What it means
Not-for-profit organisations include charities, universities, hospitals, professional associations, cultural bodies and many community groups. They may be structured as trusts, companies limited by guarantee, associations or other legal forms depending on the country.
What they share is a rule that profits cannot be distributed to owners. This does not mean they cannot earn a surplus.
Many charge fees, sell goods or win grants and contracts, and a healthy surplus is vital for building reserves and funding new projects. The difference is where the money goes, which is back into the mission.
Many countries give not-for-profits special tax treatment, such as exemption from income tax on mission-related activities and tax relief for donors. These benefits come with obligations, including reporting to a regulator, keeping governance records and sometimes limits on political activity or on how much can be spent on overheads.
Eligibility rules are set by each country. The accounts look similar to a business but use different labels.
Instead of a profit and loss statement there is often a statement of activities, instead of retained earnings there are net assets, and funds may be restricted by donors to specific purposes. Managers must track restricted and unrestricted money separately.
Performance is judged by impact and efficiency as well as finances. Donors and regulators often look at the share of spending that goes directly to programmes compared with administration and fundraising, along with the reserves held.
A well-run not-for-profit still needs commercial discipline, including budgets, cash flow forecasts, controls and risk management. Running at a deficit year after year threatens the mission, so a surplus is a means of survival and growth rather than something to avoid.
In practice
Real-world examples.
Example
A community health clinic charges patients modest fees and receives grants. It uses a $60,000 surplus to buy new equipment and cannot pay any of it to the people who govern it. The trustees must show in their annual report how the money furthered the clinic's purpose.
Example
A professional association collects $2,000,000 in membership fees and conference income. It spends the money on training, standards and events, and holds three months of costs in reserve. Three months of costs on $2,000,000 a year is about $500,000.
Example
A private university earns tuition and research funding. It reinvests a $15,000,000 surplus in scholarships and facilities, and its governing board is not allowed to take profits. The surplus helps the university stay open to students who could not otherwise afford to attend.
Formula
Calculation
Programme expense ratio = Programme expenses / Total expenses
A charity spends $720,000 on its programmes, $100,000 on administration and $80,000 on fundraising in a year. Total expenses = $720,000 + $100,000 + $80,000 = $900,000. Programme expense ratio = $720,000 / $900,000 = 0.80, or 80%. If its income was $950,000, the surplus is $950,000 - $900,000 = $50,000, which is retained for future work. A surplus of $50,000 on $900,000 of spending is a margin of about 5.6%, which gives the charity a modest cushion.Case study
Seen in the real world.
Riverbend Food Bank is a fictional charity invented to illustrate this idea. It collected surplus food from shops and distributed it to families, financed by donations of $460,000 and a $100,000 grant restricted to a new delivery van.
The treasurer separated restricted from unrestricted money in the accounts. Over the year the charity spent $330,000 on food handling and distribution, $40,000 on administration and $30,000 on fundraising, a total of $400,000, so income of $560,000 left a $160,000 surplus. Of that, $100,000 was the van grant, which could only be used for the van, and the remaining $60,000 was unrestricted.
The trustees put the $60,000 into the start of a reserve fund. They explained to donors that the surplus was not profit for owners but a safeguard that would keep the food bank open if donations dipped. The annual report showed each fund separately so that donors could see their gifts had been used as intended.
Watch out
Common mistakes.
- Believing a not-for-profit cannot make a surplus. Surpluses are normal and necessary, but they must be used for the mission.
- Mixing restricted and unrestricted funds. Restricted grants must be spent as the donor required and tracked separately.
- Judging an organisation only by its overhead ratio. Low overhead can reflect under-investment in systems and staff.
Questions
People also ask.
Do not-for-profits pay tax?
Often they receive tax exemptions on mission income, but rules differ by country and some activities can still be taxed. Trading activities unrelated to the mission are a common example of income that may be taxable.
Can staff be paid?
Yes. Employees and managers may be paid fair wages, but profits cannot be shared out among owners or controllers. Pay is usually expected to be reasonable for the role and the sector.
Is not-for-profit the same as a charity?
Not always. Charity is a specific legal status in many countries, whereas not-for-profit is a broader category. A sports club may be not-for-profit without having charitable status.
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