Differences Between For-Profit and Nonprofit Accounting

When starting a company, one of the first decisions you need to make is whether the business should be a for-profit company or a nonprofit organization. For some founders, the answer is immediately obvious. It makes sense for a company that wants to make money to be a for-profit business. For a company with a social component, such as a business that produces a product or provides a service that enhances the greater good, the answer might be less clear.

Understanding the differences between for-profit businesses and nonprofit organizations can help you decide which one best suits your company. One way to get a better grasp of the differences is to look at how nonprofits compare to for-profits, especially with accounting practices.

For-Profit vs. Nonprofit Organizations

When a business earns a profit, it brings in more revenue than it spends. One common misconception about the differences between a for-profit and a nonprofit company is that a nonprofit doesn’t earn more than it spends or doesn’t have money remaining at the end of each quarter. The definitions of a for-profit and a nonprofit business are a little more complicated than that. Take a closer look at what it means to have a for-profit business or a nonprofit organization:

What Is a For-Profit Company?

A simple way to define a for-profit company is a business that exists to earn money. A for-profit business wants to bring in more revenue than it spends to benefit the owners or investors or provide a financial incentive to its employees. In some circumstances, the owners or managers of a for-profit company might use the extra revenue to build or enhance the business.

For-profit companies earn money by selling products or services. For example, a clothing brand will sell clothing, and a for-profit attorney will sell their legal services.

One thing worth noting is that although a for-profit business has the goal of earning money, turning a profit doesn’t have to be the sole aim of the company. There are several examples of for-profit businesses that also have a mission or social component. For example, a clothing brand might aim to reduce the fashion industry’s environmental footprint by producing more sustainable or recyclable garments. An attorney might provide legal services to help those in need. Earning a profit then helps those companies and individuals achieve their goals.

Common Examples of For-Profit Companies

A few examples of for-profit companies include:

Restaurants
Retail stores
Attorneys
Technology service providers
Automobile manufacturers
Consulting firms
Construction companies
Real estate companies and developers

What Is a Nonprofit Company?

A nonprofit company is not necessarily a company that doesn’t earn a profit. A struggling business can’t simply decide to be a nonprofit because it is earning less than it’s spending. Instead, the term “nonprofit” means that the goal of the company extends beyond earning money. Nonprofits have a mission and typically seek to benefit the public or further a particular cause.

Compared to for-profit companies, nonprofits have certain tax advantages. Often, nonprofits apply to be 501(c)(3) organizations, which exempts them from paying certain taxes. A 501(c)(3) organization is usually a charitable organization, meaning the service or product it provides benefits the greater good somehow. To earn tax exemption, the organization needs to have at least one of the following purposes:

Religious
Scientific
Literary
Educational
Prevention of cruelty to children
Prevention of cruelty to animals
Testing for public safety
Encouraging amateur sports competition nationally or internationally
Charitable, such as defending human rights, eliminating discrimination or advancing science and education

Common Examples of Nonprofit Organizations

Some common examples of nonprofit organizations are:

Colleges and universities
Hospitals
Performing arts organizations
K-12 literacy programs
Organizations that aim to end childhood hunger
Humane societies
Adult education programs

Nonprofit vs. Not-For-Profit

Often, people occasionally use the phrases nonprofit and not-for-profit interchangeably. It’s worth noting that there are some subtle differences between the two. While a nonprofit typically services a charitable purpose or has a mission that enhances the public good, a not-for-profit company doesn’t need to do so. A not-for-profit instead operates to serve its members. The revenue it does earn goes back into meeting its goals and running the organization in general. For example, a social club or sports team can qualify for not-for-profit status.

One key difference between the two is that a nonprofit is usually a business and typically does seek to earn more revenue than it spends. Not-for-profits are usually recreational organizations. They can often apply for tax-exempt status, but the IRS isn’t likely to recognize them as organizations eligible for 501(c)(3) status.

Who For-Profit vs. Nonprofit Companies Serve

In addition to qualifying for tax exemption or not, nonprofit and for-profit — and not-for-profit — organizations differ when it comes to their users and needs or who they aim to serve:

The public: Nonprofit organizations typically need to benefit the public in some way. Any profit earned by the organization gets directed back into the organization to further its cause and mission. All accounting information about a nonprofit organization needs to be freely available to the public to review.
Stakeholders and investors: Often, for-profit companies have stakeholders and investors who own a share of the business and who have an interest in how it is doing and its financial situation. If the business earns a profit, the investors earn a portion of the profit based on their stake in the company.
Members: Not-for-profit organizations often exist to meet the needs of their members. A social club or credit union provides services that benefit the people who sign up. Any additional revenue earned by a not-for-profit gets cycled back into the organization to help it better serve its members.

For-Profit vs. Nonprofit Accounting Differences

How you handle your company’s accounting will differ depending on whether you apply for for-profit status or to be a nonprofit. Take a closer look at some of the major accounting differences between for-profit and nonprofit organizations.

1. Tax Status

Tax status might be the difference that comes to mind first for many people when they think about for-profit versus nonprofit companies. A nonprofit organization that qualifies for 501(c)(3) doesn’t have to pay federal income taxes. Whether the organization has to pay state or local taxes depends on its location. Many nonprofit organizations also don’t have to pay property tax or sales tax.

If an organization has tax exemption under IRS section 501(c), it does need to file Form 990 each year. The public can access the information on Form 990 to see how a nonprofit organization manages its finances.

Form 990 can influence a potential donor’s decision to give money to an organization or not. Suppose the form reveals that an organization is spending a significant portion of its revenue on overhead and a small portion of its income on fulfilling its mission. A donor might decide not to give money to the company.

In contrast to nonprofit organizations, for-profit companies need to pay federal income tax, state and local taxes where applicable and sales and property tax. The type of tax return a company needs to file and when it needs to file its returns depends on the corporate structure. A sole proprietor, for example, files Form 1040 and Schedule C each year. Corporations get taxed on their profits and need to file Form 1120 with the IRS.

Although for-profit companies do pay taxes, many can reduce their tax obligation through deductions. Deductions reduce the value of a company’s taxable income, lowering its tax bill.

2. Balance Sheet vs. Statement of Financial Position

Whether they are answering to investors or the public, for-profit and nonprofit companies need to prepare financial statements. The format of the financial statements differs based on whether a company is for-profit or nonprofit.

Nonprofit organizations typically prepare a statement of financial position. A statement of financial position, or SOP, provides a snapshot of an organization’s finances at a particular point. A statement of financial position includes:

The organization’s assets: An organization’s assets are what it owns or has. Examples include cash and money in savings and investment accounts, furniture and equipment, valuables such as artwork, prepaid expenses, long-term investments and investments in endowment funds. Grant money that an organization has won but hasn’t yet received and money it has loaned others can also count as assets.
The organization’s liabilities: Liabilities are what an organization needs to pay to others. Examples of liabilities include accounts payable to vendors or service providers, loans the organization is repaying, payroll and credit cards or lines of credit.
The difference between the two: The difference between an organization’s assets and liabilities is its net assets. Net assets can be unrestricted, meaning a company can use them whenever and however it wishes. If assets are restricted, a company needs to use them for a particular purpose, such as paying a particular employee’s salary. Temporarily restricted assets have restrictions set by the donor, which can be fulfilled within a short time.

For-profit companies’ financial statements include balance sheets, which they usually prepare every quarter. A balance sheet looks a lot like an SOP, but there are some key differences. You’ll typically find the following on a balance sheet:

Assets: Like an SOP, a balance sheet lists a company’s assets, or the value of what it owns, such as cash on hand, real estate, furniture and equipment, accounts receivable and investments.
Liabilities: A balance sheet will also include the value of a company’s liabilities, such as its debts and accounts payable. Liabilities can be long-term, such as a 10-year loan, or short-term, such as bills the company needs to pay by the end of the month.
Shareholders’ equity: Another way to describe shareholders’ equity is the company’s net worth. This net worth is the amount investors initially put into the business that the company decides to retain at the end of the year rather than pay out to investors. A company’s assets should equal its shareholders’ equity plus its liabilities.

3. Income Statement vs. Statement of Activities

For-profit and nonprofit companies have different ways of reporting their income and expenses. A for-profit company will create an income statement known as a profit and loss statement (P&L). It should include the following:

Sales and revenue: Sales and revenue are examples of income a company might earn during a quarter, such as the value of products or services it sold.
Operating costs and expenses: Operating costs and expenses can include the cost of the goods a company sold, bank fees, rent, office expenses, advertising costs and marketing expenses.
Net income: Net income is sales and revenue minus operating costs and expenses. If a company has a positive net income, it has a profit for the quarter. If the net income is negative, the company has a loss.
Other sources of income: Other sources of income a company might include on its P&L include interest income or income from investments.
Other expenses: Other expenses might include costs not directly related to the cost of running the company, such as taxes or penalties the company has to pay.

A nonprofit’s statement of activities is very similar to a P&L statement. The statement lists a nonprofit’s revenue during a period, such as a quarter. It also lists the organization’s expenses during that time and shows the difference between the two. A statement of activities will usually include:

Revenue: A nonprofit’s sources of revenue can include donations from individuals, grant funding and funds released from restricted endowments.
Expenses: Expenses include operating costs, fundraising costs, management costs and program costs.
Change in net assets: The change in net assets is the difference between revenue and expenses during the quarter. It can be positive, if there is more revenue than expenses, or negative, if the nonprofit brought in less than it spent.

4. Net Assets

How an organization handles and classifies its net assets, or the value remaining after subtracting expenses, differs depending on whether a company is for-profit or nonprofit. Nonprofit organizations need to classify their net assets into three categories:

Restricted: Also called permanently restricted, restricted funds or assets are amounts of money that an organization needs to invest in perpetuity, usually in a trust or endowment. The money usually needs to be used for a single purpose. For example, restricted assets might fund a chair position in a department or pay for a particular program offered by a nonprofit.
Temporarily restricted: Temporarily restricted assets are often earmarked for a particular reason, such as paying for a new wing at a hospital or getting a literacy program off the ground. They usually need to be used during a specific time frame.
Unrestricted: An organization is free to use unrestricted funds whenever and however it would like, as long as the use of the assets helps the organization fulfill its mission and purpose.

Handling net assets as a for-profit company involves calculating total assets minus liabilities. The remainder is the company’s profit.

For-Profit vs. Nonprofit: Company Ownership

Another important difference between for-profit and nonprofit organizations is who owns the company. For-profit companies can have one of several different types of ownership structures:

Sole proprietor: In a sole proprietorship, an individual owns the company. As the sole owner, they benefit when the company earns a profit. On the other hand, they might have difficulties if the company loses money. Sole proprietors typically file an individual tax return, Form 1040.
Partnership: In a partnership, two individuals usually have joint ownership or equal ownership of the business. Both partners pay taxes on their share of the business’s income on a personal tax return.
Cooperative: In a cooperative ownership model, multiple people own the business. An employee-owned company is an example of a cooperative, as are food co-ops or credit unions.
Corporation: When a company becomes a corporation, it creates a separate legal entity. Corporations become liable and responsible for the company’s actions and financial issues. Corporations have their own type of tax return to file.

A group of investors or shareholders can privately own corporations, or they can be publicly traded. In the case of publicly traded corporations, businesses and individuals can buy shares of the company, staking out small ownership claims. In some cases, a single or small group of investors will hold a majority stake in a publicly traded corporation.

No ownership structures exist for nonprofit companies because no one owns a nonprofit. Many nonprofits have a board of directors that guide the organization and ensure its longevity. Still, the members of the board don’t financially benefit from their participation in the nonprofit.

What For-Profit and Nonprofit Companies Have in Common

For all their differences, particularly for accounting and taxation, for-profit and nonprofit organizations do have some things in common. Perhaps the biggest similarity between the two is that both are examples of business entities. A nonprofit organization can be a corporation, for example. That means that no individual is solely responsible for the actions of the nonprofit, just as no individual is solely responsible for the actions of a for-profit corporation.

In either case, if a corporation loses money, the employees or executives won’t be directly affected. Likewise, if either type of corporation gets sued, no person at the corporation will be responsible for paying the court costs or the settlement.

Another feature nonprofit and for-profit companies have in common is the presence of a board of directors. At a nonprofit, a board of directors oversees the governance of the organization. The board can make decisions that affect the organization’s overall operation, such as its strategic plan. The board isn’t typically responsible for managing the organization or overseeing the day-to-day functioning of the nonprofit. Usually, term limits exist for board members so no single person is carrying the weight of the organization for more than a few years.

For-profit companies also have boards of directors, if they are publicly owned. The board of a for-profit company usually consists of people in executive-level roles, such as the CEO and CFO. Board members at a for-profit usually get paid, while nonprofit boards are made up of volunteers who usually financially support the organization.

Members of for-profit and nonprofit boards of directors have a duty of care. For-profit boards have a duty of care to the stakeholders of the organization, and nonprofit boards have a duty of care to the organization itself. They need to make sure that assets aren’t used fraudulently. Nonprofit board members also need to ensure that the organization follows its mission to maintain its eligibility for tax exemption.

Work With Marshall Jones for Expert Accounting Advice

Whether your company is for-profit or nonprofit, working with Marshall Jones Certified Public Accountants And Advisors helps you get your books in order. Our team of CPAs and advisors can help you prepare your monthly or quarterly P&L statements or statements of activities. We can also help you clean up your accounting records and prepare your annual audit. Learn more about our outsourced accounting services, or contact us today for more details.

Sources: