How to efficiently categorize nonprofit expenses for a Statement of Functional Expenses

Introduction

Maintaining an accurate record of expenses is crucial for any nonprofit organization and absolutely essential for transparency and accountability. All nonprofits are required to prepare a Statement of Functional Expenses (SFE) —a vital document for demonstrating how funds are allocated across different program and administrative functions. An SFE is in accordance with Financial Accounting Standards Board (FASB) standards so stakeholders have a clear view of expenses, both from a functional and natural classification. The statement is also a requirement for the IRS 990 form to maintain nonprofit status. 

When using manual processes, it can be time-consuming for nonprofit admins to keep records of the various categories of expenses in order to accurately prepare financials. One powerful tool that can help simplify this process is an expense management system, like Expensify. In this blog post, we’ll explore how Expensify helps nonprofits categorize expenses automatically, making it easier to create a Statement of Functional Expenses.

What is a Statement of Functional Expenses?

The Statement of Functional Expenses is a key component of a nonprofit organization's financial reporting. It provides a detailed breakdown of expenses according to their functional categories, such as program services, management and general administration, and fundraising. This statement offers transparency into how resources are utilized to achieve the organization's mission, fostering trust among donors, stakeholders, and the public.

What are functional expenses?

Functional expenses are not necessarily a specific expense category. Instead grouping expenses by function is used to represent the purpose of the expense and the purposes can fall into one of three categories: fundraising, management and general administration, and program services. An organization can then further categorize expenses into subcategories within each of these buckets.

What are natural expenses?

The natural expense categories are based on the type of expense incurred. This is the same method as how for-profit companies would categorize their expenses (e.g. meals and entertainment, supplies, travel). Importantly, to prepare the Statement of Functional Expenses you have to provide both the functional and natural categories for all of your expenses.

Expensify's role in expense categorization:

Now that we have been introduced to the concept of functional and natural expenses, let’s consider how we can use Expensify to help with coding these expenses accurately. One of Expensify’s significant advantages for nonprofits is its robust categorization features.

1. SmartScan technology:

   Expensify's SmartScan technology utilizes optical character recognition (OCR) to automatically extract information from receipts and invoices. This includes details like merchant names, transaction amounts, and dates. This allows your employees or volunteers to automate the bulk of work required to submit their expenses so they can focus on accurately categorizing the expenses by both their functional and natural categories.

2. Customizable expense categories:

   Nonprofits often have unique expense categories based on their specific programs and activities. Expensify can import these categories from any accounting system via a direct integration (e.g. QuickBooks Online, Xero, NetSuite, or Sage Intacct). Typically, an organization would import their natural expense categories as Categories and then import functional expense categories as Tags. For example, if you’re using QuickBooks Online and recording functional expense categories as Classes, you can import these Classes as Tags in Expensify so employees can assign a functional category to any expense. A similar process is available with other accounting systems.

3. Policy enforcement:

   Expensify enables nonprofits to set and enforce expense policies. These policies can include rules related to spending limits, allowable expense types, and required documentation. Specific to categorization, organizations can require employees to categorize and tag every expense before submitting an expense report. Administrators reviewing and approving these reports can always update the selected functional and natural expense categories if they see a selection made in error.

4. Real-time reporting and analytics:

   Expensify provides real-time reporting and analytics tools that empower nonprofits to monitor and analyze their expenses on an ongoing basis. This allows organizations to proactively manage their finances, identify trends, and make informed decisions about resource allocation. Organizations can create a custom export of all expenses grouped by both natural and functional expense types. All of these expense details are also automatically exported to your accounting system so that you can build your financial statements with clean and organized data.

Conclusion:

In conclusion, Expensify serves as a valuable ally for nonprofit organizations seeking to streamline their financial management processes. By leveraging its advanced features, nonprofits can efficiently categorize expenses and generate a Statement of Functional Expenses that meets regulatory requirements and enhances transparency. As nonprofits continue to face increasing scrutiny regarding financial stewardship, adopting tools like Expensify becomes essential for demonstrating responsible and effective use of resources in pursuit of their mission.

If you’re a nonprofit interested in improving your expense categorization and organization, contact our sales team to learn more.