Wednesday, April 14, 2010

How to Reduce Costs - financial analysis

Increasing profits through cost reduction must be based on the concept of an organized, planned program. Unless adequate records are maintained through a proper accounting system, there can be no basis for ascertaining and analyzing costs.

Cost reduction is not simply attempting to slash any and all expenses unmethodically. The owner-manager must understand the nature of expenses and how expenses inter-relate with sales, inventories, cost of goods sold, gross profits, and net profits.

Cost reduction does not mean only the reduction of specific expenses. You can achieve greater profits through more efficient use of the expense dollar. Some of the ways you do this are by increasing the average sale per customer, by effectively using display space and thereby increasing sales volume per square foot, by getting a larger return for your advertising and sales promotion dollar, and by improving your internal methods and procedures.

Profit is in danger when good merchandising and cost control do not go hand in hand. A big sales volume does not necessarily mean a big profit, as one retailer, Carl Jones, learned.

Jones's pride was stocking stylish and well assorted lines of merchandise. Each year, sales volume increased. This increase was attributed to good merchandise which Jones felt took care of the steady rise in expenses.

But Mr. Jones began to have doubts when he found it necessary to get bank loans more often than had been his practice. When he discussed the problem with his banker, Jones was advised to check expenses. As the banker said, "A large and increasing sales volume often creates the appearance of prosperity while behind-the-scene expenses are eating up the profit."

Paying The Right Price
Your goal should be to pay the right price for prosperity. Determining that price for your operation goes beyond knowing what your expenses are. Reducing expenses to increase profit requires you to obtain the most efficient use of the expense dollar.

Look, for example, at the payroll expense. Salesclerks are paid to sell goods, and their productivity is the key to reducing the payroll cost.

If you train a salesclerk to make multiple sales at higher unit prices, you increase productivity and your profits without adding dollars to your payroll expenses. Or, if four salesclerks can be trained to sell the amount previously sold by seven, the payroll can be cut by three persons.

An understanding of the worth of each expense item comes from experience and an analysis of records. Adequate records tell what has happened. Their analysis provide facts which can help you set realistic goals, you are paying the right price for your store's prosperity.

Analyze Your Expenses
Sometimes you cannot cut an increase item. But you can get more from it and thus increase your profits. In analyzing your expenses, you should use percentages rather than actual dollar amounts.

For example, if you increase sales and keep the dollar amount of an expense the same, you have decreased that expense as a percentage of sales. When you decrease your cost percentage, you increase your percentage of profit.

On the other hand, if your sales volume remains the same, you can increase the percentage of profit by reducing a specific item of expense. Your goal, of course, is to do both: to decrease specific expenses and increase their productive worth at the same time.

Before you can determine whether cutting expenses will increase profits, you need information about your operation. This information can be obtained only if you have an adequate recordkeeping system. Such records will provide the figures to prepare a profit and loss statement (preferably monthly for most retail businesses), a budget, break-even calculations, and evaluations of your operating ratios compared with those of similar types of business.

A useful method for making expense comparisons is break-even analysis. Break-even is the point at which gross profit equals expenses. In a business year, it is the time at which your sales volume has become sufficient to enable your over-all operation to start showing a profit.

Once your sales volume reached the break-even point, your fixed expenses are covered. Beyond the break-even point, every dollar of sales should earn you an equivalent additional profit percentage.

It is important to remember that once sales pass the break-even point, the fixed expenses percentage goes down as the sales volume goes up. Also the operating profit percentage increases at the same rate as the percentage rate for fixed expenses decreases - provided, of course, that variable expenses are kept in line.

Locating Reducible Expenses
Your profit and loss (or income) statement provides a summary of expense information and is the focal point in locating expenses that can be cut. Therefore, the information should be as current as possible. As a report of what has already been spent, a P and L statement alerts you to expense items that bear watching in the present business period. If you get a P and L statement only at the end of the year, you should consider having one prepared more often. At the end of each quarter might be often enough for some firms. Ideally, you can get the most recent information from a monthly P and L.

Regardless of the frequency, for the most information two P and L statements should be prepared. One statement should report the sales, expenses, profits and/or loss of your operations cumulatively for the current business year to date. The other should report on the same items for the last complete month or quarter. Each of the statements should also carry the following information:

  1. this year's figures and each item as a percentage of sales.
  2. last year's figures and the percentages.
  3. the difference between last year and this year - over or under.
  4. budgeted figures and the respective percentages.
  5. the difference between this year and the budgeted figures - over and under.
  6. average percentages for your line of business (industry operating ratio) when available, and
  7. the difference between your annual percentages and the industry ratios - under or over.

This information allows you to locate expense variation in three ways: (1) by comparing this year to last year, (2) by comparing expenses to your own budgeted figures, and (3) by comparing your percentages to the operating ratios for your line of business. The important basis for comparison is the percentage figure. It represents a common denominator for all three methods. When you have indicated the percentage variations, you should then study the dollar amounts to determine what line of operative action is needed.

Because your cost cutting will come largely form variable expenses, you should make sure that they are flagged on your P and L statements. Variable expenses are those which fluctuate with the increase or decrease of sales volume. Some of them are: advertising, delivery, wrapping supplies, sales salaries, commissions, and payroll taxes. Fixed expenses are those which stay the same regardless of sales volume. Among them are: your salary, salaries for permanent non-selling employees (for example, the bookkeeper), depreciation, rent, and utilities.

Taking Action

When you have located a problem expense area, the next step obviously is to reduce that cost so as to increase your profit. A key to the effectiveness of your cost-cutting action is the worth of the various expenditures. As long as you know the worth of your expenditures, you can profit by making small improvements in expenses. Keep an open eye and an open mind. It is better to do a spot analysis once a month than to wait several months and then do a detailed study. Take action as soon as possible. You can refine your cost-cutting action as you go along.


A company which rents out industrial equipment decides to expand its facility, so it can offer more equipment. Of course, building is a big capital expense, and the company has to go loan hunting. Or maybe not.

What if the company could take an asset it's not using to full potential... such as equipment which only goes out on weekends, and turn it into that warehouse... or part of that warehouse anyway. Hocus pocus?

It's called barter.

When you join a barter network, you exchange goods or services for barter dollars from members of the network. Then you use those to purchase from other members. The accounting's simple, and it's easy to market your services to other members.

Barter has three big benefits. It allows you to turn downtime into goods and services. It's great for employee incentives. And it can help generate real -- that is, cash -- business.

Here's how the rental company can turn it's downtime into a warehouse.

Barter's great if you can use an underutilized resource. The equipment that's sitting idle has a new market. The members of the network will be more apt to come to the rental company, because they'll save cash. The barter dollars the rental company receives can be put toward the expansion in building supplies and contractors.

Presto. Rental equipment into warehouse space.

You can also use barter to save on employee benefits. By using barter dollars as hiring incentives, raises, bonuses, or as medical benefits -- since many medical services can be bartered -- you can provide valuable rewards for less. You can also look at sending employees to special events or on training using the barter network.

Barter can help you get new clients and generate business.

Say you're bidding on a big contract from a hotel customer. You can consider taking partial payment in cash and the rest in hotel rooms (since hotels always have empty rooms.) By being creative and flexible in your terms, you can win bids.

As well, once you introduce your service to new customers in the network, you can expect to get real cash business from many of them down the road.

Next time, we'll show you how to get customers to invest in your business.

How to find the right barter exchange

Barter exchanges abound. Make sure that barter is right for you, and the exchange you choose is right for you, too.

1. Check on its history. A well established exchange is a good bet for service, variety of products and services available and confidence it's going to be around.

2. But get references, too. Talk to some of the people on the exchange and find out how they've found service and availability in the past. Ask specifics about how they've used it to make sure their comments are relevant to you.

3. Make a list of products and services you require and check to see that the exchange offers these on a regular, ongoing basis.

4. Find our whether the exchange is regional, national or global. While you might buy office supplies from a company 1000 miles away, you're not going to be able to take advantage of the automotive oil change offered in that city.

5. Check out the fees. These usually include monthly membership, plus a percentage on purchases and sales.

6. Make sure you can sell, but also that your income won't exceed your ability to purchase. While you can put a hold on your service -- go on standby -- you continue to pay monthly fees.

Get more information on Entrepreneurship


Book Details

  • Book
  • Authors
  • KHAN, M.Y. JAIN, P.K.
  • Publisher
  • ISBN-10
  • 007040223X
  • ISBN-13

  • Edition
  • 1/e, 2000

Book Description


The book provides a framework for understanding of the fundamentals of financial management in terms of investment; financing and dividend policy. It gives a comprehensive account of the basic concepts, theories, and techniques underlying the subject, in the context of the financial, legal, and taxation environment in India. The authors have followed an analytical approach, with due emphasis on managerial problem-solving and decision-making situations that business firms encounter in their day-to-day operations. Learning aids are: easy-to-understand language and lucid presentation; numerous real-life illustrative solved problems; end-of-chapter exercises, with answers as appropriate; discussion on contemporary industry practices, including procedural aspects; financial tables; glossary; bibliography, and Index.

Finance Books

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finance for companies

In 2009, our Opportunities in adversity program led to more than 45,000 meetings with companies to discuss the challenges of the new market conditions. Insights from these meetings enabled us to identify Lessons from change — and a new performance wheel comprising eight key goals.

But we wanted to take this a step further, so we commissioned the Economist Intelligence Unit (EIU) for additional research, surveying 876 global executives. Can we move from observed practice of what companies are doing to a more helpful guide to what they should be doing?

What high-performing companies are doing differently

The companies we surveyed showed high levels of adoption of the eight goals of the performance wheel.

Using EBITDA (earnings before interest, taxes, depreciation and amortization) as our measure of performance, we have sought to identify the differences between the level and types of action undertaken by those companies experiencing above 5% growth in earnings and those experiencing less.

Higher-performing companies have significantly higher levels of adoption of almost all programs, as you can see on the two actions per “spoke” on the performance wheel, where the differences in levels of adoption were most pronounced.

Findings from the market

A picture is beginning to emerge from our work — across countries and sectors — of a group of companies that share a particular performance agenda to drive market success. High performers are consistently:

  • Seeking to develop a broader and deeper view of their market opportunities, today and tomorrow
  • Being more innovative in strategy and structure than their competitors, more collaborative with partners and more questioning of themselves and their potential
  • Taking a much more holistic and long-term approach to their people and communicating more frequently and transparently to both their internal and external stakeholders
  • Broadening their understanding of risk in their market and from their actions, and tightening their execution and key support processes to mitigate that risk
  • Pursuing and attaining greater speed in making and executing decisions to take advantage of their changing market

These successful companies are equipping themselves for the new economy. What actions do you need to take to be one of them?

Driving toward the rebound

Twelve months ago, companies were focused on survival. Today we see the economy beginning to recover, for a wide variety of reasons:

  • US$1.8 trillion in government stimulus
  • The resilience of some larger emerging markets
  • The continued existence of large amounts of mobile capital

The global recession — already over in many countries — is now expected to end in 2010. The common view holds that a gradual recovery will become more apparent, although markets are only likely to strengthen in 2011 and 2012.

Optimism has increased...

Our research shows that over 50% of companies still have a focus on securing their present business, down from 74% in January 2009. And the number who report they are aggressively looking for future opportunities has almost doubled. It is the action of these companies that will drive the rebound.

...but growth remains a challenge

Only 32% of respondents saw revenue growth returning to pre-crisis levels within six months. A further 31%, however, said it would take two years or more for this level of recovery to be achieved, suggesting a rather sluggish recovery for much of 2010.

This is the burning platform for companies: getting revenue growth back. Indeed, if we have just been through a “credit crisis,” we have now entered a “growth crisis.” Revenue growth is the dominant challenge for today’s executives.

The need for action

We believe the critical determinant of a company’s performance is management action. Executives would be unlikely to adopt all the action programs we have identified, but results have shown that the higher-performing organizations follow several of the programs of action concurrently.

Not surprisingly, since the majority of companies are still focused on securing the present, levels of adoption reflect the fact that companies are at the early stages of responding.

Only in the area of optimizing capital availability and deployment have respondents already implemented 50% of the action programs we identified. Given the initial “credit crunch” nature of the economic crisis we are going through, this is to be expected.

But, while overall adoption rates are currently just under 40%, a further 36% of our highlighted practices are under active consideration — and companies are following more than one program in each area.

Can earnings be sustained without growth?

Historically, most business models have been built on an assumption of consistent revenue growth. Part of the reason we are seeing the recovery (despite shrinkage in revenue) is that companies have changed their model to extract earnings growth despite anemic sales (through cost cutting, process redesign, outsourcing, shared services and productivity improvements). The real question may turn out to be: how long can companies sustain earnings growth without revenue growth?

Cash Management Basics

Handling and Avoiding Crises

How Do You Define Cash Flow?
If your definition of cash flow is flawed, and you're not tracking the right numbers, you may grow your company right into a cash crisis.
The 10 Absolutely Must Follow Cash Flow Rules

Everyone wants cash on hand at all times. Here are 10 rules to help you get there.
The Magic Number
Every business has a magic number. By employing his, our columnist didn't overstaff this year.
Riding the Economic Roller Coaster
Tighten your seatbelt. Surviving the ups and downs of the world economy means keeping an eye on business finances.
When a Cash Crisis Strikes
Credibility with vendors, bankers, and other creditors is built slowly, but can be destroyed quickly if your company falls behind on payments. Know how to break the bad news to preserve your business's relationships.

Hot Tip: Prepare for a Cash Crisis

How do you prep for a cash crisis? Wayne Karpoff, president of Myrias Software Corp., knew cash would be a problem late last year. His 15-employee, $1.5-million company dropped selling its products and became a full-time service business. So he built a contingency fund into his annual budget -- an amount equal to three months' worth of payroll. He got the idea when his bank suggested he set up a contingency fund to safeguard his mortgage payments in the event he found himself out of work. He dipped into the fund three times last year to float the company during project and payment delays.

Source: Ilan Mochari, Inc magazine, March 2000

Forecasting, Projections and Budgets

The Secrets to Formatting Cash Flow Projections
Here are the keys to creating a powerful tool to take control of your cash flow.
Cash Flow Projections Made Easy
Here is a 4-step process you can use to create cash flow projections you can trust.
Breaking Free from Budgets
Exasperated by budgets that hamstring creativity, a growing number of companies are tossing off financial constraints--and still holding the line on spending.
Budgeting for Blunders
Lisa Hickey created a fund to support creative risks her Boston-based ad agency, Velocity Inc., takes when trying innovative ideas that might not pan out.
A Passion for Forecasting
Don't put together an annual sales forecast using only gut instinct and wishful thinking! Here are some rules you can follow to create a forecast that you and your employees can count on.
Action Plan: Forecasting and Cash-Flow Budgeting
Developing a budget is simple, and when created with solid sales and expense forecasts in mind, you can ensure that your budget will stand up to the daily demands of your business. Here are some steps you can take to create a cash flow budget you can rely on.

financial management: Basics


Whether you are just starting a nonprofit or have been in existence for years, your organization will need a budget. The larger your organization, the more complex the process may be, including creating multiple project or department budgets with the help of several staff. Even a one-person shop needs a budget which details the basic income and expenses of the organization. According to MCN's Principles and Practices for Nonprofit Excellence, "a nonprofit should operate in accordance with an annual budget that has been approved by the board prior to the beginning of each fiscal year".

In order for the board to adequately manage your nonprofit's financial health, it needs a benchmark to measure current income and expense against. A budget can also help predict tough financial times, and will give the board time for contingency planning if grants or other income sources fall through. Lastly, funders will require a budget if you are planning on applying for grants.

New organizations may start the budgeting process by looking at potential income -- figuring out how much money they have to spend. Existing organizations will have an easier time developing a budget as they will be able to review its history of contributed income and stability of earned income revenue streams, such as fees for service or organizational dues.



Establishing an accounting system from scratch is a process that can be greatly simplified by using one of the basic accounting software packages. QuickBooks ( and Peachtree ( each have users that have a strong preference. Quickbooks has also recently released "Nonprofitbooks", accounting software specifically designed for nonprofit organizations ( Ask colleagues and similar organizations if there is one that will work better for the new nonprofit.

  1. Seek the advice of professionals — Hiring or contracting with a part-time or full-time accountant or bookkeeper should be one of the first steps when an organization gets started. Accounting is a tricky business and a service worth paying for.

  2. Documentation is key — Accountants and auditors often refer to a "paper trail" when examining an organization's financial records. It is the responsibility of the nonprofit managers to maintain good records about each financial item whether it is an invoice, a paycheck or a bank statement. Good record keeping helps prevent fraud inside the organization.

  3. File, file, file — Maintain good files that keep relevant information together and make key documents easy to access. Tracking down an invoice from a vendor or a contribution deposit record shouldn't take an afternoon.


the board and financial management

Nonprofit board members have specific responsibilities as stewards of their organizations. Many of these responsibilities are requirements under Minnesota law. Board members are responsible for ensuring that the nonprofit is managed in a fiscally sound way and that the organization has adequate resources to operate its programs and fulfill its mission. Board members must do so by monitoring the organization's financial activity on a regular basis. Failure to do so can result in serious consequences for the organization (see Jon Pratt's article, "Financial Malfeasance and Nonfeasance: Ten Pitfalls Boards Should Avoid".)

Nonprofit board members are responsible for:

  • Reviewing and approving the organization's financial statements (usually a statement of functional expenses and balance sheet) on a regular basis.

  • Reviewing and approving the organization's federal Form 990 and annual audit, if one is conducted.

  • Making sure and taxes and accompanying forms and paid and filed with the appropriate state and federal agencies (Minnesota Department of Revenue, IRS etc).

  • Updating the organization's mandatory insurance policies

  • Reviewing and approving contracts and large financial transactions or payables.

  • Reviewing and approving the salary of the Chief Executive and salary ranges for staff positions.

  • Developing and overseeing internal financial controls and investment policies.

  • Investigating warnings or reports of officer or employee theft or mismanagement, including reporting the misconduct to the proper authorities.


legal requirements for financial management and reporting

IRS Form 990
Return of Organizations Exempt from Income Tax. Even though a nonprofit organization may be tax exempt, it must file an annual tax return with the Internal Revenue Service. Generally, charities with more than $100,000 in gross revenues and more than $250,000 in total assets must file the Form 990; smaller charities may file the EZ Form.

This is the most detailed and most misunderstood filing for nonprofits. It is the most complete documentation of an organization’s financial history and is often used to hold the organization accountable for its past actions and future decisions. Recent rulings by the Internal Revenue Service state that nonprofit organizations must make their Form 990 and applications for tax-exempt status widely accessible and available to anyone who requests. The Form 990 is available in the back of this book.

Filing Fees: None.
Late filing: Severe penalties apply for filing late or failing to file.
Mail to: Internal Revenue Service, Ogden, UT 84201-0027.

Charitable Organization Annual Report Form
The Charitable Solicitation Act states that an annual report must be filed with the Attorney General by the 15th day of the 7th month after the close of the organization's fiscal year. An organization must also include a copy of IRS Form 990 and an audited financial statement, if applicable. This form is provided in the back of this book.

Filing Fees: $25
Mail to: State of Minnesota, Office of the Attorney General, Charities Unit, Ste 1200, NCL Tower, 445 Minnesota St., St. Paul, MN 55101.

Nonprofit Corporation Annual Registration
After an organization has filed for incorporation, it must continue to register annually with the Minnesota Secretary of State. Failure to register by December 31 each year will result in the dissolution of the organization, and a $25 fee will apply to reinstate the organization’s corporate existence.

The Secretary of State’s Office will send the incorporated nonprofit its registration form each year with the organization’s name and address already completed. If that information has changed, the organization will also need to amend its articles of Incorporation.

Filing fee: None if filed on time. $25 fee to reinstate if filing late.

Mail to: Secretary of State, Records Processing Division, 180 State Office Building, 100 Constitution Ave., St. Paul, MN 55155-1299.

Unrelated Business Income Tax (UBIT)
According to the IRS, 501(c)(3) organizations are subject to an Unrelated Business Income Tax, which is any unrelated trade or business income that is regularly carried on and not substantially related to the organization's exempt purpose or function.

Nonprofits with more than $1,000 in UBIT must complete Form 990-T by the 15th day of the fourth month after the end of the tax year. Excessive UBIT can jeopardize the tax exempt status of an organization.

Filing fee: None.
Late filing: Severe penalties apply for filing late or failing to file.
Mail to: Internal Revenue Service, Ogden, UT 84201-0027.

Minnesota Employers Unemployment Quarterly Tax Report (MDES-1)
Required if the organization has paid employees. Filing is quarterly. MCN members can save money by opting to join the Unemployment Services Trust (UST) rather than participating in the state unemployment tax system.

Other forms and legal requirements:

  • IRS Form 941 (Employer's Quarterly Federal Tax Return). Required if the organization has paid employees.
  • Worker's Compensation Insurance. Required if the organization has paid employees.
  • Minnesota State Sales Tax. If not granted a sales tax exemption from the Minnesota Department of Revenue, Minnesota nonprofits are required to pay state sales tax on taxable purchases at the time of purchase.
  • IRS Form W-4 (Employee's Withholding Allowance Certificate). Must be completed by all employees.
  • INS Form I-9 (Employment Eligibility Verification). Must be completed by all employees. Proof of employee's eligibility to work in the United States.
  • IRS Form W-2 (Wage and Tax Statement). Must be distributed by the employer to ALL employees who were paid during a calendar year who were not contracted employees.
  • IRS Form 1099 MISC. Must be distributed by employer to all contracted employees who were paid in a calendar year.


(From the Summer 2002 issue of Nonprofit News, Minnesota Council of Nonprofits. By Dan Sprague, Small Business Management Instructor, South Central Technical College.)

NonprofitBooks has arrived. QuickBooks Pro® no longer stands alone as the sole solution to your nonprofit fund accounting needs. Many nonprofit organizations cannot afford expensive fund accounting packages and don’t have the trained personnel to implement them effectively. These organizations desperately need a cost-effective solution to their accounting needs to meet the many reporting and information demands required by external agencies, boards and donors.

QuickBooks Pro is a very robust package with excellent support, capabilities and a huge installed base. It is a proven product. However, QuickBooks is not designed specifically to do fund accounting. Add-on packages such as NonprofitBooks, by B2P Commerce Corporation, augment the ease and capability of using QuickBooks for specific applications such as nonprofit fund accounting.

Intuit, the maker of QuickBooks, recently created an interface (a way to connect data between QuickBooks and applications) designed to help specialty software work with QuickBooks. NonprofitBooks is one of these new solutions.

B2P says you will save time by reducing the amount of data entry, thus reducing the number of input errors. Input uses forms familiar to fund accounting transactions. Additionally, reports are in the correct format for informing boards and agencies. That’s the theory in a nutshell.

Using NonprofitBooks requires purchasing current versions of both software packages. QuickBooks will do all the regular business functions such as payroll, accounts payable, accounts receivable and database management. NonprofitBooks provides an easy-to-use template for allocating program expenses, keeping track of restricted grants, and generating specialized financial reports for stakeholders.

NonprofitBooks will help you setup your chart of accounts, programs, and grants. Statements include Statement of Functional Expenses, Statement of Financial Position, Form 990 preparation information, Statement of Cash flow, Allocation History, and Statement of Activities. Both programs can operate with Windows 95, 98, 2000, ME, NT or XP. NonprofitBooks helps implement the requirements of FASB 117, which requires the designation of permanently restricted, temporally restricted and unrestricted accounts. Note: all this can be done with just QuickBooks Pro, but requires more user expertise.

There is a downside. Organizations wanting to use the QuickBooks Pro/ NonprofitBooks combination will have to start over. This means creating a new organization and re-entering all relevant data. This can be a significant disadvantage if your present transaction file is large. In addition, this is new and unproven software from a small company with no installed user base. The upside: this package looks promising and addresses some very important issues for nonprofits. Visit NonprofitBooks at

South Central Technical College is a certified training partner with NonprofitBooks and certified advisors for QuickBooks Accounting software. Upcoming QuickBooks for Nonprofit classes offered by SCTC and MCN will offer a NonprofitBooks module. Please check MCN’s Web site for updates and further information (


(By Melanie Herman, Nonprofit Risk Management Center)

In 1950, the Internal Revenue Code (IRC) was amended to include a provision concerning unrelated business income tax or UBIT. The change in the code was intended to remove unfair competition between nonprofits and for-profits. Thus, it made net profits from activities that don’t further a tax-exempt organization’s exempt purposes subject to normal corporate-tax rates. Although this sounds straightforward enough, the regulations offer a sumptuous feast of complicated options each of which need to be sampled and digested before moving on to the next course.

Under Section 512(a) of the IRC, tax-exempt nonprofits are subject to tax on gross income, minus directly connected expenses, for activities that constitute an “unrelated trade or business.” The Code offers a three-prong test for determining whether a particular activity is an “unrelated trade or business.” The activity must be (1) a trade or business that is (2) regularly carried on, and (3) isn’t substantially related to the organization’s exempt purpose. Remember:

  • Incurring UBIT liability isn’t inherently bad. If you generate “unrelated business income” per the IRS rules, you should report this income and directly connected expenses on IRS Form 990-T. Subsequently, you may owe some taxes on that income. However, since you only pay taxes on the activity’s net income after you subtract allowed expenses (“directly connected expenses”) from the gross reported income, in many cases, generating unrelated business income results in no tax liability. Many nonprofits that have been at this for a long time simply consider the tax liability on their UBI as a cost of doing business.

  • If your nonprofit incurs unrelated business income, you’re in good company. In 1995, more than 36,000 exempt organizations reported gross unrelated business income. This number has no doubt risen in the past five years.

  • The IRS can help. Obtain a copy of Publication 598, which offers a thorough explanation of UBIT. It’s available as a PDF document at Or start at and look for Publication 598 under the “Publications and Forms” section of the IRS Web site.

  • A nonprofit that expects to incur $500 or more in UBIT liability must make estimated tax payments on a quarterly basis. Large nonprofits that generate substantial unrelated business income may be subject to the Electronic Federal Tax Payment System (EFTPS).

  • Seek advice and counsel. If you are uncertain whether or not your nonprofit is generating unrelated business income, seek the advice and counsel of an attorney or a CPA with experience in this area.

A number of activities are specifically excluded from the IRC’s definition of “trade or business.” Here’s a partial list:

  • Volunteer services - an activity where substantially all of the work performed is done by uncompensated personnel.

  • Provided for the convenience of members - an activity offered for the convenience of an organization’s members.

  • Qualified sponsorship activities - recognizing the financial support of a corporate sponsor by listing the sponsor’s name. An acknowledgement of sponsorship isn’t “advertising” as long as it doesn’t include qualitative or comparative language, price information or other indications of savings or value, or the nonprofit’s endorsement.

  • Bingo games - in states where bingo is legal and isn’t regularly sponsored by for-profit businesses.

  • Mailing list exchanges - the exchange of mailing lists between exempt organizations.

  • Convention or tradeshow activity - a convention offered for educational purposes, including the sale of exhibit or display space at the convention.

The Usual Suspects
While there various activities that may result in unrelated business income (UBI), we focus below on two areas that generate concern and confusion among nonprofits. For a thorough treatment of this subject, see IRS Publication 598.

Licensing Arrangements – During the past two decades there has been phenomenal growth in the number of nonprofits that enter into licensing arrangements with for-profit businesses and earn a royalty for these arrangements. As long as the tax-exempt organization’s participation is passive, it’s unlikely to face the prospect of UBIT. When the nonprofit actively participates in the arrangement, such as by aggressively promoting the sale of a mailing list or assigning a staff to undertake specific tasks that promote the licensor’s products, the IRS may find that the activity falls outside the exception for licensing arrangements. To avoid converting your licensing arrangement to one that generates unrelated business income:

  • Make your mailing list (or other items licensed by your nonprofit) available on a selective basis only, devoting only minimal staff time and expenses to the maintenance and marketing of the list;

  • Avoid providing any specific services to the licensee that assist them - beyond something as simple as informing members of the availability of the product through an annual notice - in promoting their products or services;

  • If you do provide services, delineate these services in an agreement that is separate from your mailing list rental or other licensing agreement;

  • Refer to the agreement as a “Licensing Agreement,” and make certain that the agreement specifies that the nonprofit isn’t providing specific services in exchange for the royalty payment;

  • Make certain that fees charged for mailing list rental or other licenses aren’t based on the actual net income generated by the renter - doing so could result in the classification of the arrangement as a joint venture, rather than a true licensing agreement;

  • Report the income generated through licensing arrangements as royalty income on your Form 990.

Advertising - Paid advertisements are one of the most common sources of UBI in the nonprofit sector, as numerous nonprofits feature paid advertising in their periodicals to offset the expense of publishing educational material. In many cases, however, the expenses specifically related to the advertising may offset the revenue resulting in no net tax liability to the nonprofit.

The IRS recognizes that nonprofits often publish for educational purposes. It’s important to make certain that your nonprofit properly accounts for its advertising revenues and expenses and keeps within the requirements established by the IRS. Unless, of course, it’s your intention that your publishing activities fall outside the safe harbor, you should pay close attention to the four-prong test used by the IRS to determine if publishing activities are educational and thus consistent with a nonprofit’s exempt purposes. This test consists of the following criteria:

  1. The content of the publication must be educational - such as information to help individuals improve their capabilities.

  2. The preparation of materials must follow “educational” methods. Reasoned and factually supported material is likely to be considered educational; unsupported opinion is not.

  3. The distribution of materials must be necessary or valuable to achieving the nonprofit’s exempt purposes; and

  4. The manner in which the distribution is accomplished must be distinguishable from ordinary commercial publishing practices - the lack of a profit motive is often cited as the most important factor distinguishing a nonprofit’s publishing activities from regular commercial publishing. Substantial net profit from publishing may result in an unfavorable ruling from the IRS.

Understanding the unrelated business income provision of the Internal Revenue Code is no easy task. However, like consuming a Thanksgiving feast, the safest approach is to take small bites, chew carefully and pace yourself. And never forget the critical importance of reaching out to the professional advisors that serve your nonprofit - your attorney and your CPA - for help understanding and applying the regulations and the judicial interpretations of the regulations to the circumstances facing your organization.

Melanie Herman is executive director of the Nonprofit Risk Management Center, a resource organization that provides free technical assistance to nonprofits, in addition to a host of products and services.

article: "Financial malfeasance and nonfeasance: ten pitfalls boards should avoid"

(By Jon Pratt. Reprinted with permission of Board Member, a publication of BoardSource).

Recitals of fiduciary duties of boards are rich in prescriptive advice about due diligence and prudent investments, but usually fail to explain just how things can go wrong. Learning from the bad experiences of others is strongly preferred to the school of hard knocks, especially since board members may confront any given situation only once or twice in the course of serving on many boards.

The following are my nominations for the top ten types of financial malfeasance (misconduct or wrongdoing) and nonfeasance (failure to perform an official duty) by nonprofit boards.

  1. Ineffectually scrutinizing the overall enterprise. Proper financial oversight requires board members to receive (and read) timely financial statements. An obvious red flag is late or incomplete financial reports, but statements that are either too voluminous or too sketchy can be just as bad. Three frequent blunders of boards are: they don't receive or distribute to other members the organization's IRS Form 990, the informational disclosure from that most nonprofits must file with the IRS every year; they don't know how functional allocations were made (between fundraising, management, and program expenditures); and they don't discuss their auditor's management letter.

  2. Failing to monitor key indicators, allowing the organization to drift into financial trouble. Both the management and the board need to make sure revenue and expenses match up -- tracking trends in income, debt-to asset ratios, and overspending in particular budget categories. When income is delayed or less than expected, a surprising number of executives are reluctant to tell the board. Instead, they hope things will turn around; meanwhile they defer paying outside obligations, including the IRS. If you are a board member there is nothing more frustrating than to discover your personal tax refund has been frozen pending satisfaction of an IRS claim against the charity you serve.

  3. Failing to pay sufficient attention to whether the organization's financial resources are being effectively spent on programs. What are the documented performance results of the major programs of the organization? Donors, the media, and recipients of services are all asking for documentation of outcomes, not just the number of clients served or total dollars spent.

  4. Being too trusting of staff who handle money. While the people in the office with the blank checks would not have been hired if they were not judged to be trustworthy, prudence requires that boards not only trust but verify. The embarrassing number of embezzlement cases in nonprofits is due to inadequate internal controls (separation of functions, limits on check writing authority, etc.), and some boards are now forming financial control committees.

  5. Lacking strong external checks on financial reporting. Organizations with budgets above $350,000 per year should have a certified audit, but many do not (only three states require registered charities to have an audit).

  6. Emphasizing executive compensation at the expense of other employees. Board members are frequently grateful for the hard work of senior management and show it by paying competitive salaries. The focus on executive pay to the neglect of organization-wide compensation policy results in steeper hierarchies of pay, with stagnant income from the middle of the organization down, decreased morale, and high turnover among front-line workers.

  7. Failing to "bid out" the sale of organizational assets. The most pressing examples of uncompetitive sales are in the current wave of nonprofit hospital conversions, but the same issues have risen in sales of buildings, camps and religious television stations, which often go to a single bidder. Has the board independently ascertained the selling price to ensure its fairness?

  8. Failing to scrutinize outside service contracts sufficiently. Is the organization getting the best deal possible from its fundraising, direct mail, or telemarketing consultants? Most outside contracts should be re-bid at least once every three years.

  9. Spending funds restricted by time or purpose. Sometimes board reviewing financial statements allow special project dollars, capital, and even endowment funds to be spent on general expenses as a "temporary" internal fix for cash flow problems. Such temporary uses of restricted funds are technically a violation of law in every state, but the real problem is that many organizations dig themselves into permanent holes.

  10. Mixing charitable and business interests. Board conflicts of interest are on the rise as nonprofits increasingly seek out "win-win" partnerships. The dilemma is that this is an intentionally tangled web. Since many board members are sought for their connections, it is not surprising that some board members leverage deals at both ends of the relationship.

Staying on top of organizational finances is more and more important, especially in light of increased use of the Internet as an accountability tool for the nonprofit sector. Most organizations' IRS Form 990 is available on the Internet, allowing the whole world to look over and organization's shoulder and second-guess any financial decision of the board.