By Heather Clara Young
Astute corporate philanthropists seek that sweet spot where the charity’s mission resonates with corporate values and priorities, and where the scale and profile of patron and beneficiary are a good fit.
When evaluating applications for support, they also scrutinize program budgets and often require financial reporting to show that their donation will be used responsibly and effectively. Differences in financial perspective can lead to potential misunderstandings between the donor and charity.
The fact is that charities approach finance differently than corporations. Further, “biz school” curriculum rarely addresses the not-for-profit sector in-depth, so business folk may tend to interpret nonprofit financials through an incompatible lens.
Let’s review some radical differences that reveal the roots of the distinction between businesses and charities.
Expenses – bad or good?
Let’s start with expense — such a common, day-to-day term that everyone feels they understand it. Yet, expenses lie at the heart of the difference between nonprofit and commercial mentalities.
The CPA Canada Handbook — the bible of accounting practice in Canada — defines expenses as “decreases in economic resources.” That sounds bad! However, expenses must be incurred to operate the business and, ultimately, generate a profit. The common saying is that you have to spend money to make money.
In the nonprofit world, we flip that on its head. We’re not “for profit.” We’re “for” something else — mandate, mission, and the good we want to do in the world. Charities raise money so that they can spend it on activities that deliver the greatest impact on their cause or community — in other words, expenses are good — the reverse of business leaders restricting costs to generate a more favourable bottom line.
Nonetheless, charities, just as much as businesses, place great importance on managing costs. A charity that cannot live within its means won’t be around for long. Strategic spending is crucial in all sectors, although the underlying thinking may be different.
It’s also true that a non-profit’s delivery of community value may have a commercial dimension — a theatre selling tickets; a college selling registrations. In these cases, the classic approach to expense applies, but charity regulation puts guardrails around commercial activity. According to CRA, “[Fee-based] programs remain charitable as long as they manifest the two essential characteristics of charity — altruism and public benefit.”1
The logical extension of this approach to spending money is that nonprofit financial planning will never be based purely on financial considerations. As corporate philanthropists are well aware, it’s common for charities to proceed with money-losing programs and activities based on mandate and community need, and to make up the shortfall through other means, including donations.
It’s unwise to decide on nonprofit support solely by looking at financials
An important take-away for all those who decide which charities to support largely based on their financials — and I’m thinking about individual and corporate donors, potential volunteer Board members, and lenders — is that you may need to broaden your thinking to fairly evaluate a charity’s operating results.
Language shapes our thinking, and the charitable sector has distinct accounting terminology that sets it apart from the commercial world.
Businesses aim to generate a profit for their owners. While charities are allowed to make money, they name the result differently. Surplus — the nonprofit term — describes an amount exceeding what was required. The opposite — deficit — indicates a shortfall or deficiency compared to what was needed. That puts a very different spin on it!
The idea of sufficiency is baked into nonprofit financial vocabulary. The accumulation of wealth drives business, but a well-managed charity seeks to accumulate the optimal amount to secure its longevity. The rest is poured into community service.
We see this on the balance sheet, too, where the equity section (commercial language) is replaced by net assets (nonprofit language).
All of us who studied introductory accounting for business will remember the basic accounting equation:
Assets = Liabilities + Equity
This equation describes the accumulation of a company’s assets. We acquired some of them via borrowing (liabilities), and some from our own resources (equity). A savvy business owner knows how to utilize borrowing to drive the business forward. Common business ratios include the debt-to-equity ratio and the return on equity — measurements of the owner’s acumen at building wealth.
In the nonprofit sector, we restate the basic accounting equation as follows:
Assets – Liabilities = Net Assets
Conceptually, we’re looking at the same things! Net assets, functionally, are the same as equity. Note that the business world isolates the term assets meaning liabilities plus equity. The nonprofit world isolates the term net assets meaning what’s left of assets after debt is paid.
The commercial balance sheet focuses on the accumulation of wealth, while the nonprofit version supports an evaluation of whether the organization’s residual value is sufficient to secure its future.
We can dive even deeper.
Equity vs. Surplus
Leaving aside owner’s equity (or contributed capital), which doesn’t exist in the nonprofit world because there are no owners, businesses subdivide their equity into current earnings and retained earnings — that is, this year’s profit, and the historical profit over the company’s lifetime. Business owners want to measure the wealth generated from their operations. Making the time period distinction (last year versus previous history) is helpful for analysis.
Not-for-profits also need to evaluate how operations impact their overall wealth. A surplus increases net assets, and a deficit depletes them. That’s important information for evaluating sustainability and setting next year’s budget goals. However, the nonprofit balance sheet lays out the net assets section according to an entirely different framework: whether that residual value is accessible or restricted.
We need to spend a few minutes on revenue to unpack that comment.
Charities’ revenue is for general use or restricted
By and large, when a business generates revenue, it can do whatever it likes with the money. A sale is an exchange of goods or services for money — and once the exchange is concluded, the seller walks away with no further obligations.
The same is true for nonprofits with commercial activities, such as the theatre company selling tickets and the college selling course registrations. After the applause, after the final exam, that’s it! The seller’s obligation to the buyer has been satisfied.
When averaging the income of all of the charities in Canada, no-strings-attached revenues from sales comprise only 8% of charity income, according to the Charities Directorate2. The rest of the sector’s income comes from government (70%) and philanthropy (22%). While some philanthropic support also arrives with no strings (e.g., many individual donations), institutional support is typically earmarked for a defined (restricted) purpose.
Readers of a nonprofit’s financial statements need to know what portion of the charity’s net assets is restricted, and what’s available for general use. Financial statements disclose the amount that’s been invested in capital assets (inaccessible because it’s sunk); the portion that’s externally restricted by a third-party agreement; the portion that’s internally restricted by the Board of Directors; and the rest — which is unrestricted.
It’s important to recognize that those last two — unrestricted and internally restricted net assets — are both under the Board’s control. Combined, they yield a key indicator of the organization’s sustainability, and its ability to carry on with planned operations.
As you can see, Accounting 101 leaves much unsaid about the peculiarities of nonprofits! Corporate patrons and their charitable beneficiaries can only benefit by a clearer understanding of their distinct approaches to finance.
Heather Clara Young, CPB founded Young Associates in 1993 to provide bookkeeping, payroll, training, consulting and outsourced CFO services to not-for-profits and charities, specializing in the arts and culture sector. Heather teaches accounting and financial management in Humber College’s Arts Management program, and has taught for Humber’s Fundraising and Volunteer Management program and University of Toronto’s Arts Management program. Her book Finance for the Arts in Canada (2005, 2024) is a self-study textbook and reference source on how to master arts-sector nonprofit accounting and financial management skills.
- https://www.canada.ca/en/revenue-agency/services/charities-giving/charities/policies-guidance/ policy-statement-019-what-a-related-business.html
- https://www.canada.ca/en/revenue-agency/services/charities-giving/charities/about-charitiesdirectorate/report-on-charities-program/report-on-charities-program-2023-2024.html
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