How much profit should a Non profit make?

It sounds like a tongue twister but it's a question that comes up regularly, in certain quarters anyway. Read on to find out how much.

What feels like a deliberately provocative question, is something I often ask when working to understand the concept of financial sustainability and the interaction of the financial statements.

🃏 Now, the get out of jail card, this can be a very deep question but here we will concentrate on the concept of financial sustainability.

So how much profit should a not-for profit organisation make?  Well to answer this let’s have a look at two of the main financial statements, the balance sheet (or the statement of financial position) and the income statement (or the profit and loss).

The balance sheet is made up of three main components, assets, which the organisation owns or has the right to use, liabilities, what the organisations owes and equity what has been invested into the organisation or the owner’s residual interest in the organisation.  These three components need to ‘balance’ and this leads to the fundamental accounting equation:

 ✅ Assets 🟰 Liabilities ➕ Equity 

If we assume equity is zero the this would mean the organisations assets equals its liabilities.  This would create a very risky organisation as any reduction in value of the entity’s assets may mean it is not able to repay all of its liabilities when they become due, leading to an organisation not being solvent. 

Keeping with the accounting equation, if equity is greater than zero then that means that assets would be greater than liabilities and hence create a more sustainable and less risky organisation. 

So, what are the main sources of equity for a not-for-profit?  Well for many this will be retained surpluses (yes, I used the term surplus rather than profit).  Retained surpluses come from the surplus of income over expenses from prior periods or financial years.  The difference of a surplus is that it must be re-invested into the organisation as opposed to a profit which can be distributed to the organisation’s owners.

Now, back to the question, how much profit does a not-for profit need to make?  Well technically none if we use the term profit, but it must generate sufficient surpluses over time to increase its equity and make it a more financially sustainable organisation.  In other words, it needs to bring in more income than it spends in expenses.

➡️ Conclusion

Like any topic there can always be a lot more to this, but the concept of financial sustainability applies across all organisations.  This is why you see governments reducing expenditure if the economy is not forecast to grow, councils seek rate increases just to maintain service delivery and charities need to manage their costs to ensure they are within their expected level of income. 

How well does your workforce understand this concept of financial sustainability?  Please reach out if you need help elevating their capability.

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