The statement of functional expenses is one that nonprofits prepare that for-profits don’t. It breaks your expenses into 3 pots –programs, fundraising, and management and general. More detailed classification can be helpful to people reading your financial statements, e.g. if you have multiple programs, list each one individually as well as the total for all programs. Within these 3 functions, expenses are also reported by their natural classification, e.g. salaries, rent, supplies.
Program expenses are those that keep the programs running, e.g. staff, office space, travel. Management and general covers general management of the organization (not program or fundraising management), accounting and finance functions, preparing an annual report, etc. Fundraising includes any costs of soliciting donations – fundraising campaigns and events, preparing and distributing materials, maintaining donor lists, etc. Some expenses don’t fall entirely into one category, such as rent or the executive director’s salary. You should have a consistent, written policy for how you allocate these across the 3 functions. Common bases for allocation include:
- Actual usage of the expense in question, when it’s practice to determine, e.g. a phone bill with several lines, some of which are for fundraising staff and some are for program staff, would be allocated based on how many lines are used by each type of staff.
- Proportional to where people spend their time (full time equivalents, or FTEs), e.g. printing, office supplies, sometimes rent. Whatever percentage of staff members work in each function (programs, fundraising, management), multiply the allocated expenses by this percentage.
- Square footage of each department, e.g. utilities or rent paid for an office with multiple departments. Similar to an allocation based on FTEs, if half of an office is used for program staff, a quarter for management, and a quarter for fundraising staff, that portion of the rent would be charged to those functions.
The SoFS is presented as a grid – columns for each function, and rows for the nature of the expenses. Here’s an example from AccountingCoach.com:
Statements of functional expenses are often used by people outside an organization to judge the efficiency of its work. If a high percentage of your expenses related to fundraising or management, some people may question why you aren’t investing more in your programs. In recent years, more criticism has come up about relying too heavily on efficiency metrics, since it doesn’t tell the full story about your organization’s work and what you are achieving. In some cases, financially similar organizations may allocate expenses differently, which would skew their efficiency metrics. In other cases, an organization might invest heavily in staff salaries in order to attract highly experienced people, and training to make staff more effective. Investing a lot of money in fundraising may be a result of going through a capital campaign, or may be a very active department that increases donations more than enough to justify the cost and improves the organization’s finances overall. This doesn’t give carte blanche to spend unwisely in these areas, but efficiency is not the only criteria you should use in evaluating your organization. Your organization exists to improve the lives of your constituents, and you should always be prepared to show what you have accomplished and how that is supported and enhanced by what you’re investing in.