When people use the term “nonprofit” they usually are referring to charities like food banks, the Red Cross, and other organizations dedicated to helping other people. But while the colloquial term can be very broad, encompassing different organizations from women’s shelters to universities, the financial term “nonprofit” has a very specific definition. Understanding how nonprofit businesses operated can allow us to better appreciate the role they have in our society.
What is a Nonprofit?
Legally, the term “nonprofit” describes any business or organization that uses its profits, the surplus of its revenue, to further its objective instead of distributing them to its leaders, shareholders or employees. Many large corporations, in contrast, use their profits to buy back stocks or give bonuses to executives. Some companies offer profit-sharing programs that distribute excess revenue evenly among employees. A non-profit, on the other hand, cannot do any of these things with its revenue.
Since nonprofits are intended to further important social causes, like education or advocating for social justice, they are exempt from paying income taxes on their revenue. Because of this tax-exempt status, a nonprofit’s use of revenue is restricted and closely monitored. For example, nonprofits are prohibited from donating to political campaigns and most forms of lobbying.
In order to make monitoring transactions easier, special nonprofit accounting systems are designed to easily track spending. Large nonprofits like universities or megachurches can have thousands of individual accounts for things like endowments, scholarships or operating funds. Keeping track of transactions across thousands of accounts is an essential part of nonprofit bookkeeping, and needs to be carefully organized.
Donating to a nonprofit is one of the easiest ways someone can support a cause they believe in. Because of their unique economic nature, nonprofits must be extremely careful when tracking donations to make sure that they are spent in a way that is true to their cause.