Nonprofit financial statements are the reports that show where an organization’s money came from, how it was spent, and what it owns and owes at the close of a reporting period. Under generally accepted accounting principles (GAAP), a nonprofit produces four core documents: a Statement of Financial Position, a Statement of Activities, a Statement of Cash Flows, and a set of Notes that explains the other three. The Financial Accounting Standards Board (FASB) sets the rules that govern how these documents are prepared.1FASB. Not-for-Profits Donors, board members, grantmakers, and regulators all read them to judge whether an organization is financially healthy and spending responsibly.
The Four Core Statements
Each statement answers a different question. Read alone, any one of them can mislead. Read together, they give a complete picture.
Statement of Financial Position
This is the nonprofit equivalent of a balance sheet. It lists everything the organization owns (assets) alongside everything it owes (liabilities) at a single point in time. The difference between those two numbers is “net assets,” which replaces the concept of owner equity that for-profit businesses use. A reader glancing at this statement can quickly tell whether the organization has enough liquid resources to cover its short-term obligations, or whether it is relying heavily on restricted funds that can’t be tapped for general operations.
Statement of Activities
Where the Statement of Financial Position is a snapshot, the Statement of Activities tells the story of an entire fiscal year. It tracks all revenue, including donations, grants, membership dues, and program fees, against all expenses. The bottom line shows whether the year ended in a surplus or a deficit. Revenue and expenses are broken out by net asset category, so a reader can see whether growth came from unrestricted sources the board can deploy freely or from restricted gifts earmarked for a single purpose.
Statement of Cash Flows
An organization can report a surplus on the Statement of Activities and still struggle to pay its bills if that surplus is tied up in pledges or property. The Statement of Cash Flows solves this by tracking actual cash moving in and out during the year. It separates cash activity into three buckets: operating activities (day-to-day revenue and expenses), investing activities (buying or selling equipment and investments), and financing activities (borrowing or repaying debt). This is where you spot problems the other statements can hide.
Notes to the Financial Statements
The notes aren’t a separate document so much as the fine print that makes the other three statements understandable. They explain the accounting methods the organization chose, describe any significant concentrations of risk in its investments, spell out the terms of donor restrictions on net assets, and disclose contingencies such as pending lawsuits or conditional grants. If a nonprofit holds endowment funds, the notes will explain how it interprets state law governing those funds and how much is available for spending. Skipping the notes is like reading a contract but ignoring the footnotes: the numbers alone rarely tell the full story.
How Net Assets Are Classified
Net assets are what’s left after subtracting liabilities from total assets. A nonprofit splits this residual value into two categories based on whether donors attached strings to their gifts.
- Without donor restrictions. Money the board can spend on any purpose that advances the mission. This category includes general donations, earned revenue, and investment income that carries no usage instructions. Some boards voluntarily set aside a portion of these funds for a specific project or as a reserve. Those internal designations, sometimes called board-designated net assets, are disclosed in the notes but remain technically unrestricted because the board can reverse its decision at any time.
- With donor restrictions. Money that comes with conditions. A donor might require that funds go toward a particular program, be spent only after a certain date, or remain invested permanently so only the earnings get used. Once the organization satisfies the restriction, the funds get reclassified as unrestricted through a process called “net assets released from restrictions” on the Statement of Activities.
This two-category system came out of FASB’s Accounting Standards Update 2016-14, which replaced an earlier three-category framework.2Financial Accounting Standards Board (FASB). ASU 2016-14 – Presentation of Financial Statements of Not-for-Profit Entities
The Statement of Functional Expenses
Under GAAP, every nonprofit must show how its spending breaks down by both function and nature. “Function” means the purpose of the spending: program services (the actual mission work), management and general (administrative overhead), and fundraising. “Nature” means the type of cost: salaries, rent, supplies, travel, depreciation, and so on. The result is typically a matrix-style report where each column represents a function and each row represents a type of expense.
This breakdown answers the question donors care about most: how much of each dollar goes to the mission versus keeping the lights on? If a food bank spends 85 cents of every dollar on distributing meals and 15 cents on administration and fundraising, that ratio shows up clearly here. Organizations have some flexibility in presentation. The breakdown can appear as a standalone statement, as a schedule within the notes, or on the face of the Statement of Activities.
Getting the allocation methodology right is one of the trickier parts of nonprofit accounting, because many costs, such as the salary of an executive director who splits time between programs and administration, must be divided across functions using a reasonable basis. The same functional categories feed into the IRS annual information return (Form 990), where expenses are reported by program, management, and fundraising.3Internal Revenue Service. About Form 990, Return of Organization Exempt from Income Tax
Liquidity and Availability Disclosures
ASU 2016-14 also requires nonprofits to disclose both qualitative and quantitative information about how much cash the organization can actually access within the next year. A nonprofit might report $5 million in total net assets, but if $4 million of that is locked in donor-restricted endowments and another $500,000 is tied up in property, the true liquid position matters far more than the headline number.2Financial Accounting Standards Board (FASB). ASU 2016-14 – Presentation of Financial Statements of Not-for-Profit Entities
The quantitative piece typically shows up as a table listing financial assets available to cover general expenses within one year of the balance sheet date. That calculation starts with total financial assets and then subtracts anything unavailable due to donor restrictions, board designations, or contractual limits. The qualitative piece explains the organization’s strategy for managing liquidity, such as maintaining a line of credit, holding operating reserves, or timing fundraising campaigns to match cash flow needs. Together, these disclosures give a far more honest picture of financial health than the balance sheet alone.
When an Independent Audit Is Required
GAAP governs what goes into the financial statements. Whether those statements have to be independently verified is a separate question, and the answer depends on a combination of federal rules, state law, and funder requirements. At the federal level, any organization that spends $1,000,000 or more in federal awards during a fiscal year must undergo a Single Audit under the Uniform Guidance.4eCFR. 2 CFR 200.501 – Audit Requirements A Single Audit goes beyond a standard financial audit by testing whether the organization complied with the specific terms of its federal grants.
Most states also impose their own audit thresholds tied to charitable solicitation registration. The trigger varies, but it’s common for states to require an independent audit once a nonprofit’s annual revenue crosses somewhere between $500,000 and $2,000,000. Below those thresholds, many states accept a less rigorous financial review or compilation instead. A review provides limited assurance that nothing materially wrong jumps out; a compilation simply organizes the numbers into proper format without the accountant testing anything. Major funders and government agencies frequently require audited financials as a condition of grant eligibility regardless of what the law demands.
Organizations that handle federal money should watch whether they are approaching the $1,000,000 Single Audit threshold, because crossing it adds significant cost and complexity. The audit itself can run from $15,000 to $50,000 or more depending on the organization’s size and the number of federal programs involved. Budgeting for that expense before accepting a large federal grant is one of the planning steps that separates well-run nonprofits from ones that find themselves scrambling at year-end.
A Note on Form 990
The financial statements described here are separate from the IRS annual information return. Form 990 draws on the same underlying numbers, and its functional expense categories mirror what GAAP already requires, but it is a public tax filing rather than a financial statement. Most tax-exempt organizations must file some version of it each year.5Internal Revenue Service. Exempt Organization Annual Filing Requirements Overview If you are preparing financial statements primarily to satisfy an IRS obligation, check the 990 rules for your organization’s size; if you are preparing them for donors, boards, or auditors, the four statements and the disclosures around them are what matter.