Why Nonprofit Tax Status Shouldn’t Hinder Efforts to Turn a Profit

BlakeBooth_WhyNonprofitTaxStatusShouldntHinderEffortstoTurnAProfit July 18, 2022 By: Patricia Blake, FASAE, CAE and Eric Booth

While most associations fall under the nonprofit tax status, that doesn’t mean they shouldn’t generate revenue. In fact, nondues revenue is necessary to better serve members without resorting to excessive dues.

“We are a nonprofit organization, so we aren’t supposed to make money.”

This sentiment is commonly expressed by board members, committee chairs, or staff members who are passionate about continuing a financially unsustainable activity.

While the importance of an association’s tax status is notable, it does not eliminate the need to maintain a fiscally viable organization. The myth that the tax designation of our associations nullifies our ability to be profitable needs to be dispelled. A pivotal duty of nonprofit leaders is to properly incorporate business models that generate sufficient financial resources for their organization to be viable for the foreseeable future.

In this article, we’ll look at what the nonprofit tax status really means, along with why and how creating a profitable business model and infusing a profit-margin culture can help your organization succeed in championing valuable programs for your members.

Understanding the Designation

The modern IRS definition of a nonprofit lies primarily in the Revenue Act of 1954, which codifies the 501(c). Most associations fall into 501(c)(3)—charitable, religious, educational, or scientific organizations—or 501(c)(6)—which include trade or commerce classifications.

Recognizing that certain activities will be undertaken only if they generate a profit margin is often an uncomfortable concept for boards and some staff members.

All 501(c) organizations have specific benefits and limitations related to their tax status, but none are restricted from earning profits. The major difference is that in tax-exempt organizations, profit is returned to the organization. Conversely, in for-profit organizations, profits are distributed to shareholders, other individuals, or corporations.

The Need for a Business Model

Nonprofit organizations need to determine and develop business models so they generate enough revenue to support all aspects of the organization and yield a margin. Traditionally, membership, meetings, publications, advocacy, and corporate partnerships have been the core support pillars.

All funded activities should be viewed through the lens of margin generation. The resulting picture is clarity on program costs and the sufficiency of the cushion that allows for contingencies, operations, and future investments.

The first tier of cost assessment is often limited to direct costs associated with the program. The secondary tier incorporates more sophisticated models accounting for indirect costs. The rarer component is the tertiary assessments of how this contributes to or invests in the organization’s sustainability.

To be financially successful, it is necessary to cultivate a culture that advocates for the creation of activities that will generate a positive net revenue. This approach requires educating volunteer leadership and staff about applying the principles of business models and diversifying revenue streams.

How to Develop a Business Model

To help develop a sustainable business model, start with a proper accountability of cost allocation. For example, staff time should be attributed to specific activities and programs as a foundation to determine true costs and thus the basis to assess profitability. The organization’s budget should be compartmentalized by program, project, or activity, as well as for the consolidated whole. Accounting systems should provide financial information with that level of sophistication in a timely and reliable manner.

Boards and staff need to be educated about the importance of understanding profitability, and the precise data elements that demonstrate that outcome. Using words like margins and profits with boards and staff as a part of the decision-making process is a simple but effective way to begin changing the narrative. This also provides a gateway to highlight the fiscal contribution of various programs to the organization’s bottom line.

Infuse a Profit-Margin Culture

The need to provide services for our members that will never generate a profit is a common rejoinder to this profit focus. This need is exactly why it is so important to develop products and services that do generate margin—to support those that will not. 

Healthy associations have a balanced mix of both and identifies how each impacts the financial success of the organization. Recognizing that certain activities will be undertaken only if they generate a profit margin is often an uncomfortable concept for boards and some staff members.

Paradoxically, effective strategies to develop a profit-margin culture include establishing a fund that is specifically designed to support programs that are not profitable and are member-value focused. These activities are critical to supporting our constituents but need the profitable income streams from other initiatives to establish and support them.

The path to moving a nonprofit organization toward a culture of generating profit margins requires strategy, education, communication, and follow-through.

Patricia Blake, FASAE, CAE

Patricia Blake, FASAE, CAE, is CEO of the Heart Rhythm Society and a former ASAE board chair.

Eric Booth

Eric Booth, CPA, MBA, CGMA, is chief financial officer of the Heart Rhythm Society.