on a regular basis.  In some situations, a nonprofit may be very effective at securing pledge commitments and performing “billable” services but can run into liquidity issues if such receivables are not collected in a timely manner.  Cash flow statements and projections can help highlight such dynamics before they come serious issues.

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