Understanding the Statement of Functional Expenses
In nonprofit financial reporting, few documents are as crucial — or as misunderstood — as the Statement of Functional Expenses (SFE). For financial officers, executive leadership, and donors alike, this statement provides insight into how a nonprofit allocates its resources across mission-driven and administrative activities.
At Good Steward Financial Company, we help nonprofit organizations not only prepare their financial statements but also interpret them with clarity and confidence. In this guide, we’ll break down what the SFE is, why it matters, and how it supports transparency, compliance, and donor trust.
What Is the Statement of Functional Expenses?
The Statement of Functional Expenses is a key component of nonprofit financial reporting. It shows how a nonprofit’s total expenses are allocated among three primary categories:
- Program Services – Expenses directly tied to mission-based activities
- Management and General (M&G) – Administrative costs required to run the organization
- Fundraising – Costs associated with soliciting donations and grant funding
The SFE goes beyond just listing expenses — it assigns functional purpose to each cost, giving readers insight into how efficiently the organization uses its resources to achieve impact.
Why the Statement Matters
1. Promotes Financial Transparency
By breaking expenses by function, donors and stakeholders can see how much of their contributions go toward programs versus administrative or fundraising costs.
2. Strengthens Donor Confidence
Many donors want assurance that the majority of funds support mission-related work. The SFE helps demonstrate that the organization is responsible and efficient with its spending.
3. Supports Compliance and Audit Readiness
IRS Form 990 and generally accepted accounting principles (GAAP) require nonprofits to report functional expenses. A well-prepared SFE supports external audits and regulatory compliance.
4. Informs Strategic Decision-Making
Board members and financial officers use this statement to assess organizational health, identify spending trends, and guide budgeting and staffing decisions.
The Three Functional Categories Explained
1. Program Services
These are the core expenses directly related to delivering mission-based activities. Examples include:
- Staff salaries for program delivery
- Materials and supplies for community events
- Travel and training for program staff
- Direct assistance to beneficiaries
- Contract services tied to specific initiatives
Example:
If your nonprofit provides after-school tutoring, then instructor wages, learning materials, and student transportation all fall under program services.
2. Management and General
Also known as overhead or administrative expenses, these are costs related to running the organization, regardless of specific programs.
- Executive leadership and HR staff salaries
- Legal and accounting fees
- Office rent and utilities
- Insurance premiums
- Board meetings and governance
These expenses are essential for compliance, coordination, and long-term sustainability — even though they’re not directly tied to service delivery.
3. Fundraising
Fundraising expenses include all costs incurred to raise funds and maintain donor relationships.
- Event planning and venue rentals for fundraisers
- Marketing materials and mailings
- Development staff salaries
- Donor database software
- Consulting fees for grant writing
Understanding and reporting fundraising costs correctly is critical to portraying organizational efficiency and ROI for supporters.
Common Allocation Methods
Not all expenses fall neatly into one category—many must be allocated across functions based on actual usage. This process is crucial for accurate reporting and compliance, especially for nonprofits filing Form 990. Utilizing a professional nonprofit bookkeeping service can help ensure that shared costs like rent, utilities, or staff salaries are properly divided among program, management, and fundraising functions. Proper allocation supports transparency and strengthens donor confidence by showing how each dollar contributes to the organization’s mission.
1. Time-Based Allocation
Used for staff salaries and benefits. For example, if a staff member spends 60% of their time on program work and 40% on fundraising, their salary should be split accordingly.
2. Square Footage Allocation
Used for occupancy-related expenses like rent or utilities. If 70% of the office space is used by program staff and 30% by administrative staff, costs are allocated proportionally.
3. Usage-Based Allocation
Used for shared resources such as supplies, IT services, or software. Allocation is based on actual or estimated usage of each functional area.
Proper allocation is both an art and a science — it requires documentation, consistency, and clear reasoning. Financial officers should keep allocation of worksheets and time logs to support audit readiness.
Sample Statement of Functional Expenses (Simplified)
| Expense Category | Program Services | Management & General | Fundraising | Total |
| Salaries and Wages | $200,000 | $40,000 | $30,000 | $270,000 |
| Office Supplies | $5,000 | $2,500 | $2,000 | $9,500 |
| Rent and Utilities | $15,000 | $6,000 | $4,000 | $25,000 |
| Marketing & Outreach | $8,000 | $1,000 | $12,000 | $21,000 |
| Travel and Training | $10,000 | $1,500 | $500 | $12,000 |
| Total Expenses | $238,000 | $51,000 | $48,500 | $337,500 |
This format helps readers see both the total amount spent and the functional allocation, offering transparency into spending priorities.
Best Practices for Preparing Your SFE
✔ Keep Detailed Records
Track time, space usage, and other allocation factors with real data rather than estimates.
✔ Review Regularly
Revisit allocations quarterly or with leadership changes. Your assumptions may shift as programs expand or staff roles evolve.
✔ Train Program Staff
Ensure program managers understand the importance of coding expenses correctly — their input is critical for accurate categorization.
✔ Use Consistent Methods
Avoid switching allocation approaches unless there’s a clear and documented reason, especially between reporting periods.
✔ Leverage Accounting Software
Modern nonprofit accounting platforms offer functional tracking tools that simplify expense categorization.
What Donors Should Look For
If you’re a donor or funder, reviewing the Statement of Functional Expenses offers clues about how an organization operates:
- High Program Ratio — 75% or more of expenses on program services often indicates mission-focused spending.
- Reasonable Fundraising Costs — These vary, but sustained high fundraising expenses could warrant questions.
- Transparent Allocation Methods — Are methods documented and explained clearly?
While numbers alone don’t tell the full story, the SFE is a powerful tool for evaluating fiscal responsibility and strategic focus.
How Good Steward Financial Co. Supports Nonprofits
At Good Steward Financial Co., we help nonprofits enhance transparency and build financial systems that inspire confidence. Our services include:
✅ Functional expense categorization and allocation audits
✅ SFE preparation and GAAP-compliant financial statements
✅ Grant and funder reporting support
✅ Accounting system setup for functional tracking
✅ Training for finance and program staff
Whether you’re building your first Statement of Functional Expenses or seeking ways to improve reporting accuracy, we’re here to help you steward resources wisely and communicate your impact clearly.
Final Thoughts
Understanding the Statement of Functional Expenses isn’t just about accounting — it’s about trust, transparency, and accountability. By clearly showing how funds are used, nonprofits build credibility with donors, empower leadership to make informed decisions, and fulfill their obligation to steward public and philanthropic support responsibly.
If you’re ready to improve your nonprofit’s financial reporting and build a more transparent financial framework, Contact Good Steward Financial Co. We’re here to help your organization thrive through solid financial practices and trustworthy reporting.
Need help with your Statement of Functional Expenses?
Contact Good Steward Financial Co. today to schedule a consultation and learn how we can strengthen your financial reporting.
FAQs (Frequently Asked Questions)
The Statement of Functional Expenses helps nonprofits show how their expenses are allocated between program services, management and general activities, and fundraising. It provides transparency and supports accountability to donors, boards, and regulators.
Expenses are classified both by function (what the expense was for, such as programs, administration, or fundraising) and by natural classification (the type of expense, like salaries, rent, or supplies).
This statement is typically required for U.S. nonprofit organizations filing IRS Form 990. It’s also considered a best practice for any nonprofit that wants to demonstrate financial responsibility and operational efficiency.
Functional expenses relate to the purpose of the cost (programs, management, fundraising), while natural expenses describe what was purchased (e.g., utilities, payroll, office supplies). The statement shows how these overlap.
By clearly showing how resources are allocated, the Statement of Functional Expenses helps donors understand where their contributions are going. It also reassures stakeholders that the organization is focused on its mission and using funds wisely.