What Makes a Nonprofit Profitable?
Tuesday, October 13, 2020
When you hear the word nonprofit, what comes to mind? If you work for a nonprofit business, you’ve probably figured it out. But for many others, the very phrase spurs confusion. If a nonprofit is a business, shouldn’t they seek to make a profit? And how can a business of any kind function in the absence of money? What exactly qualifies as non-profit? Can a nonprofit make a little bit of money and still qualify for tax exempt status?
These, and many other questions, are valid, especially if you’re new to thinking about nonprofits. The first step to finding the answers is in understanding what exactly a nonprofit organization is.
A nonprofit organization is still a business when it comes down to it. They just operate a little differently than a company that seeks to make money that goes above operating expenses--a profit, if you will. Nonprofits are often known for their charitable work, gathering together people who want to work toward something noble.
Nonprofit organizations are tax exempt, and there are nearly three dozen types of such organizations, each in a different section of the tax code. For each, specific conditions must be met.
In non-financial terms, a nonprofit organization is a group of people joining together under a common cause and shared point of view, usually working toward providing a service. In economic terms, it is an organization that uses surplus revenue to offer more or additional services, for which they are rewarded with tax exempt status.
People who work for nonprofits can count on their job satisfaction coming from things like service, benefits, and work environment. On average, even executive directors make around $50,000, which is much less than their counterparts in for-profit businesses. Nonprofits often rely on the hard work of volunteers to sustain their tight budgets.
Remember that nonprofit organizations have founders--not owners. These founders cannot benefit from the net earnings of the organization, although they can collect a salary. Nonprofits can and do try to achieve positive revenue with enough leftover to save for future operational experiences or emergencies. Profit is never distributed to an individual or private interest.
Why become a nonprofit?
Aside from the desire to perform meaningful work, you may be questioning why an organization would choose to operate as a nonprofit business instead of a for-profit business. Their reasons might include:
- Tax exemption.
- Ability to obtain private or public grants, which are generally unavailable to for profit businesses.
- Desire for an organization that exists as a separate entity from its owner.
- Status as a limited liability company, which means that founders, members, employees, and directors are not responsible personally for debts the nonprofit incurs. Of course, this does not mean any of these people can use the nonprofit as a shield against illegal activity.
Disadvantages of being a nonprofit
Sure, all of this sounds great--so why wouldn’t you start a nonprofit? Aside from a lack of profitability, nonprofits aren’t a good fit for every business idea. Consider:
- Cost--nonprofits require a lot of time, effort, and cash. They need staffing, legal and accounting expertise, and space to operate.
- Logistics--obtaining nonprofit status requires substantial paperwork, as does maintaining it, managing deadlines, and reporting to various entities.
- Control--an individual has very little control over a nonprofit, so people who hope to make all decisions or set their own rules may not be comfortable with a nonprofit, which is required to report to a board and maintain a high level of visibility.
- Judgement--nonprofits may face public scrutiny because they’re so visible. Where there is an expectation that for profit businesses perform a certain way, communities can be more critical of nonprofits.
A few key differences between for profit and nonprofit businesses
Profit and no profit is the obvious differentiator between for profit and nonprofit businesses, but there are a few other distinguishing characteristics. These businesses tend to differ in mission, leadership structure, finances, and employee labor structure.
Nonprofits receive oversight from a Board of Directors, which is usually fairly large in size. Typically, it consists of community members from all backgrounds who work in other places. For profit businesses have presidents and vice presidents, directors, etc. For profit businesses often have stockholders who must receive progress reports, but can suffer when a business experiences decline.
Nonprofits also rely on the work of volunteers to help stretch resources, while for profit companies typically pay everyone, save some college interns (and even that is rapidly changing). The overall approach to business is different because the goals are different, although both must earn money to stay afloat.
How do nonprofits make money?
Obviously, nonprofits require money to operate, just as any other business does. Nonprofit organizations must have reliable income to pay for things like office space, employee salaries, equipment, and day to day operations--not to mention the services they provide. There are restrictions on how that money can be made though, given the tax exempt status. Donations, money made from fundraising events, items sold in the name of fundraising are all fine. And, while there are other ways a nonprofit can make money (selling gift baskets that were paid for but never retrieved after a fundraising event, for example), they should be kept to a minimum to avoid losing the tax-exempt status.
A word on fundraising
Nonprofit organizations rely on a variety of fundraising options to maintain business. They are funded (to the tune of 70 percent) by individual donations, although foundations, bequests from supporters, and corporations also supply a decent part of their income. They also frequently receive grant funding, which covers a large portion of their cost of operations.
Different organizations focus on fundraising in different ways--they may sell a branded product, host a fun run, or plan an elaborate charity dinner. Although their strategy is as varied as the populations they serve, these organizations rely on the generous support of the community to put the ‘profit’ in nonprofit.
Maintaining nonprofit status
Because the rules are more complicated for nonprofits, following them takes some knowledge and commitment. The most important thing a nonprofit can do is to maintain tax exempt status, and this process doesn’t have to be difficult. Nonprofits can maintain status by:
- Always filing a return with the IRS.
- Acknowledging all donor gifts over $250 by providing a written receipt.
- Maintaining a formal process for managing contractors and compensation agreements with outside and inside employees to ensure that it is in service of the public and not private interests.
- Familiarizing themselves with potential restrictions on lobbying to avoid breaking rules or crossing lines.
- Avoiding engaging in political campaign activity that can be construed as favoritism. This includes less obvious activities like selling mailing lists, renting offices, or paid political advertising.
- Paying taxes on unrelated business income.
- Asking the right questions. If nonprofits have questions about something, they should consult with a lawyer or nonprofit accountant.
Producing a budget
Nonprofits still allocate their money and create budgets, and most (if not all) prepare balance sheets and income/expenditure statements at the end of the fiscal year. This provides a record for communities and nonprofit boards that paints a picture of an organization’s financial health. Any surplus goes back into the organization, assuming there are no outstanding debts. Additional money (which might be considered profit in a for-profit organization) may also be put into savings for the nonprofit.
Nonprofit profitability often goes beyond finances. For many who work or even volunteer for a nonprofit, they’ll tell you that they benefit beyond the paycheck. There’s a reason that, despite the lack of emphasis on profit, nonprofit organizations often make “best of” lists for places to work. If you choose to work for a nonprofit, you may benefit from the following:
- Increased flexibility. Nonprofits are often more flexible about a lot of things, including work schedule or work from home opportunities.
- Better benefits. Nonprofit organizations offer normal benefits for full time employees (like medical and dental insurance, life insurance, and retirement plans), but they often go above and beyond. You may get opportunities for sabbaticals, tuition reimbursement, or additional vacation time.
- Purposeful work. For many people, the opportunity to do important work in service of others is the main driver for nonprofit work.
- Good community culture. People like working places where they feel respected, valued, and useful to their communities and their leadership. Nonprofits tend to develop positive company culture that keeps people around.
The bottom line
What makes a nonprofit profitable is a difficult question because it depends on so much. Profit is sometimes in the eye of the beholder. For nonprofits, it gets more complicated. Ultimately, a nonprofit organization hopes to stay out of the red--to have enough money to continue providing services, save for a rainy day, and pay their employees a good wage. Although they aren’t driven by the need to put dollars into executive bank accounts, they do require capital to run, and are usually acting in the interest of continuing service through fundraising.
To talk more about how to transition your nonprofit to a more sustainable financial model or simply discuss your financial situation, contact a nonprofit accountant!