How much profit is too much for nonprofit organizations?

Some people use an administrative overhead percentage such as, “90% of our money goes directly to helping our clients.” But I dislike discussions about overhead costs because we never look at corporations and say, “How much do they spend on overhead?” as though it’s an official measure of success or viability. I think it’s an unrealistic expectation of nonprofits.

A fellow consultant of mine said we should call it “infrastructure” instead of overhead, because overhead sounds like it’s unnecessary. Whereas, infrastructure relays its crucial nature because it is a vital resource. I encourage organizations to avoid discussing “overhead” in their public-facing communications. Instead, I point them toward other language, such as:

• We are a lean organization that maintains enough staff to fulfill our mission effectively.
• We are good stewards of your money, and we use every penny wisely.
• We assure our supporters, through our accounting practices, that all of our funding goes where we say it’s going to go.

A basic measurement for reserves is three to six months of operating reserves, which means your organization can pay all their bills, staff, and everything, for at least three months. Every organization needs to have reserves in order to:

• Deal with an unexpected problem, such as losing a major funder or having to repair or replace assets.
• Be able to cover expenses during an event like the pandemic.
• Invest in the future.

In addition to 3-6 months of cash on hand, organizations should have some investments that could be accessed fairly easily in an emergency or rainy-day situation, plus endowment. It’s a long game to earn interest year over year in invested accounts. It takes time before it adds up to a lot, but every little bit helps. So having a net revenue at the end of each year to put away is important.

Because nonprofits having a net revenue at the end of the year differs from for-profit businesses, how they handle those leftover funds at the end of year is important. Nonprofit organizations are not dividing that money among leadership (or shareholders). Nonprofits are subject to reasonable compensation guidelines.

In fact, many foundations have moved in the direction of asking grant applicants, “How many months of money do you have in reserves?” or “What’s your LUNA (Liquid Unrestricted Net Assets) score?” If losing one major funder could be the difference between continuing operations, and having to close your doors, your organization is not considered sustainable in the long term. In contrast, some funders (quite a lot) still look at overhead % and require it to be low, and some donors likely do as well. Educating the public in this regard is important, and the tide is turning slowly.

The idea of nonprofits never achieving or maintaining a profit is probably going to stick around for the foreseeable future. But organizations can begin taking steps to start building reserves—and eventually endowments—and communicate to their supporters how it is beneficial to those the organization serves, and how it will enable them to both continue to fulfill their mission and increase their ability to do so.

Brady Ware Nonprofit Advisors want to help you fulfill your mission with financial health and compliance services and a network of nonprofit consultants who specialize in strategic decision-making.