Nonprofit groups wouldn’t be around without profits

Published in the September 9, 2005 edition of Columbus Business First.

Editor’s note: Allen Proctor’s column for executives involved with managing nonprofit groups will appear monthly for the next year. His series makes its debut with the column below.

Most people refer to tax-exempt organizations as nonprofits.  That unfortunate term is misinterpreted too often as a license to lose money, commonly expressed as “Of course they lose money, they’re a nonprofit.” 

It is doubly unfortunate because it is wrong-headed: Nonprofits need profits to survive, just like any other business. What separates tax-exempt organizations from taxable organizations is not whether they earn a profit, but how they spend their profit. If a nonprofit always loses money, it will fail, no differently than any company will fail. 

A nonprofit providing some profitable services is not bad or greedy or dishonest; it is doing what is necessary. In exchange for granting tax-exemption, however, society does impose limits.

Most importantly, a nonprofit must use its profit to support the level, quality or reliability of its services. It doesn’t use its profit to pay dividends to supporters, to award outsized salaries or bonuses to its staff or board, nor to finance expensive office facilities or travel and entertainment that cannot be clearly connected and justified with respect to service delivery. 

There are many reasons why nonprofits need profits.  Oftentimes, for example, the services that nonprofits provide are most needed or hardest to finance during economic recessions. The only way to weather bad economic times is to set aside some money in good times. The only way to get money to set aside is to earn more money than you spend; that is a profit. 

Without profit, and the wisdom of some to save those profits, the past recession would have seen even more nonprofits facing hardship or bankruptcy. As the Central Ohio economy recovers, nonprofits need to be encouraged and allowed to return to profitability and to rebuild healthy cash reserves. 

Most nonprofits provide a number of different services that vary in their capacity to pay for themselves. A viable nonprofit usually makes its ends meet by offering some services that do not fully pay for themselves (unprofitable services) and some services that bring in more money than they cost (profitable services). 

While commercial businesses may have some items or services that they sell at a loss (loss-leaders), the role of loss-leaders is to attract customers that will simultaneously purchase profitable items so that the total purchases of that customer are profitable.

In contrast, a nonprofit is willing to have all the purchases of some customers be unprofitable. For example, nonprofit hospitals usually lose money in their emergency rooms as well as on uninsured patients. They usually remain financially viable by making money in their cardiac and orthopedic wards (which is one reason why they are so concerned about for-profit specialty hospitals).

Similarly, museums often lose money on school groups but make money on gift shops. 

A mix of profitable and unprofitable activities is desirable because it allows the nonprofit the most flexibility in fulfilling its mission and benefiting its community.

Nonprofits that take the extreme position that all their services should be unprofitable are jeopardizing their future ability to provide any services. At the opposite extreme, nonprofits that do not offer any unprofitable services may be shortchanging their mission and missing important opportunities to benefit their community. 

Which is better for the community – providing in-home meals only to elderly residents who can pay the cost, or providing a mix of meals at a loss to indigent elderly offset by meals at a modest profit to elderly who can afford to pay? Which is a more valuable mission – charging a uniform entrance fee to all visitors or running a loss from lower prices for students which is balanced by running a profit from gift shop sales to students who can afford such purchases?  A mix that includes both profitable and unprofitable services will likely provide the greater benefit to the community.

The conscious decision to earn profits and the choice and mix of profitable and unprofitable activities can determine whether a nonprofit fulfills and sustains its mission or falls short and fails.

Next time you hear someone say, “Of course they lose money, they’re a nonprofit,” give them a piece of your mind. 

Allen J. Proctor was chief financial officer of Harvard University and is the author of “Linking Mission to Money, Finance for Nonprofit Board Members.” Reach him at www.proctorconsulting.org

Copyright 2005. Reprinted with permission, Business First of Columbus Inc.