Do Nonprofits Have Retained Earnings?

While the term “retained earnings” is associated with for-profit businesses, nonprofits have an equivalent concept representing their accumulated financial strength. This article explains this financial concept and its function within a nonprofit context.

Understanding Unrestricted Net Assets

Nonprofit organizations utilize “Unrestricted Net Assets,” the functional equivalent of retained earnings in for-profit entities. These assets represent resources a nonprofit’s governing board can use at its discretion to further the organization’s mission, free from donor-imposed stipulations. This category reflects the accumulated surplus, or sometimes deficit, of a nonprofit’s operations over its existence, after all expenses have been covered.

Unrestricted net assets do not solely represent cash on hand. They encompass the net value of all unrestricted resources, including monetary assets like cash and investments, as well as non-monetary assets such as property and equipment, after accounting for liabilities. The Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 958 governs how nonprofits classify and report these net assets, categorizing them as “net assets without donor restrictions.”

How Unrestricted Net Assets Accumulate

Unrestricted net assets increase primarily when a nonprofit generates an excess of revenues over expenses in a given fiscal period, resulting in an operating surplus. This accumulation signifies sound financial management and successful resource generation. Conversely, consistent operating deficits over time will reduce these accumulated assets.

Various revenue sources contribute to the accumulation of unrestricted net assets. These often include individual donations made without specific donor instructions, revenue from fundraising events, program service fees, and government grants that do not carry specific restrictions. Investment income that is not donor-restricted also adds to this category. The ability to accumulate these funds provides a nonprofit with the flexibility to allocate resources where they are most needed, supporting day-to-day operations and strategic initiatives.

Financial Reporting and Importance

Unrestricted net assets are reported on a nonprofit’s Statement of Financial Position, which is comparable to a balance sheet in a for-profit business. This line item provides a snapshot of the organization’s financial health at a specific point in time, reflecting the cumulative difference between revenue and expenses over the organization’s life. The Statement of Financial Position, along with other financial statements, helps demonstrate an organization’s accountability to donors, grantors, and other stakeholders.

The balance of unrestricted net assets indicates a nonprofit’s financial stability and its capacity to sustain operations and pursue its mission. A healthy balance allows an organization to withstand unexpected challenges, such as economic downturns or unforeseen expenses, and provides a financial cushion to manage cash flow fluctuations. It also enables the nonprofit to fund future initiatives, invest in capacity building, or cover operational costs during periods of lower revenue. A low or negative balance may signal financial distress and a limited ability to respond to changing needs or pursue new opportunities.

Key Differences from For-Profit Retained Earnings

The fundamental distinction between unrestricted net assets in nonprofits and retained earnings in for-profit companies lies in their core purpose and ownership structure. Retained earnings in for-profit entities represent accumulated profits that belong to the shareholders and can be distributed as dividends or reinvested to generate further profit for owners. The primary goal of a for-profit business is to maximize shareholder wealth.

In contrast, unrestricted net assets in nonprofits are accumulated solely to advance the organization’s public benefit mission. Nonprofits do not have owners or shareholders, and therefore, these assets cannot be distributed as profits or dividends to individuals. Any surplus generated by a nonprofit is reinvested back into the organization to support its programs, services, and operational continuity. This structural difference underscores the distinct legal and operational frameworks governing nonprofit and for-profit entities.