It sounds fairly obvious that not-for-profit organisations are different to profit-making ones, but this also affects the way they manage and report on their finances. It can quickly become confusing, so a good starting point is looking at the different types of charitable organisations which exist.
Charities, not-for-profits, and Community Interest Companies: what is the difference?
The aims of any organisation are all-important, helping the people who run it to make the best decisions for meeting those goals.
In an ordinary limited company, the aims will often be quite broad, set out in its memorandum and articles. These documents formalise what the directors of the company should (and shouldn’t) do. In practice, this more often than not boils down to make a profit for the shareholders.
Charities, not-for-profits, and Community Interest Companies are different, in that they’re normally set up to deal with much more specific issues.
This means that the trustees of a charity set up to provide talking books probably couldn’t one day decide to set up a bicycle race – unless it helped them deliver on their aims. A business can be much more flexible if the owners want it to be.
It’s a really important point because often, the aims of the organisation dictate how it is structured.
What is a not-for-profit organisation?
The phrase ‘not-for-profit’ is something of a catch-all term, which describes an organisation set up to deal with an issue in the public interest. In short, their activities are for the benefit of the wider community, rather than the financial gain of an individual or a group of shareholders.
They’re often set up to deliver a project or ongoing solution, such as to provide arts facilities for local people, sports clubs for youngsters, or to run a food bank for people in need.
Is a not-for-profit the same as a charity?
Not-for-profits aren’t necessarily always registered charities, though the terms ‘charity’ and ‘not-for-profit’ are often used interchangeably. A registered charity has formal requirements, and must meet the Charity Commission’s rules and regulations. A not-for-profit doesn’t have the same restrictions.
A registered charity is always a non-profit organisation.
A not-for-profit organisation isn’t always a registered charity.
When we talk about not-for-profits, we are really talking about an organisation that doesn’t conform to the same principles of making money for its owner that a business does. For example, a regular limited company might be a not-for-profit organisation, but rather than paying dividends to shareholders it will use any income to meet its charitable aims.
Larger companies often set up and fund not-for-profit organisations as a charitable arm, channelling donations through a subsidiary that is in their control, but not regulated by the Charity Commission.
What is a Community Interest Company?
A Community Interest Company (CIC) is a limited company which has additional features (and reporting requirements!). They exist in order to carry out activities in the interest of the community or a specific subsector.
Known in the accounting world as a Public Benefit Entity (PBE), CICs are at liberty to make a profit and act just like any other business as long as they comply with their aims. Shareholders can even receive dividends, but these are capped:
65% of the profits in a CIC must be used for community purposes
A maximum 35% of the profits can be used to pay shareholder dividends.
Are Community Interest Companies the same as charities?
No, CICs are not the same as registered charities. An organisation can only be a charity or a Community Interest Company – not both. As such, CICs don’t need to conform to Charity Commission rules.
Their aims can be much broader than a charity’s, meaning that they can be set up to generate income for charities. Charities often set up subsidiary CICs to manage their commercial activities, or for related work like lobbying whilst the charity delivers on its aims. Sometimes CICs will be set up as joint ventures between charities and public bodies to deliver on mutually beneficial aims.
Accounting for charitable organisations
When it comes to accounting in charities and not-for-profits, size really does matter. Some of the very large charities will have huge accounting departments to cope with the variety and volume of transactions that they generate.
For the majority of charities though, accounting can be a struggle as they have little in the way of resources and so must cut their cloth accordingly. Smaller organisations often prefer to outsource their accounting and bookkeeping, which leaves them free to deliver on their aims.
Do charities, Community Interest Companies and not-for-profits need to submit tax returns?
All organisations have reporting requirements, but these are different depending on what sort of organisation it is, how it’s set up, and even the amount it receives. It can be quite complicated!
A good place to start is whether or not the organisation is a registered charity. If a charity receives income which doesn’t qualify for tax relief, it will need to submit a tax return.
A charity set up as a trust must complete a Trust and Estate Self Assessment tax return.
If the organisation isn’t a registered charity, it will need to submit a tax return. The kind of return it submits depends on what sort of legal structure it is. For instance, Community Interest Companies and regular companies which are not-for-profit must both submit company tax returns.
There can also be additional reporting requirements depending on what sort or organisation it is. For example, a registered charity will need to submit an annual return to the Charity Commission if its income is more than £10,000. A Community Interest Company must also submit separate reports.
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What records do not-for-profit organisations need to keep?
All organisations must keep accounting records, regardless of what they’re for or how they’re set up! Most businesses use Financial Reporting Standards (FRS). These change depending upon the size and nature of the business, but for registered charities there are different standards entirely.
The Statement of Recommended Practice (SORP) is a reporting standard used by registered charities when they report on their activities. It takes into account the fact that charities are totally different from profit-making enterprises, and that this naturally affects the reporting requirements.
In short, if the organisation is a registered charity, it must use the Statement of Recommended Practice (SORP). Anyone else can use the Financial Reporting Standards (FRS).
Showing what the funds are for
This is arguably the biggest difference between a normal limited company and an NFP or charity (even if they’re also set up as limited companies).
Businesses are free to earn money and then use it as they see fit, but the same isn’t always true for NFPs. When people give donations to a charity, they might do so with no specific expectations, but will likely have some sort of general understanding that the money will be used in a certain way.
Reporting on restricted funds
When local authorities, or grant-making bodies like The Arts Council or National Lottery, give money, it’s often given for a specific reason. The organisation which receives it is not able to use that income for a different purpose. Called ‘restricted funds’, money given for a specific purpose must be kept separate and reported upon.
For example, an organisation might ask the National Lottery for cash to deliver five-a-side football sessions for disadvantaged youngsters. They wouldn’t then be able to use some of it to build a new office.
This means, at the very least, a not-for-profit needs to be able to categorise income in terms of restricted or unrestricted funds.
Accounting for expenses in charitable organisations
When donors give money for projects, they will sometimes ask that the not-for-profit reports on what it was used for. This means that a not-for-profit spending cash to provide services will also need a way to allocate expenses to specific projects so that they can report on them later.
People costs for team members who work on the project will also need adding in, as will the cost of any admin staff supporting it, for example. This can actually get quite complex and time-consuming, and we often find that it can be difficult for smaller charities to achieve.
Choosing the right approach
The world of not-for-profits, CICs and charities is incredibly diverse. They may have totally different aims, completely different resources, and can be tiny or huge. Like all organisations, this means that the approach it takes to accounting must reflect the organisation itself.
The best advice we can give is that if you are unsure how you should deal with the accounting for your organisation, give us a call and we’ll be happy to talk about your particular situation.