Nonprofit organizations (or not-for-profit organizations) operate to serve the greater good. And, while this is their primary purpose, they still need to generate consistent revenue to operate successfully and carry out their mission.

Nonprofits can take various legal forms, such as charitable organizations, foundations, religious institutions, educational institutions, and social advocacy groups. While they may generate revenue through donations, grants, or program fees, the surplus funds are reinvested back into the organization to further its mission, rather than being distributed to owners or shareholders.

Understanding how nonprofits spend their funds is of significant importance for several reasons.

Transparency and accountability

Nonprofit organizations rely heavily on public trust and support. Donors, volunteers, and stakeholders have a right to know how their contributions are being utilized. By understanding how nonprofits spend money, individuals can ensure transparency and hold organizations accountable for their financial decisions. This knowledge helps maintain trust and confidence in the organization's integrity.

Informed decision-making

Donors and supporters want to ensure that their contributions are being used effectively and efficiently. By understanding how nonprofits allocate their resources, individuals can make informed decisions about which organizations to support. They can evaluate whether an organization's mission aligns with their values and assess the impact their donations can have.

Assessing effectiveness

Understanding how nonprofits spend money provides insights into their operational effectiveness. It allows stakeholders to assess whether an organization is efficiently using its resources to achieve its mission. By analyzing expenditure patterns, individuals can gauge the effectiveness of programs, services, and initiatives offered by the nonprofit. This information can guide decisions on long-term support and collaboration.

Ensuring ethical practices

Knowledge about how nonprofits spend money helps ensure ethical practices within the sector. It allows for scrutiny of financial management, including executive compensation, administrative expenses, and compliance with legal and regulatory requirements. This understanding helps identify any potential misuse of funds or conflicts of interest, promoting responsible financial stewardship within the nonprofit sector.

To better understand what nonprofits are allowed to spend money on, let’s break down their core activities.

Mission-based programs are the primary activities through which nonprofit organizations fulfill their purpose and make a positive impact on society. These programs involve providing services or support to beneficiaries in various areas.

Here are some examples:

1. Education: Nonprofit organizations focused on education may provide tutoring programs, scholarships, mentorship initiatives, or educational resources to enhance learning outcomes and promote equal access to education.

2. Healthcare: Nonprofits in this sector may offer medical services, preventive care programs, health awareness campaigns, or support for individuals with specific medical conditions. They may operate clinics, mobile health units, or partner with medical professionals to deliver healthcare services to underserved communities.

3. Social Services: Organizations addressing social services may focus on issues such as poverty alleviation, homelessness, domestic violence, or substance abuse. They may offer emergency shelters, counseling services, job training, rehabilitation programs, or initiatives that empower vulnerable populations and promote social well-being.

Fundraising and development activities are essential in securing the necessary financial resources to support programs and operations. These activities involve:

1. Raising funds: involves fundraising strategies to gather monetary contributions. This can include soliciting individual and corporate donations, applying for grants, organizing crowdfunding campaigns, or seeking sponsorships.

2. Cultivating donor relationships: building and maintaining strong relationships with donors. Nonprofits cultivate connections by engaging donors, expressing gratitude, and keeping them informed about the organization's progress and impact. Regular communication, personalized acknowledgments, and donor appreciation events are common practices. For more insights, watch my podcast on Donor Cultivation.

3. Conducting fundraising events and campaigns: organizing fundraising events and campaigns to generate financial support and increase public awareness. These can include galas, charity auctions, benefit concerts, charity runs, or online fundraising campaigns through social media platforms.

While nonprofit organizations primarily focus on their mission-based programs, they also need to manage administrative and operational functions to ensure their smooth functioning. This includes:

1. Overhead costs: expenses related to office space, utilities, maintenance, and supplies necessary for daily operations.

2. Staff salaries and benefits: wages for staff members who play crucial roles in program implementation, administration, fundraising, and support services. Salaries, wages, and benefits are allocated to these employees.

3. Legal and accounting expenses: nonprofits must comply with legal and regulatory requirements. They may need to hire legal counsel for compliance matters and accounting professionals for financial reporting and tax-related obligations.

4. Technology and communication infrastructure: technology tools, software, and communication infrastructure to carry out their activities effectively. This includes computer systems, internet access, software licenses, and communication platforms that facilitate internal collaboration and external communication with stakeholders.

Effectively managing administration and operations allows nonprofits to operate efficiently, maintain financial transparency, comply with legal requirements, and support the delivery of mission-based programs.

Overall, the core activities of nonprofit organizations encompass mission-based programs to serve beneficiaries, fundraising and development efforts to secure financial resources, and administration and operations to ensure organizational efficiency and compliance.

Now that we’re clear on the core activities of nonprofits, we can delve into what they are allowed to spend money on.

Nonprofit organizations are permitted to allocate funds towards expenses directly related to delivering their mission-based programs and services. These expenses are essential for the organization to fulfill its purpose and make a positive impact. Permissible program expenses include:

1. Staff salaries and benefits directly supporting programs: Nonprofits can use funds to compensate employees directly involved in program implementation, such as program coordinators, educators, healthcare providers, or social workers. The key phrase here is “directly supporting programs.”

2. Program-related supplies, materials, and equipment: Organizations may spend money on necessary supplies, materials, and equipment required to deliver their programs effectively. This can include textbooks and educational resources, medical supplies, counseling materials, or tools for community outreach. Again, these need to be directly related to the programs the nonprofit offers.

Nonprofit organizations rely on fundraising efforts to secure the financial resources needed to support their programs and operations. Permissible fundraising expenses include:

1. Costs associated with soliciting and collecting donations: This includes expenses related to donor outreach, communication, and cultivation. It may involve direct mail campaigns, online fundraising platforms, or hiring fundraising consultants.

2. Fundraising event expenses: Nonprofits often organize events to engage donors, raise awareness, and generate financial support. Permissible expenses can include venue rental, event planning, catering, marketing materials, and logistical costs.

3. Marketing and promotional materials: Organizations can spend money on creating marketing materials, such as brochures, newsletters, website development, social media campaigns, and advertisements, to promote their mission and attract donors.

Nonprofits require administrative support to effectively manage their operations. Permissible administrative expenses include:

1. General organizational management costs: This includes expenses associated with the day-to-day functioning of the organization, such as rent for office space, utilities, insurance, office supplies, and postage.

2. Financial management and reporting: Nonprofits need to maintain accurate financial records and prepare financial statements. They may allocate funds toward accounting software, bookkeeping services, audits, or financial reporting systems.

3. Human resources and personnel: Organizations require skilled employees to handle administrative tasks, human resources management, and organizational development. Permissible expenses include staff salaries and benefits for administrative personnel.

Organizations must adhere to legal and regulatory requirements to maintain their tax-exempt status and comply with applicable laws. Permissible compliance and legal expenses include:

1. Meeting legal and regulatory requirements: This includes costs associated with business licenses, permits, annual filings, and compliance with federal, state, and local laws.

2. Filing taxes and maintaining nonprofit status: Nonprofits may incur expenses related to tax preparation, filing tax returns, and maintaining their tax-exempt status with the appropriate government agencies.

3. Hiring legal counsel for specific matters: Organizations may need legal advice or representation for issues such as contracts, negotiations, intellectual property rights, employment law, or resolving legal disputes.

It's important to note that while these categories represent permissible expenses, nonprofits must exercise good financial stewardship and ensure that their expenditures align with their mission, are reasonable and necessary, and are consistent with applicable laws and regulations.

Even more crucial is that you understand that the majority of these expenses are not going to be covered by restricted funds.

Restricted funds include:

1. Grants

2. Contracts

3. Donations

What does this mean? We go back to a concept I keep bringing up (because it’s that important): A funder’s purpose is not to fund the nonprofit: that is the board’s responsibility.

Funders expect nonprofits to cover operational costs. Therefore, operational expenses, as outlined below, are the responsibility of the organization and should not be derived from funders’ money:

1. Salaries not associated with a program (e.g., legal, accounting, fundraising roles)

2. Rent

3. Utilities

4. Office equipment and supplies

5. Fundraising efforts (all events and costs associated with those events)

Bear in mind that funders typically only allot 8% - 25% of a grant to overhead expenses. This is why nonprofits HAVE to diversify their funding streams and generate unrestricted revenue to cover those costs (75% of overhead), which is the bulk of the organization’s expenses. 

Read my book, The Fund Development Plan, to learn everything you need to generate consistent funding from multiple sources that leads to long-term impact and a sustainable organization.

Naturally, nonprofits are subject to certain restrictions and regulations to ensure that their resources are used for the public benefit and in accordance with their tax-exempt status. Just as you must know what nonprofits are allowed to spend money on, you also need to know the key restrictions on nonprofit spending. Let’s take a look.

Nonprofits are required to ensure that their assets and income are used to benefit the public, rather than individuals associated with the organization. This is known as the prohibition of inurement. The following aspects are involved:

• Ensuring assets benefit the public: use funds and assets to further the mission and provide services to the public. They should not be used to primarily benefit private individuals or insiders.

• Executive compensation limits: exercise restraint in compensating their executives and key employees. The compensation should be reasonable and commensurate with the services provided. Excessive compensation that unjustly benefits individuals can violate the prohibition of inurement.

The private benefit doctrine requires nonprofit organizations to primarily serve public interests rather than private individuals. This doctrine ensures that the organization's activities and resources are focused on benefiting the broader community. Key considerations include:

• Primarily serve public interests: The primary purpose should be to serve the public, advance a charitable cause, or address a specific societal need. The organization's activities and programs should be designed to benefit the public or a specific target population.

• Limited transactions with board members or insiders: Nonprofit organizations should avoid conflicts of interest and self-dealing. Transactions between the organization and its board members, officers, or insiders should be conducted at arm's length and should be for fair value. This ensures that the nonprofit's resources are not used for personal gain or to benefit individuals closely associated with the organization.

Nonprofit organizations have restrictions on engaging in partisan political campaigns, but they are allowed to participate in non-partisan issue advocacy and lobbying. Some factors to consider are:

• Restrictions on partisan political campaigns: Refrain from endorsing or supporting specific political candidates or political parties. Engaging in activities that support or oppose a particular candidate or party can jeopardize their tax-exempt status.

• Allowance for non-partisan issue advocacy and lobbying: Nonprofits can engage in non-partisan advocacy and lobbying activities to promote their mission and advocate for specific social, environmental, or policy changes. They can educate the public, policymakers, and the community about issues relevant to their mission and seek to influence legislation or public opinion.

It is essential for nonprofits to understand and comply with these restrictions to maintain their tax-exempt status and uphold the public's trust. By adhering to these regulations, nonprofit organizations can demonstrate responsible stewardship of their resources and ensure that their activities align with their charitable purposes.

To maintain public trust and accountability, nonprofits must meet reporting requirements that provide transparency about their financial activities. The following are some of the key requirements for reporting and disclosure:

Nonprofits are generally required to prepare and submit annual financial statements that provide an overview of their income, expenses, and assets. These financial statements help stakeholders understand the organization's financial health and how funds are being utilized. Key considerations include:

• Annual reporting on income, expenses, and assets: organizations must compile financial statements, including an income statement, balance sheet, and statement of cash flows, to provide an overview of their financial performance and position.

• Auditing requirements for larger nonprofits: larger groups may be required to undergo an annual audit by an independent certified public accountant (CPA). The audit provides an independent assessment of the organization's financial statements, internal controls, and compliance with accounting principles.

Nonprofit organizations are required to file Form 990 with the Internal Revenue Service (IRS) annually. Form 990 is a detailed informational return that provides comprehensive disclosure of the organization's financial information and operations.

This is important because it is:

• A detailed disclosure of financial information: Form 990 requires nonprofits to disclose detailed information about their revenue, expenses, assets, liabilities, governance structure, board members, executive compensation, and program activities. This information provides transparency and enables the public to evaluate the organization's financial stewardship and accountability.

• Available to the public to promote transparency: Form 990 is a public document and is accessible to anyone who wishes to review it. Nonprofits often make their Form 990 available on their websites or through platforms like GuideStar. This promotes transparency and allows stakeholders, including donors, volunteers, and the general public, to assess the organization's financial health and operations.

Complying with reporting and transparency requirements demonstrates your commitment to transparency, accountability, and good governance. It helps maintain the public's trust, allows stakeholders to make informed decisions about supporting the organization, and ensures that the organization is operating in accordance with applicable laws and regulations.

Read my quick guide on how to file nonprofit taxes.

Spend your organization’s money wisely

As nonprofit leaders, you play a crucial role in society by addressing important causes and providing vital services to beneficiaries. Understanding how to allocate your resources responsibly is essential for maintaining transparency, accountability, and public trust.

Throughout this article, we have explored the permissible areas where you can spend your funds. These include mission-based programs, fundraising and development efforts, administration and operations, and compliance and legal expenses. By strategically allocating resources to these areas, you can effectively fulfill your mission and make the impact you want to.

It is important to remain mindful of the restrictions placed on nonprofit spending, such as the prohibition of inurement and the private benefit doctrine. These regulations ensure that resources are used to benefit the public rather than individuals associated with the organization. Additionally, navigating the boundaries of political activities by avoiding partisan campaigns while engaging in non-partisan issue advocacy and lobbying will help you maintain your tax-exempt status and credibility.

Reporting and transparency requirements are essential for demonstrating your organization's accountability. By diligently preparing financial statements and filing Form 990, you provide stakeholders with the necessary information to evaluate your financial performance, governance practices, and impact. Embracing these reporting obligations enhances transparency and fosters trust among donors, supporters, and the public.

Remember that responsible financial management is crucial for maximizing the effectiveness of your programs and services. By ensuring that your funds are allocated wisely and in alignment with your mission, you can achieve meaningful outcomes and make a lasting difference in the lives of those you serve.

Visit my shop for more resources on funding a nonprofit.