Nonprofits Should Strive to Generate the Right Level of Surplus
By Frank A. Monti, CPA
Many nonprofit organizations end the year with a surplus, sometimes a sizable surplus, which may lead donors and others to question whether this is allowed and how much is too much.
Nonprofits are allowed to generate a surplus (called profits in the for-profit world) and this occurs when revenue exceeds expenses in a given year which surely beats the alternative, operating at a loss. And operating at a break-even is almost impossible unless you operate like some government agencies and spend money wildly near the end of the year.
The benefits of a surplus are clear. It lets you do more with less stress and equips your organization to undertake new activities to accomplish its mission. It also creates a financial cushion that can help mitigate surprises, such as disappointing fundraising results, a drop in membership or other revenue generating activity, emergency repairs, or the need to hire experts to handle an unexpected problem.
It's also important to realize that all surpluses must be invested back into the organization they cannot go into the pockets of staff or board members. This does not mean that nonprofit organizations cannot have incentive compensation plans for their employees, but the incentives that earn the additional compensation should not be based on profit goals.
Can there be too much annual surplus? Yes. If your operational surplus is very high, donors and funders may ask why you have not directed more resources into your mission.
If, for example, you are raising X amount of resources each year but spending substantially less than X (less than 85% of X would be substantially less), you should be ready to explain why. The reason for generating an unusually high surplus may be that the surplus arose late in the year and there was insufficient time to effectively increase spending in mission-related areas.
Remember the golden rule of publicizing operating results: anticipate what a critic might question and prepare your response in advance. If you dont think you have a good reason why your were so profitable in your most recent fiscal year, you might consider addressing the issue by talking about how these profits will be used in the coming year. Operating at a surplus for purposes of building financial reserves is also acceptable.
And that brings us to the question many nonprofits would be pleased to worry about: how much is too much in financial reserves?
The Better Business Bureau Wise Giving Alliance, a respected charity watchdog, says that having a surplus of more than three times the annual budget is too much. This means, for example, if your annual budget is $100,000 you should not accumulate a surplus of funds in excess of $300,000.
Many organizations try to accumulate four or five months of operational surplus funds. This means for example, if your annual budget is $100,000 you would have about $33,000 to $42,000 of cash surpluses available, obviously much less than the charity watchdog group is concerned about.
Annual profitable results should be your goal and consistently achieving your goals is the road to success.
While there are many tactics organizations can employ to help build a reasonably healthy surplus, the following are worth bearing in mind:
- Budget a surplus every year. Aim to spend only 90% of the revenue you anticipate receiving.
- Monitor your budget vs. actual results on a monthly basis and react to actual results that are different than what was budgeted. If you spend more than anticipated in one area, look to where you can cut back so that your actual spending remains at 90% of your anticipated revenue.
- Analyze each budget/actual difference so that you will learn and develop better budgets over time.
Today, to a greater degree than ever, our communities need financially sound nonprofits much more than they need organizations operating by the seat of their pants, constantly distracted by worries about where the next dollar will come from. Operating at a surplus, and taking steps to ensure reasonable growth of that surplus, is the way to get there.
Frank Monti manages the nonprofit practice at the accounting firm of Kahn, Litwin, Renza & Co., Ltd. Email him at firstname.lastname@example.org or call 781-547-8800.