To Be Sustainable, Nonprofits Need to Have Profits
It is difficult to search for a single aspirational goal that works for all nonprofit organizations because nonprofits are a lot like people, with no two organizations exactly alike. However, I believe there is one aspirational goal that most nonprofits have in common: to have a long, stable, and sustainable existence. To achieve this goal, nonprofits need to commit to making a profit.
In the nonprofit world, making a profit means having annual operating budgets that include bottom-line surpluses. These budget surpluses must in-turn become actual surpluses from operations by fiscal year-end. The key to longevity is to avoid regular recurring deficits and commit to saving funds for the future.
There are the many benefits and reasons for nonprofits to focus on “making a profit,” which requires committing to a “profit-based” planning approach that includes budgeting for surpluses and saving funds for the future.
First, financially strong nonprofits are best positioned for longevity. A financially strong nonprofit will have the resources to weather disruptions, invest in new programs, pursue growth pathways, and generally take advantage of opportunities and changing circumstances that a financially weak nonprofit cannot.
A strong balance sheet is important to financial health. The best indicator of financial health on a nonprofit balance sheet is the operating reserve status. An organization that has built up substantial operating reserves and has an operating reserve policy that keeps the focus on building, protecting, and proper use of operating reserves will have the basic building blocks to support longevity.
Operating reserves are generally built up slowly over time through annual operating surpluses. To grow operating reserves, the process begins with approving annual budgets with surpluses.
Next, make sure program and operational budgets are prepared on a total cost basis. Avoid focusing only on direct costs of programs and activities and disregarding costs related to labor allocations, overhead, and investing in the future (additions to operating reserves).
For example, an annual meeting program that only includes direct costs will appear to have larger net revenue. This could cause the organization to underprice registration fees. If the annual meeting requires a substantial amount of staff time, the program could be running at a net deficit on a total cost basis. Analyzing programs through a total cost approach will help organizations to observe which programs are bleeding and decide whether it would be beneficial to reallocate staff efforts to other programs.
Other benefits of a profit-based approach include heightened awareness of planning factors associated with inflation, economies of scale, and break-even analysis. Forecasts, what-if scenarios, and cash flow projections will benefit when a profit-based performance analysis is considered. Additionally, incorporating a profit-based approach and targeting annual budget surpluses helps nonprofits to reduce risks associated from unexpected disruptions. Budgeted surpluses can act as a discretionary cushion, allowing management room to re-direct costs and efforts while avoiding or mitigating the potential of operating deficits.
Planning Tip – Committing to annual operating budgets with bottom-line surpluses is an accepted best practice even for nonprofit organizations with substantial operating reserves. However, organizations need to prepare for negative perceptions that constituents, leadership, and the public may have related to budget surpluses. First, document in budget policies and guidelines the reasons for having budget surpluses (enhance sustainability, hedge inflation, support growth, and respond to disruptions) and provide calculations for performance goals (contribution to reserves, budget surplus percent range, or other bottom-line target goals). Next, include this information in regular financial communications with the Board and volunteer leadership, donors, members and the public when discussing financial statements, approving budgets, and reporting on annual operations.
Lastly, adopting a profit-based approach will help nonprofit organizations balance responding to public need vs. improving organizational sustainability. Nonprofits want to provide the most services and programs as possible, but also must avoid damaging future capacity and stability. Need is never-ending. An organization that over-delivers in the short-run resulting in deficits and depletion of assets will be poorly positioned for the long-run and may have to curtail or eliminate programs down the road.
