Accounting for Social Enterprises: Lessons Learned

Starting a social enterprise can be a great way for your organization to achieve the double bottom line:  mission impact and a new unrestricted revenue stream. Measuring mission success is core to every nonprofit. Managing finances is, too, and a new social enterprise will also mean significant responsibilities to your accounting department. How do you launch and maintain a successful social enterprise without causing your accounting department to walk out? In our experience at Propel Nonprofits, there are five key things to keep in mind.

1. Separate organization or not?

There are many ways to legally structure a social enterprise.  Many organizations keep their social enterprises under their organization’s umbrella as another program. Other organizations set-up separate nonprofits or LLCs to house their social enterprises due to liability and tax concerns. Each method has its pros and cons.To figure out the best solution for your organization keep your mission top of mind and engage with an attorney and financial professional.

2. Is your social enterprise making money?

While there can be many benefits to starting a social enterprise besides financial rewards, helping an organization’s bottom line is the key reason many nonprofits look to start social enterprises. So how can you tell if your social enterprise is adding cash to your organization?

Cost of Goods Sold

COGS, or Cost of Goods Sold, is how much money each unit of product costs to produce. The more you produce the higher your COGS expense. This is separate from your fixed operating costs, which are consistent no matter how much product you produce. Calculating COGS can be as simple as adding up ingredient costs to including salaries and equipment costs.  In most cases, an estimate will suffice. As your social enterprise grows in size and sophistication you can always refine your COGS calculations.

Know your margins

Your margin is the money you receive for a product minus your COGS for the product. Once you know your margins you can start asking questions like: Am I making or losing money on each sale (very important to know!)? How much product do we have to sell to pay for the social enterprise’s fixed operating costs? How much do we have to sell to contribute to our organization’s operating costs? At what price do we need to sell our product to break even?

Knowing the answers to these questions can give you a much better idea if your social enterprise is adding to your organization’s bottom line or if it is being subsidized by your other programs, which you do not want to do for a social enterprise.

3. What is your source of truth?

Let’s say you open an art gallery. You now have dozens of sales transactions a day rather than a couple dozen a month. As a client of mine figured out very quickly, trying to enter that volume of transactions into your accounting software makes you want to throw your computer out the window.

Instead, they decided not to have their accounting software be the only source of truth when it comes to tracking transactions. They now enter all sales into their point of sale (POS) software, also called a subsidiary journal. Every month one journal entry transfers the needed high-level information (total sales, cash received, sales tax payable) to their accounting software and individual transaction information stays in their POS software.

You don’t have to reinvent the wheel. When you encounter accounting issues, it’s likely other organizations have struggled with the same things. Copy their solutions, even if you have to invest in new technology.

4. Tracking inventory

If your social enterprise involves selling product, you now get the fun new task of tracking inventory. This could look very different depending on the type of product you’re selling (does it expire?), how you’re selling it (online? storefront?), and the sophistication of your POS software. One coffee company I worked for sold most of its coffee directly over the phone or by customers emailing in orders. Because of the need to track both orders and monitor coffee expiration dates, it tracked inventory in its accounting software but kept a separate spreadsheet that detailed the coffee expiration dates.

Another client tracks everything in their POS system, as they don’t have expiration dates or online sales to worry about, plus they have a POS sophisticated enough to track what they need. In both cases, the organizations regularly physically count their inventory to ensure their inventory system matches what’s on the shelves.

5. What about taxes?

Paying taxes, while not ideal, can actually be a good sign – your social enterprise is making money! Not so good: needing to pay sales tax or unrelated business income (UBIT) and not knowing it until the auditors come knocking. While these taxes could be their own blog posts, here are a few key points to remember about these two taxes:

Minnesota Sales Tax

  • Tax that your organization needs to collect and pay to the State when selling items
  • Requires creating a login with the Minnesota Department of Revenue and submitting sales reports
  • Generally if a for-profit would have to collect sales tax on it, you will as well, unless it’s specifically for a fundraising event

Unrelated Business Income Tax (UBIT)

UBIT is tax nonprofits pay when they are making money doing activities not related to their mission. It’s intended to level the playing field between nonprofits engaged in purely profit-making activities and for-profit businesses. The key question is whether the activity furthers your nonprofit’s mission (besides raising money); if the answer is “no,” you’ll have to pay UBIT. For example, a housing nonprofit would have a hard time justifying not paying UBIT on a café it opened, whereas a nonprofit focused employment for formerly incarcerated people who does job training at the café could argue that the café – and related income – is mission critical. Key points to remember are:

  • UBIT is tax regularly carried on business activities not related to the mission of the organization
  • Requires 990T to be filed with 990
  • Renting out debt-financed property could lead to UBIT

Starting a social enterprise is exciting but can be a challenging decision for your organization. Making sure your accounting practices are set-up for success can help ensure this exciting time doesn’t turn into an accounting nightmare – or a financial liability for your organization.

Want to learn more? Register for the 2018 Nonprofit Finance & Sustainability Conference on April 19 to attend my full session on Accounting for Social Enterprise.

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