Do Non-Profits Make Profits?

Do Non-Profits Make Profits?

The term “non-profit” is misleading because it implies that these organizations do not have “extra” money. Those not familiar with non-profit or business nomenclature tend to think that non-profits do not make a lot of money or do not have excess revenue.  This article will break down what a non-profit actually is and why it is important for Muslim donors to understand the basics of non-profit entities when donating to non-profit organizations.

What is Profit?

Before discussing what a non-profit entity is, we must understand what profit is.  In all corporations, whether they are considered non-profit or for-profit, the basic categories of funds either fall into revenue or expenses.  When revenue exceeds expenses, a “net revenue” is the result. It is common to assume that the net-revenue is “profit”. However, this is only part of the definition of profit.  In for-profit corporations, when a corporation has net revenue, that net revenue is distributed amongst the owners or shareholders of the corporation. That distribution, which typically happens quarterly, is the profit.  Basically, for-profit corporations’ net revenue ultimately serves the owners of the corporation.  In contrast, when a non-profit has net revenue (i.e. “leftover money” after expenses), that leftover money goes back to the non-profit as non-profits do not have owners or shareholders to share that leftover money with.

What is a Non-Profit Organization?

A non-profit organization is nothing more than a tax designation that allows them to be exempt from paying certain taxes and gives donors the ability to receive a discount on their own taxes.  Some non-profits generate millions of dollars and some operate on shoestring budgets, but the bottom line is that a non-profit status does not indicate how much money it generates. There are in fact 29 types of tax-exempt designations established by the IRS.  The most well-known non-profit tax designation in the United States is a 501(c)(3), which is established by IRS Publication 557.  In order for an organization to be eligible for a 501(c)(3) status, the organization must be organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes; or for testing for public safety, to foster national or international amateur sports competition, or for the prevention of cruelty to children or animals.  501(c)(3) status is highly sought after because the organization does not pay federal tax and its contributions are tax deductible, which creates an incentive for donors to donate. Other than that, nonprofits can generate as much excess or net revenue as it can.

How Do Non-Profit Executives Abuse the Non-Profit?

As stated above, net revenue is simply revenue minus expenses.  Labor, including executive salary, is considered an expense and executive salary is one of the ways that founders can abuse non-profits for personal gain.  Although the International Revenue Service (IRS) requires that executive salary be “reasonable,” the standard is not cut and dry and enforcement by the IRS is questionable. When considering reasonable salaries, however, the IRS takes into account factors such as the overall percentage of the revenue being paid as salary and general overhead. One notable example is that of the CEO of the Florida Coalition Against Domestic Violence, Tiffany Carr, receiving an annual salary of $761,560.  To be clear, in and of itself, a high salary for a nonprofit employee or executive is not illegal, nor should it be (though a $761,650 is definitely questionable). 

Personally, I believe that nonprofit workers should be able to make a good living so that the nonprofits can attract reliable talent and that nonprofit employees do not feel financial stress as such stress can lead to fraud.  The point of this illustration is simply to further state how misleading the concept of a “nonprofit” is. In that light, when considering donating to an organization, the top organizations and nonprofit watchdogs have issued a letter explaining their proposed standard for nonprofit performance.  In the letter, the organizations call for an end to using the overhead ratio as the proxy for nonprofit performance, but rather, call for using other tests such as performance of the nonprofit for meeting the goals of its mission.  The most important test for a reliable nonprofit is the organization’s transparency in meeting the organization’s stated mission and goals.

Some nonprofits are out-right scams with almost 100% revenue being paid to overhead and employee compensation and none of the money going to the ones the nonprofit claims to serve.

Do Non-Profits Need to Disclose Their Numbers?

         Generally, non-profit organizations must file a 990 form, which is the equivalent of a tax return displaying revenue, executive salaries, and expenses.  Churches and other types of religious-based organizations do not need to file 990 forms, meaning they do not need to disclose their financial information.  There are several limitations, however, regarding 990s forms, even when they are filed, so if fraud is involved, those numbers could falsified.  Firstly, they are self-reported. Secondly, the information reported is very basic and does little to provide information as to whether they are fulfilling their mission.  This is not to say that 990s forms are not helpful. There are also consequences to lying on 990s forms – if caught. Nevertheless, the point here is simply that 990s forms should not be the sole benchmark for a non-profit organization’s integrity.

How Can Donors Assess Which Non-Profits to Donate To?

As noted above, non-profit organizations must be transparent about their operations, spending, and how, in detail, they are meeting the goals of their goals.  This can be done by annual reports. Another helpful measure is an organization’s willingness in having an independent, third party auditor audit their operations and sharing those audits on a regular basis on their website.  Such an audit will provide, in detail and by a third party, a non-profit’s financial operations.

What donors should not do is rely on testimonials or an organization’s founder’s mere reputation.  I’ve previously written in detail common tactics that fraudulent non-profits engage to raise funds and what questions donors can ask to assess the integrity of a non-profit organization.  I highly encourage you to read my previously written piece.

Conclusion

There are many misconceptions about non-profit organizations.  People often equate non-profit organizations with lack of money and inherently morally superior ethos.  While there are many honest and struggling non-profit organizations, there are also many unscrupulous organizations as well. It is important to understand exactly what a non-profit organization and what tools donors have available in order to assess properly whether a non-profit organization is worthy of donations.

 

 

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