NPO (Non-Profit Organization)
Refers to the type of business organization that is mainly set up to promote society's welfare or culture and art in society
A non-profit organization, in simple words, refers to the type of business organization that is mainly set up to promote society's welfare or culture and art in society. Such organizations are generally known as charitable organizations.
These firms do not have owners. Rather, the functioning of these organizations is under the supervision of their trustees, and the members of the organization tend to elect the trustees through a voting process.
Non-profit firms receive funds from their members and the general public via charitable donations, and the main purpose of these organizations is to serve the people.
Although the name suggests that such firms are not concerned about their earnings, they tend to make profits during their operations. Therefore, non-profit firms do not need to prepare a capital account. However, the funds received by the firm are credited to the capital fund account.
Since the main purpose of non-profits is to promote a social cause and welfare in society, these firms are granted certain benefits, such as tax exemptions by the Internal Service Revenue (IRS).
Moreover, the members' money is generally tax-deductible, and the firm itself does not have to pay tax on the money received from donations or other charitable fundraisers.
Some of the most prominent non-profit organizations worldwide are American Red Cross, Bill & Melinda Gates Medical Foundation, Garfield Weston Foundation, and Azim Premji Foundation.
Features of Non-Profit Organization
The different characteristics defining non-profit organizations can be explained as follows:
1. Purpose to serve society
The motive of these firms is not to manufacture goods and services for consumption purposes but to provide services to people to promote welfare and well-being in society.
The services these firms provide are free of cost or sometimes a very minimal fee, as the firm's goal is not to earn profits. Moreover, such firms welcome a wide variety of customers and do not discriminate based on caste, religion, skin color, etc.
The most common types of services NPOs provide are health, education, food, clothing, and shelter to people displaced from their homes due to unforeseen events.
2. Member Composition
Since these firms operate as charitable trusts, the firm’s operations are undertaken by the trustees and the organization's board of directors. The members generally elect these trustees via voting.
Anyone can be a member of these firms, but the firms at times demand a minimal membership fee that has to be paid by the members on a yearly or monthly basis.
3. Sources of Income
Non-profits generally receive from several different sources, such as donations, government grants, subscriptions, membership fees, legacies, and income earned from investments made by not-for-profits in other financial instruments.
4. Preparation of Financial Statements
After deducting all possible expenses, the money earned by non-profits is not known as profit but as surplus. This surplus is divided among the members depending on their ownership stake in the firm.
Non-profit firms do not have to prepare a profit and loss account but tend to prepare something similar, known as an income and expenditure account.
5. Users of Financial Statements
Several different individuals and corporate bodies generally use the financial statements prepared by such organizations.
This accounting information is utilized by present and potential firm members to check if the organization is performing well and is also used for analysis by statutory bodies.
Accounting for Non-Profit Organizations
Although non-profits support the needy and promote welfare in society without the expectation of making profits, they still have to prepare accurate financial statements to record their assets, liabilities, income, and expenses.
Since the major sources of funding for these include subscriptions, donations, and government grants, most of the transactions recorded by non-profit firms are in cash or through bank transactions.
However, non-profit organizations must prepare financial statements as they must mandatorily report their results to their members to indicate their performance. It is also mandatory by law so that the government can control the grants provided to the firms.
Moreover, preparing accurate financial statements helps the firm reduce the risk of fraud. Non-profits, apart from ledgers and cash books, are also expected to prepare a stock register, which is a complete record of the company’s non-current assets and consumables.
Furthermore, unlike normal companies that tend to prepare capital accounts to record the funds received, non-profit firms are required to prepare a capital fund or general fund account that tends to record the infusion of capital in the form of donations, subscriptions, and grants.
The financial statements prepared by non-profit organizations are as follows:
1. Receipts and Payments Account
The receipts and payments account are prepared to record the cash and bank transactions of the NPO, and it assists in preparing the income and expenditure account.
2. Income and Expenditure Account
The income and expenditure account is similar to the profit and loss account, but instead of determining the profit, the income and expenditure account reflects the firm’s surplus or deficit.
Just like a normal company’s balance sheet, a not-for-profit organization's balance sheet reflects the company's assets and liabilities.
Advantages of Operating as a Non-Profit Company
The key advantages of setting up a firm as a not-for-profit are explained as follows:
1. Higher Employee Commitment
Since the main purpose of NPOs is to provide service to society, many employees and members of the organization own personal interest in such firms, thereby leading to a higher commitment to the firm.
For example, a mother of a child fighting bone cancer will have a higher personal interest and motivation to be a part of a not-for-profit that aims to help children suffering from cancer.
Employees who believe in the mission and philosophy of the firm offer a key advantage to the firm, as employees with personal interests and connections tend to understand the business's operations and functions better.
2. Higher Intrinsic Rewards
The operations and activities conducted by such businesses uplift certain communities and segments of society. However, they often tend to be ignored by society, for example, services for orphans and the homeless.
It is practically impossible to measure an NPO's tangible benefits and impact on individual families. Nevertheless, the intangible/intrinsic benefits will always outweigh the dollar value of the services provided by the firm.
Moreover, employees of these organizations tend to receive intrinsic rewards in the form of satisfaction and accomplishment after lending a helping hand to community members that do not have the privilege to help themselves out.
These intrinsic rewards systems in non-profit firms can be a big advantage for the firm as all employees in the search for such rewards tend to put in more effort to do better.
3. Financial Benefits and Incentives
An organization registered as a non-profit receives several different financial benefits and incentives from the government to operate and expand its business operations.
Firstly, money received by the firm in the form of donations by members or individual philanthropists is tax deductible, giving people the incentive to donate their money to these firms to enjoy tax savings.
Secondly, since these firms aim to provide well-being in society, such firms tend to have better relations and thus receive unique discount offers from landlords, service providers, wholesalers, and retailers.
Thirdly, not-for-profits registered and recognized by the Internal Service Revenue (IRS) of the US are exempted from paying corporate income tax, so the money earned by these public charities is tax-free.
Disadvantages of operating a Non-Profit Company
Although a not-for-profit firm holds several key advantages in the form of tax benefits, financial incentives, and high employee commitment, there are several disadvantages of such firms that are explained as follows:
1. Lack of Funding
Since NPOs rely on donations and subscriptions as their source of capital, fundraising, and development, especially during economic downturns and periods of high unemployment, they can create barriers for the firm.
Fund development for non-profits requires the services of a grant writer with a high success rate. Unfortunately, the services of such grant writers can be very costly, thereby creating difficulties for the firm with respect to capital requirements.
As a result, many such organizations are compelled to discontinue their services to society due to the lack of funding.
2. Higher Social Pressures and Expectations
Potential repercussions and social quarrels surrounding these firms whose missions are considered extreme can create certain hardships for the functioning of the non-profit organizations.
For example, the actions of an NPO with a religious outlook that increase an emotional response toward the privacy of fallen soldiers and their families can lead to social backlash for such firms, thereby leading to the closure of activities.
Non-profit firms that aim to empower communities and embark on their concept of diversity by redefining family structures can also face negative reviews, thereby leading to protests and oppression regarding their philosophies.
3. Overworked Employees
Since small to medium-sized non-profit firms only employ a handful of employees due to budget constraints, each employee is expected to put in more work.
This creates a scenario where employees work more for less pay, leading to fatigue and, at times, employee dissatisfaction.
4. Higher Public Scrutiny
The financial statements and reports of nonprofits are subject to rigorous public scrutiny, implying that these firms are expected to comply with the applicable accounting standards and prepare reports.
Although preparing detailed financial statements has several advantages, it can attract unwanted press attention, especially if the firm is going through a period of financial hardship and instability.
As a result, many firms outsource this work to third-party auditors to manage company books to ensure that the firm complies with all tax codes and accounting practices. At times, auditors' services can be very costly for the firm.
Non-Profit vs. Not-For-Profit Organizations
Although the terms non-profit and not-for-profit can be used interchangeably, there are several key differences between the two types of firms. The differences are explained as follows:
1. Goals of the organization
The first key difference between the two firms lies in their objectives and goals. As discussed above, non-profit organizations aim to promote well-being in society and offer certain social benefits.
On the other hand, not-for-profit firms do not aim to promote welfare in society. Rather, a not-for-profit might exist to serve its members and not the community at large.
2. Tax Benefits
NPOs and NFPOs are tax-exempt, meaning they are not expected to pay corporate income tax on their income. However, the key difference lies in the tax benefits offered to members.
Donations made by members of non-profit organizations are tax-deductible, but donations made to not-for-profit organizations are not tax-deductible. Thus, donations made to NPOs only offer tax benefits to members.
3. Different Laws Governing the Structures
Section 501(c) of the IRS tends to govern these organizations' purposes.
NPOs operate under Section 501(c)(3) as companies or charitable trusts operating for religious, scientific, literary, or educational purposes. On the other hand, NFPOs operate under Section 501(c)(7) for recreational purposes.
Conclusion
Non-profit firms thus play an important role in society as they exist to address social issues, promote welfare and wellbeing, and serve the communities at large. Although these firms do not aim to make money, they still have to prepare detailed financial accounts.
Such firms can be attractive investment options for people, and donations made in these firms are tax deductible. Moreover, the firms are structured on the idea of limited liability, which implies that the members are not liable to pay for the firm's debts.
However, it can be difficult to operate such an organization due to the lack of funding since these firms purely have to rely on donations and subscriptions for their capital. Nevertheless, appropriate government grants and help can ensure these firms generate value in society.
People who desire to provide voluntary services can become members of these organizations to uplift society.
Furthermore, these firms tend to instill certain values in society that allow people to do good deeds. Since most of these firms are set up to help people who are in need, people donating to such firms feel satisfied and feel like they are contributing to society.
Researched and authored by Mehul Taparia | LinkedIn
Reviewed and Edited by Raghav Dharmarajan
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