The Statement of Functional Expenses for Non-Profit Organizations: Why It May Be the Most Important Schedule On Your Financials

Why the Statement of Functional Expenses might be the most important schedule on your financials

When you look at a standard set of audited financial statements, you will find both a balance sheet and a profit and loss (P&L) statement. Both of these are vital to ascertain the health of an organization. But there is another schedule that may hold even more importance to the long-term viability of an organization – the statement of functional expenses.

The GAAP definition of the Statement of Functional Expenses:

The process of tracking the money you spend according to what the money was used for –such as fundraising, administration expenses, or actual programs. This method of expense reporting is most commonly used by non-profit organizations.

Reporting functional expenses has been required by Generally Accepted Accounting Principles (GAAP) since 2017, as detailed in ASU 2016-14. In past years, it included a supplemental schedule in the back of audited financial statements. It has now become a mandatory schedule as part of the standard package of audited financial statements.

So why is this schedule so important?

The reason is simple: it reveals the organization’s overall efficiency. It shows, for every dollar the non-profit organization collects, what percentage makes its way to the program. It also offers a lens to any potential funders as to how their money will be spent and how much of their donation will ultimately make it to the organization’s programs. The more sophisticated the funder, the more likely he or she is going to want to understand this percentage. It is also available in the 990 tax return, which is public record.

For an example, if 50% of an organization’s donations are used to cover administrative expenses, then effectively, for every dollar received, only 50% is going toward the organization’s ultimate mission. A potential funder may look at this and decide that this organization is not a viable recipient for its donations.

Although there are no required percentages, generally, most agencies strive to operate with a 70% or better allocation to program. This leaves 30% for administrative costs (i.e. keeping the lights on) and fundraising activities. These are general amounts, and the actual percentage will vary depending on the program.

Now, before you begin allocating all of your costs to program, you should be aware that Generally Accepted Accounting Principles (GAPP) allows only certain costs to be considered programmatic. For example, accounting fees cannot be allocated to program but office supplies can. Understanding what things can and cannot be allocated to program is the key to setting your programmatic budgets.

The Statement of Functional Expenses is generally prepared once a year as part of the annual audit. However, program expenses and allocation to program percentages should be reviewed periodically throughout the year so you have a solid understanding of where your organization  is going to land during the year-end closing process.

If you would like to explore whether outsourcing your accounting function to ARI is the right more for your non-profit organization, contact us today.

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Frequently Asked Questions

Why is the Statement of Functional Expenses so important for nonprofit organizations?

The Statement of Functional Expenses reveals the organization’s overall efficiency. It is designed to increase transparency by showing how funds are used in relation to an organization’s mission. It helps donors, regulators, and the public understand how much of the nonprofit’s spending goes toward program services (mission-related activities) and how much goes to supporting services such as management, general operations, and fundraising.

How do funders and donors use the Statement of Functional Expenses (SFE) when evaluating nonprofits?

The SFE helps donors judge whether a nonprofit is being a good steward of resources because they can easily see the proportion of money being spent on actual program services versus the amount being spent on administrative and fundraising costs.

What is considered a healthy ratio of program vs. administrative and fundraising expenses?

For nonprofits, although there are no required percentages, generally, most agencies strive to allocate 70% or more of funds directly to program services. This leaves 30% for administrative costs and fundraising activities. 

Which types of costs can (and cannot) be allocated to program expenses under GAAP?

Program expenses that are directly related to carrying out the nonprofit’s mission – the services, activities and deliverables that fulfill its tax-exempt purpose – can be allocated to program expenses under GAAP. 

These include the direct costs of delivering services or goods to beneficiaries, salaries and benefits for staff directly involved in programs, materials and supplies used in program activities, travel related to program implementation, grants and assistance to others in furtherance of the mission, depreciation or occupancy costs for facilities used in program activities, professional services directly tied to program operations (e.g., legal or evaluation consultants hired for a specific program). General accounting and HR fees unrelated to a specific program cannot be allocated to program but office supplies can. The executive director’s salary is not a program expense.

How can outsourcing accounting to ARI help nonprofits stay compliant and improve efficiency with their functional expense reporting?

Outsourcing your accounting transforms the Statement of Functional Expenses from a compliance burden into a strategic management tool – improving accuracy, transparency, and trust, while enabling your organization stay focused on its mission. Our professional teams at ARI can help you ensure that your Statement of Functional Expenses aligns seamlessly with your IRS Form 990 Part IX (Functional Expenses).