What’s the Statement of Functional Expenses (And What’s It For?)
If you’ve ever run a business, you know how much accounting is involved. All that number-crunching doesn’t go away because you’re doing valuable work with your nonprofit. In fact, it usually gets trickier.
If you’re a small business, you only need to track the money coming in and going out. With a nonprofit, you also have to be able to show exactly what you’re doing with those funds, because nonprofits don’t exist to make profits- instead, they fulfill missions that address specific needs in society. This is where a statement of functional expenses comes in.
Okay, So What is the Statement of Functional Expenses?
The statement of functional expenses is a financial report that nonprofits use to classify each of their expenses as functional and natural expenses. What the heck does that mean?! Basically, this statement breaks down the costs associated with different expenses so you can easily see how the nonprofit is spending its money. For example, on a statement of functional expenses, you’d be able to see the total expenses that go directly towards one program (think like the supplies, rent, salaries, etc. you need to run that program). You could also see all the costs that go into the nonprofit’s fundraising or management and governance.
Is your head spinning? Don’t worry – an accountant can help you figure out exactly what all those categories look like for your organization. But here’s an overview of what you could expect to see on a statement of functional expenses:
This section includes the program expenses that are related to operating your nonprofit’s programs. Because they’re part of fulfilling its mission, most of your expenses will likely be in this category. This would include staff salaries, supplies, rent, or any other direct costs to running your program.
Management and Governance Expenses
These expenses are the costs associated with running the business. They include your filing, legal, licensing, and financing fees as well as governance, bookkeeping, and management costs. These are expenses that don’t directly relate to the mission of the nonprofit but are essential to keeping the organization up and running.
Any expenses spent on raising funds for the organization are also supporting expenses. This category could include things like fundraising event costs, postage, printing for direct mail campaigns, and employees’ salaries.
Why is Your Statement of Functional Expenses Important?
Nonprofits are businesses. Just because you’re not operating “for profit” doesn’t mean we don’t care about the money. Nonprofits still need to know how much money it costs to run and what the money is being spent on. In some ways, it can be more important to track all this for nonprofits, right?? We want to be good stewards of our funds and pursue our missions in the best way possible. And that means taking good care of the organization’s financial health and keeping things GAAP-compliant.
Plus, nonprofits are required to present their expenses in this natural and functional classification per the Financial Accounting Standards Board. And if that isn’t enough, if you have (or want to have) c3 or c4 tax-exempt status, you’ll need to report these classified expenses on your annual 990.
The 990 is where you’ll report the nonprofit’s income, expenses, assets, and liabilities to the IRS. In a nutshell, reviewing this form is how the IRS makes sure you’re worthy of maintaining your tax-exempt status. If the IRS is going to miss out on the nonprofit’s tax dollars, they’ll want to make sure we’re actually using our funds for charitable purposes. If you’re not careful, you can jeopardize your exemption. For example, if you’re paying your insiders a huge and uncalled-for salary, you can expect the government to give you a closer look.
Now, having said that, your statement of functional expenses is more than a Grade A report card for the IRS. It’s also a handy tool for you to see how the nonprofit’s resources are being used.
Got Questions About Functional Expenses? Hit Me Up for the Answers!
Running a nonprofit is rewarding work, but some of the jargon and advanced baseball can be hard to figure out, especially if you’re new to the world of nonprofits. And honestly, it’s okay not to know all the things! You’re in the nonprofit world because you have a drive for your mission, not because you know all the IRS regulations and nonprofit accounting rules out there. Find yourself the professionals you need for the nonprofit to succeed – and I’d highly recommend having an accountant who knows nonprofits as one of them!
Want to learn more about nonprofit best practices? Check out Mission Guardian Toolkit, a legal resources program that allows even the tiniest orgs access to self-service legal tools like online courses, document automations, and live Q&A webinars.