Raul Larios

Should nonprofits strive to be profitable? PART 1.

Nonprofit 1 To most people, “nonprofits” imply making the world a better place, but also that charitable organizations should not (or cannot) earn a profit while doing so.

Although the IRS clearly forbids the pursuit of profit as the primary objective of tax-exempt charitable organizations (mission must be primary), surpluses are perfectly okay and are even rewarded with tax exemption. On this basis alone, nonprofits should strive to be profitable. But there’s another, even more compelling reason.

Now I realize that “profitability” as a goal, even if secondary, is a sensitive issue in the culture of many nonprofits (especially small ones), so let me be more tactful: small tax-exempt charitable organizations should manage their finances as if they were for-profit, so that they can carry out their missions in perpetuity. After all, profits are never distributed to shareholders (because there are no shareholders), so all surpluses stay with the nonprofit to be re-allocated as it best sees fit.

I happen to admire nonprofits that are profitable because it tells me that my donation was managed well enough to not only help the current needs of the cause I care about, but also that the surplus from my donation will end up in either operating reserves, a rainy day account or even in an investment fund — all of which will subsidize future needs, turning my donation into a gift that keeps on giving!

I’m especially excited about surpluses that are used to create or expand an investment fund (a.k.a. “board-designated endowments”) that could help subsidize the charitable mission in perpetuity. And this is the compelling reason why “profit” should be every nonprofit’s close secondary objective — especially in light of the disturbing yet growing trend of donors wanting 100% of their contributions to go directly to the mission, and nothing to administrative expenses. Similarly, government agencies routinely award grants that don’t cover the full cost of running programs, which stretches nonprofits to the breaking point.

I call these donors the “under-funders”. They don’t seem to realize (or choose to ignore the fact) that it takes an expensive infrastructure of management, real estate and assets (all administrative in nature) to run any charitable program. Of course, their under-funded donations are gratefully accepted, but the cold hard reality is that you will soon go out of business if you don’t make structural adjustments to this new disturbing trend. My suggestion is that you strive for profits to build an endowment fund, so that you survive what appears to be the beginnings of a long-term trend in under-funding.

See comments and replies to Part 1 below.

Read PART 2 here

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April 7, 2015 - Posted by | New York

30 Comments »

  1. Source — LinkedIn:

    PHILIP S. WOOD, CPA (Contract CFO) — “Dr. Drucker said it quite well, “No margin, no mission”. I think the funding governments expect grantee staff to live in section 8 house and get food stamps. Service providers need form coalitions in order to receive adequate funding from grantors.”

    Comment by Raul Larios | April 14, 2015 | Reply

  2. Source — The ‘Alliance for Nonprofit Management’ LinkedIn Group:

    MARILYN DONNELLAN (Founder Emeritus, Nonprofit Management Services, LLC) — “In a word: absolutely! A nonprofit that is not making a profit is not sustainable.”

    Comment by Raul Larios | April 15, 2015 | Reply

  3. Source — The ‘Alliance for Nonprofit Management’ LinkedIn Group:

    MARILYN BOYKO (The 501c3 TroubleShooting Maven) — “Marilyn is absolutely correct. Non-profit does not mean no-money. It does mean that the profits are not for the benefit of any one individual and that all spending is approved and dispersed with the oversight of the Board of Directors, not any ONE individual and cannot be for the private benefit of the individuals, such as cruises with their girlfriends, which happened a while back.

    The real difference is how the money is managed, dispersed, and what the money to used for. Sustainability relies on good planning, good budgeting, and cash flow. This applies to all businesses, for-profit and non-profit.”

    Comment by Raul Larios | April 16, 2015 | Reply

  4. JENNIFER LAMMERS (Adjunct Professor at Hellenic College and Holy Cross Seminary) likes your discussion in the ‘Alliance for Nonprofit Management’ LinkedIn Group.

    Comment by Raul Larios | April 16, 2015 | Reply

  5. SIBI THOMAS, CPA, CFE, CGMA (Audit, Tax & Advisory Services for Nonprofits – Senior Manager, Marks Paneth LLP) likes your discussion in LinkedIn.

    Comment by Raul Larios | April 16, 2015 | Reply

  6. Source — The ‘Nonprofit Controller’s Network’ LinkedIn Group:

    JOSEPH SCARANO (CEO at Araize, Inc.) — “Definitely. If they weren’t profitable (have positive net assets), then they could not operate as an ongoing, sustainable entity, ultimately failing in their primary goal of providing a service to the community that is not being filled by for profit or governmental agencies.”

    Comment by Raul Larios | April 17, 2015 | Reply

  7. Source — The ‘Alliance for Nonprofit Management’ LinkedIn Group:

    MATTHEW LIEBERMAN (President of RAL Strategic Investment Group LLC and Majority Strategies, LLC) — “Non-Profit organizations need to make enough of a “profit” in order to cover the same, everyday costs that a For-Profit business must maintain as well. The difference is that the funds raised for the Non-Profit are needed for the services they provide and many times this means the leadership and staff are likely to be making up to as 50% less than someone with the same qualifications working at a For-Profit company. It is very hard to raise funds if your donors see admin fees in excess of 30% of total gross funds raised per year.”

    Comment by Raul Larios | April 18, 2015 | Reply

  8. Source — The ‘Nonprofit Donor Retention Best Practices’ LinkedIn Group:

    DANIEL BUCKLE — (Marketing Manager Experienced In Digital Marketing, Social Media, Advertising, Graphic Design and Marketing Automation) — “I think so, if it’s for a good cause and the nonprofit can use the funds in a ethical way.”

    Comment by Raul Larios | April 20, 2015 | Reply

  9. Source — The ‘Nonprofit Controller’s Network’ LinkedIn Group:

    SOLOMON EJIGU, CIA, CPA (Accounting Manager at The Task Force for Global Health) — “As any other company, a non-profit org should sustain themselves with no threat as a going concern in as long as it maintains public purpose. Profit is not relevant in NPO. However, the purpose of NPO should not be to created to inure its officer or a certain group but serve the public.”

    Comment by Raul Larios | April 20, 2015 | Reply

  10. Source — The ‘Nonprofit Controller’s Network’ LinkedIn Group:

    GLENN MAJOR (Non-Profit Finance Consultant) — “The key word missing is “sustainability”. Many large Private Foundation Grantor require a copy of your last one or two of audited financial statements, plus your most recent year-to-date internal financial statements. This requirement goes further in asking for an explanation of any operating losses, corrective actions your taking and will your organization be sustainable after the grant requested has expired. With respect to the IRS they too look at sustainability, especially after the IRS has taken over SOX monitoring of non-profits.”

    Comment by Raul Larios | April 20, 2015 | Reply

  11. Source — The ‘Nonprofit Controller’s Network’ LinkedIn Group:

    MARK HOOVER (Director of Finance/Controller at Southwest College of Naturopathic Medicine) — “Creating surpluses year to year is the ONLY way for NFPs to generate capital to innovate and expand. The only other immediate option is debt, but that has to be back so it’s really just a way to more the need for profits into the future.

    I do disagree that NFPs should be “run like a for profit business.” There are many things (other than generating profits) that for profit business do that NFPs should NEVER do. I believe that many for profit businesses are operating more like NFPs, i.e. requiring the desire to make profits to “share the stage” with more esoteric goals like caring for employees and having an positive impact on communities.”

    Comment by Raul Larios | April 20, 2015 | Reply

  12. Source — The ‘Nonprofit Professionals Advisory’ LinkedIn Group:

    VALERIE LOWE (Administrative Support) — “Loved the commentary. It raised a lot of interesting points.”

    Comment by Raul Larios | April 20, 2015 | Reply

  13. Source — The ‘Nonprofit Professionals Advisory’ LinkedIn Group:

    TRACIE BLISS, CPA, CGA, H.B.Comm (Finance and Operations Professional) — “Some good food for thought in this article.

    The problem of “underfunding” is just as big a problem here in Canada. Government grants and other funders all too often only want to fund the mission directly and make it very clear that the necessary administrative aspects are not allowed to draw on those funds. It makes sustainability a problem. I like the idea of using surpluses to create an investment fund that could be used to generate core administrative funding.

    That being said, while it is absolutely critical to run a not-for-profit in a business-like way when it comes to managing funds, considering “profit” to be a secondary objective may be rather complex. While Canada Revenue does not have a problem with surpluses, a not-for-profit that shows annual surpluses year after year will come under scrutiny and risk the loss of not-for-profit status. The building of a reserve fund is allowed as long as that fund is “reasonable”. The onus is on the not-for-profit to convince the government that the amount held in reserves meets that standard of “reasonable”.”

    Comment by Raul Larios | April 20, 2015 | Reply

  14. Source — The ‘Nonprofit Professionals Advisory’ LinkedIn Group:

    GENE GUILFORD (Partner at gbac Association Practice Group) — “As a non-profit CEO for 28 years I’m proud of the fact that for 28 consecutive years our non-profits earned a surplus of revenue over expenses. Such fiscal success gave us the resources we needed to be able to further our mission, to be able to attract and retain better talent, to be able to modernize and improve the efficiency of our operations, and to have an all important cushion when we ran into lean times.”

    Comment by Raul Larios | April 20, 2015 | Reply

  15. COLLEEN LAREINE KOLAKOWSKI, BS MEd (Assistant Controller – Non-Profit) likes your discussion in the ‘Nonprofit Controller’s Network’ LinkedIn Group.

    Comment by Raul Larios | April 21, 2015 | Reply

  16. BRENDA AUSTIN (Accountant | Experienced in Nonprofits) likes your discussion in the ‘Nonprofit Controller’s Network’ LinkedIn Group.

    Comment by Raul Larios | April 21, 2015 | Reply

  17. Source — The ‘Nonprofit Controller’s Network’ LinkedIn Group:

    JEFF WAKEFIELD (Director of Finance at Wayne Memorial Hospital) — “I think it depends on the type of NFP that you are talking about. Some NFP’s serve a function & in doing so, their objective is to spend the amount of funds they are given. Some NFP’s are not given funds to spend & must generate revenue to cover their expenses. Some NFP’s require huge capital outlays for which profit needs to be generated, to allow reimvestment into the purchase or maintenance of these assets.”

    Comment by Raul Larios | April 21, 2015 | Reply

  18. Excellent article. To some extent, nonprofits have touted the value of having no to unrealistically low administrative expenses. Donors see ‘administrative cost’ and see excess rather than the funding for infrastructure that helps produce mission accomplishing programs.

    Comment by Colleen Bjerke | April 21, 2015 | Reply

  19. Source — The ‘Nonprofit Professional Advisory’ LinkedIn Group:

    ALAN KINNIBURGH, PH.D. (President AJK Consulting) — “There have been many non-profits that have not strived for “profitability”. They no longer exist. If you don’t make as much money as you are spending, then as soon as your reserves are gone, so is the organization. You would think the profitability would be a key part of what a board looks for, yet I have seen boards let CEO’s spend like drunken sailors.

    To my Canadian friends, my sincere sympathy for a government that does not get it.”

    Comment by Raul Larios | April 21, 2015 | Reply

  20. Source — The ‘Nonprofit Controller’s Network’ LinkedIn Group:

    GLENN MAJOR (Non-Profit Finance Consultant) — “Unless you’re a Private Foundation or Trust, your NFP must achieve sustainability (profit or positive net assets) to ensure that your NFP can maintain its mission into the future.

    “Not run like a business” is true if you’re only looking at returns on investment to shareholders. However, the mentality and efficiencies of running your NFP like a business could never be truer. Record keeping and retention, strong internal controls, documented policies and procedures, etc. are critical requirements of all businesses. Just ask Eli Broad. Or try standing before a judge, defending your NFP, and saying you don’t have any of these business attributes in your organization.”

    Comment by Raul Larios | April 21, 2015 | Reply

  21. Good to see this discussion. Thanks for all the thoughtful coments.

    We need better nomenclature that goes beyond profit or no(n) profit. This discussion is a useful step in advancing the conversation. It is time we discussed the sector in terms of what it is and what it does – rather than what it is not and what it does not do (non-profit; non-governmental, et al.). These organizations are: mission driven; act in the public interest and provide a public or mutual benefit. It is essential that they are: 1) focussed and effective; 2) accountable and ethical ; 3) effective and sustainable. To carry out their mission these organizations must have the resources, skills, and time required to do the job.

    Let’s not confuse the need for operating effectively in a professional and a”businesslike” manner with being a business. There is a difference between a “profit” and an “operating surplus” or “funds carried over” to meet anticipated needs – like paying the rent, meeting obligations to pay salaries and vendors; or any of the other expenses required to provide the service that an organization is publicly chartered to do.

    A key measure of a business – or “for profit” corporation is whether or not it makes money and how much. Making a good product or providing a high quality service is part of the equation, but no matter how good those are, if the business does not make money for the owners it has failed. For many public benefit (nonprofit) organizations one key indicator of its success is the quality and effectiveness of the product or service it provides, or one might say, how well it spends or uses its money and other resources toward achieving a mission that serves its public purpose.

    Comment by srosdoby | April 23, 2015 | Reply

    • Appreciate your thoughtful comments.

      Comment by Raul Larios | April 24, 2015 | Reply

  22. Source — The ‘Nonprofit Professionals Advisory’ LinkedIn Group:

    TRACIE BLISS, CPA, CGA, H.B.Comm (Finance and Operations Professional) — “Does the U.S. government really not care if a not-for-profit makes continued substantial profits every year? I’m not talking about small surpluses or break even budgets (which is what most Canadian not-for-profits strive for). To me, this seems to fly in the face of the logic, point, purpose and definition of not-for-profit.

    Where does this profit go? If it’s being used to build the organization’s capacity and ability to meet or broaden its mission then the Canadian government would most likely be fine with that. What they don’t like to see is an organization accumulating wealth beyond amounts that can be reasonably used to forward the organization’s mission.

    Comment by Raul Larios | April 24, 2015 | Reply

  23. Tracie, you ask interesting questions that highlight the glaring fiscal differences between the Canadian and U.S. nonprofit regulatory systems. Generally speaking, in the U.S. most nonprofits are exempt from paying any income taxes. Moreover, they can receive unlimited income (and thus surplus, depending on expenses) in support of the organization’s charitable purpose.

    There are a few exceptions, the most important of which is the unrelated business income tax (or UBIT). Any net income that a nonprofit generates from an ongoing trade or business that is not substantially related to the charitable purpose or function of the organization (such as a restaurant in a museum) is taxable at regular corporate rates.

    You ask where the profits go. They go to either operating reserves, a rainy day fund or to Board-designated endowment funds. And these endowments can get huge (see the Columbia University example in Part 2 of my post). Profits CANNOT go or inure to the benefit of any one person or group.

    I hope the above is helpful. Thanks for your comments and questions.

    Comment by Raul Larios | April 24, 2015 | Reply

  24. Source — The ‘Non-profit Accounting’ LinkedIn Group:

    RIAZ MULLICK (CPA, CISA, Hands-on finance and accounting professional, with experience in health-care and several other industries) — “Interesting article! Every non-profit organization should aspire to remain in existence forever so that its beneficiaries can depend upon it. To accomplish this goal, the non-profit needs to diversify its funding base and adjust its programs so that it continues to interest its funding sources. As far as profit goes, the breakeven goal is adequate.”

    Comment by Raul Larios | April 24, 2015 | Reply

  25. Source — The ‘Nonprofit Professionals Advisory’ LinkedIn Group:

    MARIA DE LOURDES PEREZ-RAMIREZ (Founder and CEO of HispanEduca) — “I couldn’t agree with you more, Tracie. NPOs should strive to be responsible in managing their resources to better serve their constituents, but being profitable is a total different story. I used to work in marketing for the for-profit sector many years, and knowing how corporations do anything (even liying to make money) by oppressing people, I decided to dedicate my life to the nonprofit sector. Now it turns NPOs want to be as profitable as for-profits, not necessarily using their surplus to expand & improve services. Instead they are doing mission creep and use their profits, which I would rather call “surplus” assets, to pay CEOs and other top management, hefty salaries equal to those they would have earned in the for-profit sector.

    I have to denounce that because such profitability mentality for purposes other than to achieve their mission, is a total adulteration of what they were created for. I respect NPOs whose top management choose to accept their positions without these hefty salaries so they can achieve social justice, ensure civic rights, and promote a democratic (no reference to political ideologies) society.

    I respect the nonprofit sector, but I cannot by any stretch of the imagination, respect or support what nonprofit moguls such as United Way, GoodWill, and even the Girls Scouts and others are doing now. What a shame! Mind you, in no way or form my position means that an NPO should not be responsible in managing its resources. Any NPO that wants to be so profitable as the ones mentioned before, should consider renouncing their IRS Exempt status and become a social, for-profit corporation.

    Take for instance ACT, the testing mogul. Depite being an NPO, it is making more millions than its closest for-profit competitor, PEARSON. If use the “failure theory” to justify the existence of ACT (and UW, GW, and GS), there is NO reason for these noprofits to be IRS exempt, because the for-profit sector is doing it, can do it better, and with their for-profit taxes, genuine NPOs could have better resources. ACT has just started an LLC (Limited Liability Corporation), which tells us that this “not-for-profit” wants to use its profits without having the responsibilities that being a 501(3)(c) requires of them.”

    Comment by Raul Larios | April 24, 2015 | Reply

  26. Source — The ‘Nonprofit Professionals Advisory’ LinkedIn Group:

    GENE GUILFORD (Partner at gbac Association Practice Group) — “Raul, Anytime someone needs to put this entire discussion into a context – just remind them that the National Football League is a 501(c) (6). The NFL is a $10 billion enterprise that pays its CEO $44 million. All of the rest of us pale in comparison.”

    Comment by Raul Larios | April 26, 2015 | Reply

  27. Source — The ‘Nonprofit Professionals Advisory’ LinkedIn Group:

    LOURDES PEREZ RAMIREZ, MA, MNM, CNP (Founder and CEO of HispanEduca) — “Alan, I know many (many) NPOs that have an excellent record of managing their resources because they use most of their resources to provide the services they were created to provide.

    In fact, most funders prefer to fund npos that do not use more than 25% (but less is better) of their funds in managing and administrative activities such as paying hefty salaries to their CEOS.

    Of course, “striving for profitablilty” does not mean to cut out programs and services to increase CEO salaries and sign yummy outsourcing contracts, but many nonprofit financial advisors advice in favor of profitability instead of managing resources in such a way to provide more services to more people.

    Moreover, despite the fact that the Sarbanes-Oxley Act was signed to control for-profit businesses’ questionable practices, and that only two items of the law apply directly to NPOs , responsible and genuine nonprofit organizations have decided to follow the SO law to prevent the same hurdles and problems that the thirst for “profitablity” created for the for-profit sector.

    It’s scary that many nonprofits have bought the free-market mentality to improve profitability. Scary indeed.”

    Comment by Raul Larios | April 26, 2015 | Reply

  28. Source — The ‘Nonprofit Professional Advisory’ LinkedIn Group:

    ALAN KINNIBURGH, PH.D. (President AJK Consulting) — “I guess my perspective is from being an SVP at a medical charity. Until we have cured leukemia, lymphoma and multiple myeloma it’s not possible to raise too much money. There is excellent research that is going unfunded.

    I would guess that folks working for social causes feel the same way. If they raised more money they would spend it on mission.

    BTW I have never worked for a non profit that has spent more than 25% on admin costs.”

    Comment by Raul Larios | April 26, 2015 | Reply

  29. DAVID J. ARMSTRONG (Principal at Inventory Curve, LLC) likes your discussion in the ‘Non-Profit Accounting & Grant Management’ LinkedIn Group.

    Comment by Raul Larios | April 26, 2015 | Reply


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