If you file audited financial statements and/or a Form 990 (not EZ or postcard form), one you’ll have to prepare is a Statement of Functional Expenses. The main purpose of the statement is to break out your expenses into 3 pots – your 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.
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 where people spend their time, square footage of each department, or actual usage, when it’s practical to determine.
The SoFS is presented as a grid – columns for each pool of expenses, and rows for the nature of the expenses, e.g. salaries, rent, depreciation. Here’s an example from AccountingCoach.com:
Statements of Functional Expenses are often used by people outside the organization to judge the efficiency of your 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 give them different metrics for efficiency. In other cases, an organization might invest heavily in staff salaries and training in order to attract highly experienced people, and to make other 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.