Focus on Net Operating Income

A commercial, for-profit business has one objective – to earn a profit. It is a bonus if the nature of the business is a pleasant one, but it is secondary to actually making money.

A nonprofit entity is different. Its singular focus is its charitable mission. Money is merely a means to an end. An outwardly noble distinction, but herein lies the beginning of the slippery slope.

Many organizations are uncomfortable with accumulating money. More than uncomfortable; they feel it actually violates their charitable duty. They cannot help but calculate how much more could be accomplished if they spent that extra money. As such, organizations that are “profitable” become extremely vulnerable to mission creep. Their charitable scope starts expanding. Services become heavily subsidized, or are now offered for free. The budget inevitably expands to consume all available revenue. Many organizations even run an annual deficit, and rely on fund-raising to balance the budget.

If you have wealthy, and indulgent, sponsors, you might get away with it. But eventually, running a perpetual operating deficit, or even a zero net surplus budget, is a liquidity crisis waiting to happen.

Why? Because charitable gifts cannot be relied upon. Donations may be generous in economically good times, and utterly vanish in downturns. Donors are fickle. They get bored. They get distracted by a new pet cause. They feel unappreciated. Their kids get control of the money and stop giving.

An operating budget must stand on its own.  A service organization should arguably budget for at least a 10% net operating surplus. A capital-intensive organization, which may have to budget for debt service payments for capital assets, may find it necessary to budget a 25% net operating surplus.