Managing Profits and Losses on Nonprofit Organizations

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26th May 2020 Business Assignment Reference this

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Organizations can be classified into either profit or nonprofit.  Deciding which to pursue is an important choice from a legal, tax and branding perspective.  There are several nonprofit classifications that entities can fit into.  The reasons organizations chose to pursue a nonprofit designation varies.  According to Atlantic Publishing Company (2009), there are over 1,400,000 nonprofit organizations with over 900,000 public charities and 11,000 private foundations (p.15).  Many of these companies raise funds through offering services for more or less than what it cost to operate the programs.  They can also sell products for more or less than what the organization paid to make or procure them.  Through researching government laws and practices of nonprofits, we can better understand how these organizations handle profits and losses even though by definition they are not to make a profit.

Types of Nonprofit Organizations and IRS requirements

Nonprofit organizations can be charitable or not charitable.  Types of charitable organizations are religious, environmental, animal-related, and foundations. Non-charitable types of nonprofit organizations are health, membership groups, social, art, humanities, culture, education, and research (Atlantic Publishing Company, 2009).  501 (c)(3) federal tax-exempt status is granted to nonprofit organizations once they are approved by the Internal Revenue Service.  The most common exemption is for charitable organizations which is defined as “providing services beneficial to the public interest” (Mancuso, 2017).  Other exemptions examples are for purposes such as religious, scientific, literary, and education.

Mancuso (2017) also states that organizations need to raise funds to engage in activities primarily to what the group’s tax exempt status has been granted for.  It cannot produce a substantial amount of its income from unrelated activities (p. 46).  If an organization has a profit, it cannot use those funds to benefit individuals.  It must also pay reasonable wages to those associated with the nonprofit and not overpay them as a way to reduce profits.  The IRS has standards called excess benefit rules which are “contained in Section 4958 of the Internal Revenue Code and Section 53.4958 of the IRS regulations” (p.47) to provide guidance on the compensation, benefits and property for those associated with the nonprofit.

Branding of Nonprofit Organizations

In order to gain donors or members of a nonprofit, there must be a compelling message or reason for them to offer support.  Branding is a key aspect of a nonprofit that can sometimes be overlooked.  Nonprofits such as Good Will or the Red Cross bring images to mind of the logos that they use for branding.  Holland (2006) equates a brand with a play.  The potential donors or members are the audience and the plot is something that they can have empathy with and want to support.  “Branding uses design to communicate a message that attracts the audiences you want, a message that creates confidence in your brand while differentiating what you offer—your product or service—from all others” (p.7).  Branding helps gain trust and loyalty from supporters.  It is important to nonprofits just as it is to for profit organizations.

Basic Accounting Requirements for Nonprofit Organizations

Nonprofit organizations need to create a statement of financial position or a balance sheet just as for profit organizations.  A common financial ratio to evaluate nonprofits is the current ratio.  It is calculated by dividing the currents assets by the current liabilities.  According to Bangs Jr. (2006), a ratio below 2:1 is a red flag.  Another key ratio is the acid test.  It is calculated by taking cash plus demand deposits divided by the current liabilities.  An acid test below 1:1 is considered risky (p.109).  Smith (2000) holds that all nonprofits must follow the Financial Account Standards Board Statement of Financial Accounting Standards No. 117 which states “the results of operations must be reported by identifying changes in permanently restricted net assets, temporarily restricted net assets, and unrestricted net assets (p.297).  The statement of financial position needs to report these classes of assets.

Making Profits or Losses as a Nonprofit Organization

There is a misperception that nonprofit organizations are not able to show that they made a profit.  According to Moyers (2011), there is perception that nonprofit organizations can get into legal issues or have to pay a penalty if they make a profit.  This is not true.  Organizations that have a profit should either reinvest those funds into services or products that they offer or put the money into reserves that can be used during financial times where the organization operates at a loss.  According to the Standards for Charitable Accountability, “a nonprofit cannot have operating reserves totaling more than three years of current operating expenses” (Moyers, 2011).  Many nonprofits are concerned with doing this though because of the perception that nonprofits making a profit appears unethical and they may not appear as needing contributions.

A majority of nonprofits do not have this issue though.  Most have plans to use the funds from contributors to support the programs they have in place and operate with less than three months of operating budget in their cash reserves.  Others are unfortunately operating at a deficit.  According to (Dubas, 2017), nonprofits can offset up to two years of previous profit to offset a net operating loss.  In the net loss cannot be offset with the previous years’ profit, it can be carried forward for up to 20 years.

Profits and losses on nonprofit Organizations

In summary, nonprofit organizations have the perception that they cannot make a profit or operate at a loss.  There are IRS restrictions that dictate how to profits and losses are to be handled.  Profits can be directed back into organizational programs or put into reserves.  Losses can be handled through using reserves or through financial adjustments on taxes.  Nonprofits need to act ethically and follow IRS guidelines or risk losing their non-profit status.  Many organizations fear that they will lose supporters and members if they continually earn a profit, as they will appear as if they do not need funding.  Conversely, nonprofits that have a history of losing money may lose supporters if it is perceived that the mission is not successful.  Nonprofits need to focus on a compelling brand that positively resonates with people so that they will continue to support them regardless of the organization’s financial position.

References

  • Atlantic Publishing Company. (2009). Nonprofit Management. Ocala, Floria: Atlantic Publishing Company
  • Bangs Jr., David H. (2006). Nonprofits Made Easy. Madison, Wisconsin: CWL Publishing Enterprises, Inc.
  • Dubas, Gary. (2017). Net Operating Losses of Nonprofits are under IRS Scrutiny. Retrieved from McKonly & Asbury:  https://www.macpas.com/net-operating-losses-of-nonprofits-are-under-irs-scrutiny/
  • Holland, DK. (2006). Branding for Nonprofits: Developing Identity with Integrity. New York, New York: Allworth Press
  • Mancuso, Anthony. (2017). How to Form a Nonprofit Corporation. Berkeley, California: Bang Printing
  • Moyers, Rick. (2011). There’s No Penalty for Having Reserves. Retrieved from The Chronicle of Philantrophy: https://www.philanthropy.com/article/Theres-No-Penalty-for-Having/190573
  • Smith, Bucklin & Associates, Inc. (2000). The Complete Guide to Nonprofit Management. New York, New York: John Wiley & Sons, Inc.

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