Our not-for-profit clients often ask how much surplus they can maintain while still being viewed as a not-for-profit. This is a very common concern within the industry. In short, a surplus refers to when a not-for-profit organization reaches a point where it's making profit. And that, simply, defeats its purpose.
Generally, there are three key stakeholder groups interested in the level of surplus held by not-for-profits. These groups include the Canada Revenue Agency (CRA), current and prospective donors, and the general community.
Let's take a look at how surpluses are relevant to each of these groups.
Canada Revenue Agency (CRA)
Members of a not-for-profit's Board of Directors tend to ask how surplus relates to their status with the CRA. What kind of scrutiny could an organization potentially face from having a large surplus?
The CRA addressed this question specifically in 2001 when it released IT 496-R. Sections 8 and 9 dealt with the topic directly and can be referenced here.
According to the CRA, the grounds for surplus accumulation are determined by a case-to-case basis. If there are valid reasons for accumulating a surplus, like an upcoming capital project or the start of a new operating program, then the CRA deems it appropriate. However, if an organization is simply “rolling over” funds into a GIC each year, they may encounter issues.
Current and prospective donors
Donor perception is crucial to a Board of Directors when making decisions on surplus management. Donors are significant contributors to a not-for-profit's cash flow. If donors feel that an organization already has strong financial resources, they may decide to donate elsewhere. In an effort to prevent this, a not-for-profit needs to clearly allocate its desired purpose or use for surplus funds. A large pool of unrestricted funds will typically deter donors from allotting their resources to an organization.
The community's view of a not-for-profit is another important factor to consider when a Board manages surplus. Negative word of mouth and/or media coverage of an organization's financial status can have long-lasting, or sometimes permanent, impressions. Again, a clearly defined purpose for the surplus is imperative. The purpose should also be relevant and understandable to the general public. Being clear and transparent when it comes to the need for the accumulated funds helps keep community and public perception in your favour.
Both management and the Board of Directors need to assess the individual circumstances of the not-for-profit organization. As a general rule, it is recommended that an organization carry 6-12 months of their current operating expenditures as their surplus.
For example, if an organization has $1,000,000 in annual expenditures, it should have a surplus between $500,000 and $1,000,000 accumulated. This prudent amount would allow it to carry on activities in the event of an unexpected disruption to cash flows.
For special projects, the surplus should match the budgeted amount of the project. Another important step is for registered charities to seek permission from the CRA to accumulate funds for special projects. To do this, they can send a letter to the CRA with the following information:
- the specific purpose for which the funds will be used
- the amount required
- the length of time needed to accumulate the funds (minimum 3 years and maximum 10 years)
- the signature of a director/trustee or other authorized representative of the charity
- the name and the registration number of the charity
- the effective date (starting date)
Surplus management is vital in today's not-for-profit landscape. Managing surpluses appropriately is crucial for Boards to ensure that the organization doesn't encounter unnecessary political or regulatory risk.
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BDO's not-for-profit team provides a full range of tailored services to help organizations address their changing needs and identify new opportunities. Our professionals have extensive experience working with clients at the local, provincial, and/or national levels, enabling us to apply practical knowledge and insight to advise on various challenges. If you have questions or would like to learn more, our team would be happy to help.