Profit vs Profitability
When many people hear the term “nonprofit” they assume that an organization with such designation isn’t concerned about money. Very likely, it is the opposite--not for profit organizations are particularly caught up in conversations that revolve around finances that often go toward the organization and not the people who work for it. So, while they aren’t necessarily working toward the goal of making a profit, they are always concerned with making money for the implementation of their services.
All businesses require funding for operation, and nonprofits are no different. And, although profit and profitability are often used in place of one another, they mean different things too. Companies can be classified in a number of ways, but one important distinction is the difference between financial stability and potential for growth.
Profit is usually defined as the amount of money available after expenses are taken into account, or total revenue minus total expenses. Every business--nonprofit or not--seeks to make a profit.
While similar, profitability looks at profit in relation to size, so it is more about efficiency than money left over. Profit is an absolute number, but profitability is relative. Profitability will tell you whether or not your business yields enough profit to both sustain and expand business.
Though the calculation for profit is relatively simple, there are several ways to measure profitability, including profit margin ratio, gross margin ratio, and return on investment ratio.
Profit margin ratio shows earnings after expenses are deducted, but offers it as a percentage or ratio, which is different than a measure of profit, which is offered in dollar amounts. Profit margin is equal to revenue minus expenses, divided by revenue.
A gross margin ratio looks at gross margin compared to net sales, which may not be useful for every type of nonprofit. To figure out this number, begin with your revenue and subtract the cost of goods sold, then dividing by revenue.
Your return on investment ratio shows your profitability compared to the dollars you spent on investments. To do this, take your gain from your investments and subtract the cost of the investment, then dividing by the cost of the investment.
What profitability means
Profitability allows investors, boards, and communities to see how an organization uses existing resources, which sheds some light on overall efficiency. A company that is unprofitable is not beyond hope, but knowing that it is struggling can lead to problem identification. If a lot of funding is lost to projects that fail, a nonprofit may look at taking a more cautious approach when approving new projects, first evaluating their efficiency.
The bottom line
If you find that your nonprofit isn’t poised for growth, it doesn’t mean that you’re destined to fail--merely that you may require the advice of a great nonprofit accountant going forward! Especially with new businesses, there are some growing pains--consider your options, goals for growth, and opportunities, and you’ll be operating at your ideal profitability in no time!