How Much Money Should a Nonprofit Have In the Bank?
A nonprofit organization comes with a few unique implications. A nonprofit organization’s purpose is to provide support for a cause and because of that, it receives a tax exemption for its revenue because of the good it does for our nation. A common misconception is that a nonprofit can not hold any funds at the end of the year. This is incorrect. A nonprofit, as long as it is not a Foundation, can carry over as many funds as it feels it needs to.
If a nonprofit leader looked at this logically, if a nonprofit organization spent everything it has at the end of the year, how can it ensure that the start of the new year will go smoothly and sustain daily functions as normal? It can’t.
In fact, in order to ensure financial security for a rainy day, your organization should always put money aside in a reserve fund so you have financial security!
The National Council of Nonprofits believes that although you are not able to spend this money on the cause at the time of obtaining extra funds, it will make a more lasting impact on your mission because of the longevity and sustainability of the nonprofit organization.
How to Arrange a Nonprofit:
Becoming a Nonprofit
In order to become a nonprofit corporation, you must establish a board of directors and submit articles of incorporation, addressing basic information of the nonprofit such as the officers, mission, and contact information, to your secretary of state. Once you have achieved nonprofit status with your state, you can apply for certain types of grants and avoid paying taxes as long as your income is related to the nonprofit.
Next, you must also submit an IRS form that exempts the nonprofit from paying federal taxes. Once this application gets approved, the nonprofit becomes a 501(c) organization and you can now function like other exempt organizations. The organization will obtain a federal tax ID number in which the nonprofit will use to file its informational tax return.
Understand What Nonprofits Can Do
Nonprofit and for-profit organizations have key distinctions that set them apart from each other. A for-profit exists so that it can pay its shareholders and benefit the interests of the individuals involved. Nonprofits exist to support a mission that involves the public and charity.
In order for a nonprofit to receive the 501(c) federal tax exemption, they must prove that they are indeed a nonprofit, in which they are working exclusively for the betterment of one or more purposes of the charity. Cash flow from donations, grants, and fundraisers are sources of related income for the nonprofits as long as they use the profits received toward their mission. When there is still funding left over, and the end of the year is nearing, a smart decision for the nonprofit organization would be to take this surplus and invest it into a reserve for next year’s potential emergencies. Taking profit to save or invest, is allowed for a nonprofit. A nonprofit, like any other form of business, needs funding to survive. The executive director and board members must decide how the extra money is going to be handled.
How to Have Control Over Your Nonprofits Money:
Setting Money Aside
To stay in proximity with nonprofit values, you may want to consider using a credit union for your bank needs. Unlike banks, credit unions are not-for-profit organizations that are run by the people within that organization. If you are a member of a credit union, you are entitled to lower loan rates, lower fees, and higher savings.
Keeping track of your nonprofit’s balance sheet can also help you recognize the organization’s assets, liabilities, and net assets. It helps depict a nonprofit’s financial position at any given time. Like any corporation or small business, this can show you the health of the organization, how liquid its assets are, and presents the organization’s ability to pay for its operating needs. A nonprofit should update its balance sheet monthly and the nonprofit board should examine this when making any further financial or operational decisions.
Savings accounts and checking accounts are great to have to help keep the organization’s money in close proximity. However, nowadays saving accounts rarely offer more than a percent of interest and commonly offer less than a percent. A nonprofit, at the very least, should have a bank account with a checking account and a savings account. Checking accounts will allow for more liquid spending and for weekly/monthly expenses. Savings accounts should have money stored to avoid shortfalls in available cash.
But how can you keep money safe AND allow it to really grow? Putting excess money in a money market account will cause the principal contribution to make money while it sits there in case of emergency events.
A money market account allows your business to make interest and also allows easy access to funds. Depending on where the organization chooses to invest its money, different requirements apply. Nevertheless, you are able to make more on interest off of your principal contribution in a money market account than a regular savings account.
The excess money that is made, or even the principal, can then be put back into the nonprofit, allowing nonprofits to invest in their procedures and strategies or to provide more funding for their mission. Allowing your money to grow more steadily with a money market account while the organization is not using it is a more ideal option than leaving it in a bank account.
Having a surplus
At the end of the year, if a nonprofit has a surplus, this means they have received more in income than they have spent in expenses. Furthermore, these profits can be used toward further development of the nonprofit in the next year. Instead of immediately spending these profits, it would be a good idea to invest these in a money market account preferably with a credit union that allows for high-interest rate returns.
If the final balance on the income statement, or statement of functional expenses, at the end of the year has a positive number, do not panic. As a nonprofit, you are required to record and report all revenues and contributions. Sometimes income is recorded before it is received or a donation has been placed early for a future event. These incomes may come in right before the year ends, making the financial statement extremely misleading. These kinds of cases are all very possible, and the IRS understands the possibility of these kinds of occurrences.
Surpluses are a good thing! A surplus can save the existence of a nonprofit. Use the extra money at the end of the year to pay down any debts, invest in your mission, reward your hard-working employees, invest in a money market account, or save it in a bank account.
Dealing with a Deficit
When the income statement shows a negative number at the end of the year, there are many things that must be put into consideration to ensure this is not a recurring incident. To see whether this problem is continuous or to identify if it was just a bad month, pull all monthly financial reports to evaluate how frequently deficits occur and why they occur. Analyze these reports with the nonprofit board to see what expenses can be reduced or eliminated.
Having a loss at the end of the year is not fun. Deficits bring the morale of the nonprofit organization down and can send the organization into panic depending on how large the deficit is. If the organization has found ways to cut down on spending and it still does not fix the problem, find solutions from the other spectrum of the problem. Find ways to make more money! This may be an obvious fix, but sometimes it is not taken into consideration that the organization needs to get its name out in a different way in order to get more donations. Spending money to host fundraisers, build supporters, and gain funders will cost less in the long run when there is more income coming in due to more contributions and donations.
If the nonprofit organization is still struggling, the executive director and board members will be forced to make tough decisions. These decisions may include cutting a program or laying off staff. Recognizing and understanding the organization’s ratio of income to expenses is important to ensure the organization’s longevity.
How to Follow Nonprofit Income Laws:
What Income Can be Taxed, and What Can’t?
Profit businesses are required to submit all income and expenses where it is all then calculated as to whether it has been correctly deducted or not. However as mentioned earlier, the Internal Revenue Services cuts a break for the organizations that are ruled with tax-exempt status, also known as nonprofit organizations. Furthermore, the IRS keeps a close eye on what income the nonprofit labels as related and unrelated to the nonprofit’s mission.
Related income can include grants, donations, subscriptions, and investments. These incomes all have to be linked to the mission of your nonprofit and later used only to maintain the continuity of the organization and to provide prosperity for the cause.
Unrelated business income, or UBI, is income that is received but is not necessarily related to the mission or charitable purpose of the nonprofit. This kind of income is not received for the purpose of the cause, so it may result in taxation when filing the nonprofit income tax return.
How to Build a Reserve for Your Nonprofit:
Composing rules to Handle the Reserve
The Executive Director and Board members must decide a few heavy questions, for the purpose of handling and using the organization’s reserve in the best way possible. What will the reserve be used for? Who will be able to tap into the reserve? Will there be a required vote to determine whether the withdrawal of the funds is necessary? What is the goal amount of money for the reserve? How will the organization continue to replenish any funds that are taken out in the future? There needs to be a board agreement on any chosen answer to all these questions to ensure that the money is being consumed and monitored properly.
This type of reserve should not be used to cover long term payroll fund shortages. Instead, nonprofit organizations can use them to establish new programs or implement new strategies to support the mission. In order to keep tax-exempt status, a nonprofit must use its funds toward the mission. Together, the executive director and board of directors must work to establish a plan that identifies what the cash reserve will go towards and how it will be handled and monitored. With any amount of money there comes responsibility, so be sure to establish authority where needed.
How Much to Save for a Reserve
When a nonprofit makes money through the purpose of their mission, the income does not get taxed on their income taxes. If the income is unrelated, the organization will have to pay for federal and state taxes. In order to not get taxed, you need to be able to explain to the IRS why a certain activity or income is related to the mission. By not having to pay taxes, a nonprofit naturally gets to keep more of their income, in which they should invest those savings.
It is recommended that a nonprofit has at least 3 to 6 months of costs set aside in a reserve. In many circumstances, this may be a large amount to keep aside, but this is an essential amount if a nonprofit wants to stay in business and continue to make their lasting impacts toward the cause they are supporting. To be fully stocked, having 2 years worth of expenses would be ideal, but not more than that. At this point, the organization should continue to give more toward the mission.
It is important that every nonprofit strategizes its money allocation so that there is enough money to tap into its operating reserve in case of a rainy day or emergency.
Understand what your nonprofit is entitled to, follow the rules set by the Internal Revenue Services, establish a reserve, and maintain this reserve for your organization. The nonprofit will be in good order once it has backup funding for any financial shortfalls.
Financing Solutions Nonprofit Line of Credit
Over the last century, nonprofits have hard a hard time getting a nonprofit loan or line of credit from a bank. Banks require collateral and personal guarantees and for a nonprofit, that loan requirement can be difficult.
Financing Solutions recognized this in 2012 and began offering a nonprofit line of credit which requires no collateral and no personal guarantees. The credit line that Financing Solutions offers costs nothing to set up and nothing until used making it a great cash back up plan. Financing Solutions has thousands of nonprofit clients throughout the US who use their line of credit when cash flow is down and important bills like payroll must be used.
If you would like a quote for a line of credit please fill out our no-obligation 2-minute online nonprofit line of credit application. If your nonprofit has $200,000 per year in revenue you will be qualified.