A Tax Status, Not a Business Model

In this interview, Preethi Kumaran, Manager, Consulting, explains how thinking in terms of personal finance can help us better understand nonprofit finance. This conversation was featured in NFF’s 2024 Annual Report.

When you think about how you’re managing your paychecks and expenses like rent, groceries, and transportation, I don’t think it’s anyone’s goal to spend everything down to net zero every month. That’s because we know things happen that we can’t account for: rent goes up or the car needs repairs. We have retirement or home ownership goals we need to plan for. We need savings to fall back on.

It’s the same with an organization. If you’re spending down to zero every year, you’re not saving. Savings help nonprofits adapt to unexpected changes like inflation or emergencies. Having that extra cushion also helps nonprofits plan for the future, such as by saving up for launching new programs that will have many upfront costs before they’re able to generate revenue. Savings for all of these and more are something you can have only when you generate surpluses, not when you’re just breaking even every year. At NFF we love saying, “Nonprofit is a tax status, not a business model.” Surpluses generate the money nonprofits need to achieve stability and adaptability in the long run, just like we work to do on a personal finance level.

A for-profit business can charge a price that covers the full cost of the product or service they’re delivering, and then some (the profit). Nonprofits cannot do that because they serve populations that cannot pay the full (or sometimes even partial) cost of the services they offer – such as healthcare, housing, and even access to arts and culture. This means that there is a gap in meeting the cost of delivering a nonprofit’s services. Nonprofits fill that gap by essentially running two different businesses. They have their mission business for the community they serve, and they have their subsidy businesses to fill the gaps in covering costs, by pursuing other revenue sources like foundation grants, individual contributions, or other earned income streams. No nonprofit is started with a mission or passion centered on applying for grants. Pursuing grants is just what they have to do in order to pursue their actual purpose in the community.

Because it is hard to secure those subsidy revenue opportunities, as well as maintain the capacity and resources to run those subsidy businesses, nonprofits usually find creative ways instead to cover those gaps in delivery costs – things like relying on volunteers or donated supplies, putting in sweat equity by working unpaid hours, managing with less-than-functional equipment to avoid replacement costs, and so on.

Going back to the personal finance analogy, we all want a better world for ourselves, our family, and our community. But we can’t get there by living paycheck to paycheck, unable to prepare for growth, change, or supporting ourselves in the long run. One thing funders can do to combat this cycle is to eliminate grant restrictions so organizations can use their funds responsively based on their needs, rather than having to allocate every dollar to what funders deem as the most appropriate expenses. Funders are not the ones on the ground observing and assessing what it takes to meet community needs, so they need to learn to trust that nonprofits know how to use their resources best, whether that means spending on current program costs or saving for emergencies or future organizational goals. Funders can also talk about what full cost funding would really look like for their grantees. This would allow them to discuss and understand all the resources it would take to run an effective and sustainable organization without having to cut corners and overextend themselves in order to get by in ways that are ultimately detrimental to the organization’s health.

Organizations that are able to sustain into the long run – that are able to adapt or secure more resources – are often those that already had access to more resources to begin with. Investing in the ones that have been systemically prevented from accessing and building up these resources is the first in many steps to undo the historic underfunding of so many sectors, communities, and geographies.