Financial Management of Not-For-Profit Organizations: Generally, Financial

Financial Management of Not-For-Profit Organizations:

Generally, financial management of not-for-profit organizations is similar to the process of financial management in the profit making sector in several aspects. Nonetheless, there are several major differences that contribute to a different focus of a not-for-profit financial manager. In the commercial sector, the for-profit enterprises mainly focus on capitalizing shareholder value and overall profitability. On the contrary, not-for-profit organizations have the basic aim of providing certain socially desirable need on a continual basis instead of increasing shareholder value ("Financial Management of Not-for-Profit Organizations," 2011). The difference in focus between the for-profit and not-for-profit organizations is because the latter does not have financial flexibility of a commercial enterprise since its dependent on resource providers that are not getting involved in an exchange transaction. As a result, the resources provided are channeled towards offering goods and services to a client instead of the actual resource provider.

Important Exercises for Not-for-Profit Organizations:

Since the provided resources are given to clients rather than the resource provider in not-for-profit organizations, the organizations are required to show stewardship of these resources, which implies that finances donated for a particular purpose must be used for that purpose. Therefore, the organization's staff must demonstrate that the money was used as directed by the resource provider. However, the purpose for the provided resources may not be specified by the donor but stated in the organization's stated mission. In essence, the main goal of financial management of not-for-profit organizations is to demonstrate stewardship of donated resources as specified by the provider or as stated in the organization's mission. Notably, the use of fund accounting systems in these organizations has become even more crucial because of the shift to external financial reports on donor restriction.

In order for these organizations to achieve the objective of their financial management processes, there are several important exercises to consider. The two major exercises for not-for-profit organizations to consider in the process is budgeting and cash management. Through these exercises, the organization must critically consider whether it has adequate cash reserves to continue to offer services to its clientele. However, cash flow can be extremely difficult to predict since the organizations are dependent on revenue from resource providers that do not anticipate obtaining the services provided. This difficulty implies that the organizations can experience a management crisis if there is an increase in demand for their services. Moreover, it's challenging to estimate contribution revenue in a reliable manner annually, which necessitates the need for increased emphasis on the control of expenses. Therefore, budgeting and cash management are crucial exercises and activities for control of expenses in not-for-profit organizations.

The other important exercise in financial management of not-for-profit organizations is the need for accountability, which is one of the financial management standards. Since there are several methods that can be employed for the implementation of financial management systems, the organization should select suitable method based on its scale and scope of operations ("Financial Management Guide," 2008). As part of the financial management standards, the not-for-profit organizations should establish accounting structures that offer accurate and complete information regarding all financial transactions. In addition to ensuring that actual expenditures are comparable with budgeted amounts, the organizations should maintain accounting records on a current basis including monthly balancing.

Not-for-profit organizations should also provide protections for all grant property regardless of whether its cash or property and ensure that the property is only used for authorized or specified purposes. This can be achieved through internal control standards like immediate recording of cash receipts, reconciliation of bank accounts, and entrusting petty cash to a single custodian. The internal control standards should be accompanied by effective audit standards that enable the organization to maintain a state of audit readiness. This implies that records associated with the financial and programmatic aspects of grants are usually available and ready for auditing. The final exercise of financial management of not-for-profit organizations is effective financial reporting through suitable reporting standards. These standards promote the timely submission of reports to resource providers and enhance organizational accountability.

Budgets:

Budgets are an essential part of an organization's financial management because they are the operating plan for a financial period. The financial statements express the decisions on how the organization will accomplish its stated objective in monetary terms. Through budgeting the organization's staff and board decide necessary programs and activities that will be carried out for the upcoming financial year. Once these programs and activities are decided, the organization's staff allocates resources that are geared towards ensuring that the programs are delivered or undertaken.

For not-for-profit organizations to develop a reasonable, understandable, and accurate budget, they must have practical knowledge of terminology and accounting standards (McMillan, 2010, p.1). The accounting period for these organizations include a calendar year that starts on January and end in December, financial year that does not necessarily begin at the start of year, and short period that is considered as an accounting period set by the organization.

Not-for-profit organizations experience some budget planning issues like complexity that are associated with the scope and size of the organization's programs and asset base. Since budgets are compilations of plans and objectives of management across all operational phases for a specified time period, program priorities should be balanced in order to develop an effective budget. This requires the organization's management to allocate its capabilities and resources to influence the maximum number of the desired beneficiaries.

The budgetary planning process requires consideration of lead-time for multiyear initiatives and grant requests. During this process, the financial manager of the not-for-profit organization should prepare the budget to ensure that sufficient funds for activities scheduled to be run within a specific period longer than the average budget cycle. Following the adoption of the budget, the organizational staff should use it as a management tool to evaluate operational performance. Notably, the budget should be updated for new situations in order to respond to any unforeseen conditions that arise. Moreover, after the budget is adopted, the not-for-profit organization should use periodic reports for comparison of budgeted revenues with actual revenues as well as budgeted expenses with real expenses (Zietlow, Hankin & Seidner, 2011). The achievement of financial management proficiency is dependent on an organization's ability to improve its budgeting and financial reporting processes.

There are two major kinds of budgeting to consider during the financial management process of not-for-profit organizations. The first is zero-based budgeting that includes the planning process for establishing objectives as part of the process of budgeting. In this case, the not-for-profit organization begins from zero through assuming that no activity or program is necessary and that no finances need to be spent. In addition to using orderly evaluation of every element of revenue and expense, the zero-based budgeting process requires programs that will be undertaken to be proven worthy and financially sound in every financial year. This implies that every program must be evaluated to justify its existence and effectiveness when compared to alternative programs. As programmatic priorities are established, the cost center of each program should be examined to prove its necessity in relation to the overall organizational objective.

On the contrary, incremental budgeting evaluates current programs and departments as pre-approved based on the increases or decreases in the allocated financial resources. Though this budgeting procedure, the historical expenses of the not-for-profit organization are the normal base for the commencement of the budget planning. While the focus of incremental budgeting is on the expected changes either above or below the previous fiscal year, budget planning is regarded complete and program priorities as realized. In this case, the not-for-profit organization must determine whether the budget should be based on measurable and predictable statistics or good guesses.

Despite of the selected budgeting planning process, the not-for-profit organization should ensure that an effective budget is developed. This is mainly because a thoroughly planned and executed budget increases the likelihood that the organization will be financially successful. Moreover, a comprehensive budget is an organization tool or mechanism that translates abstract objectives into controllable and measurable units. Generally, the budget shows the performance goals for the upcoming financial year.

The preparation of budgets in a not-for-profit organization is primarily based on policy decisions (McCarthy, Shelmon & Mattie, 2012). However, the organization's treasurer may be the appropriate individual or best qualified person to deal with the figures though he/she is not necessarily involved in the policy decisions. As part of the budget planning process, the organization should appoint a budget committee consisting of people who are responsible for making policy decisions. Nonetheless, a comprehensive estimated cost study and revenue approximations for several programs should be delegated to staff members.

Asset Management:

The second step in the financial management process of a not-for-profit organization is asset management. Following the development of the budget, the not-for-profit organization must look for means to smoothly fund current operations by making the most effective and efficient use of existing or liquid funds. This process is accomplished through maximizing the accessible and obtainable resources to improve return on capital or resources. Resource maximization process incorporates evaluating costs and benefits of several sources of the not-for-profit organization's revenues. In most cases, the revenue sources or sources of income for these organizations are planned gifts and business income ("Financial Management of Not-for-Profit Organizations," 2011).

For a not-for-profit organization, asset or resource management is based on the continual concern perspective in which there is a presumption that the organization's future existence has no limitations. In this case, the organization's management must ensure that the organization has adequate liquid assets that are available to fund current operations. For the organization to function in financially solvent manner, it must pay debts in a timely way and adhere to other fiscal responsibilities. The main goal of asset management is to maintain the most advantageous balance between current assets and the invested or developing assets. Notably, business income earned by the not-for-profit organization must be set aside from those earned in pursuit of organizational objectives and from activities carried out to simply make money.

One of the major aspects of asset management in a not-profit-organization is endowment management. An endowment is described as a portfolio of assets given to a not-for-profit organization to help in its support towards the accomplishment of the stated mission and objectives. In the current world, endowment assets are held in financial instruments that include real estate investments ("Principles of Endowment Management," 2001). As an investment portfolio, the current endowment can achieve capital appreciation and current income.

In the process of endowment management, the not-for-profit managers and board member face several questions with regards to decisions on endowment management. Some of the major concerns in the process include whether the endowment remain restricted, whether funds can be used for other purposes during crises, and whether initial endowment developers require the initial asset to be retained. The other concern for these managers during endowment management is whether its principal is defined as its initial sum or the initial sum including all appreciations and excluding declines in underlying values.

For not-for-profit organizations, the question on whether there is restraint on reinvestment of cash following the sale of an asset is a critical concern during the process of asset management. This concern is accompanied by the issue on whether the asset or endowment can be offered to the specific person first before the not-for-profit organization can sell the initial asset.

As part of addressing these major issues during asset management, there are various concepts that have been developed and can be used by not-for-profit managers. One of the most recent concepts in endowment management is the total return concept which requires any appreciation in asset value used to be considered as an addition to the principal and thought of as income. The other fund balances should be categorized as unrestricted net assets including the renewal or replacement of property and equipment as well as balances originating from agreements with trustees.

Unlike a for-profit organization, the assets of a not-for-profit organization legitimately belong to the organization. Therefore, these organizations have restricted measures on how to handle or manage assets. In case of dissolution of the assets of a not-for-profit organization, its assets will be donated to other non-profit entities. However, the distribution of these assets should be based on the procedures and guidelines stipulated in the organization's constitution or policy of operations.

The Use of Fund:

A not-for-profit organization is created for the common good of the public including educational, religious, and charitable purposes. Therefore, profits or funds raised by these organizations must be channeled back into the organization in order to help in accomplishing its mission (Carter, n.d.). This implies that all the funds raised by the not-for-profit organization will be retained and channeled to activities or programs that enable it to achieve its mission. In addition to be channeled to programs that help in the accomplishment of organizational goals, the not-for-profit can use the funds to pay employees' salaries and handle any other administrative needs.

Many not-for-profit organization often use one checking account for all operations while maintaining several fund balances within one account ("Fund Accounting for Non-Profits," n.d.). Through the commonly established procedures, these organizations easy identify finances that are used for constant programs or activities within the organization from those that are reserved for specific purposes and objectives.

Not-for-profit organizations primarily use five categories of funds i.e. unrestricted current funds, restricted current funds, endowment funds, custodian funds, and land, building and equipment funds. The unrestricted current funds are those used for current assets though they are utilized at the discretion of the governing board of the organization. On the contrary, the restricted current funds are those used to account for current assets but are subject to limitations specified by donors or resource providers. While endowment funds are used for accountability of the principal amount of gifts the organization requires, custodian funds are retained and distributed based on the instructions of the donor. The land, building, and equipment funds are those reserved specifically for the purchase of these assets and associated liabilities.

As previously mentioned, the major factors that govern the use of funds in a not-for-profit organization are the organization's stated mission and the objectives stated by the fund provider. This implies that not-for-profit organizations do not enjoy much financial flexibility in their use of funds like for-profit organizations. The lack of fiscal flexibility is because the effectiveness of the organization in accomplishing its objectives and appropriate use of funds is usually dependent on finances donated for its mission or other specific purposes. In order to ensure appropriate use of funds, the not-for-profit organization must ensure that finances are used towards the accomplishment of some socially desirable need on a constant basis.

Since not-for-profit organizations should use funds or donated resources to accomplish the specific purpose that the funds were donated for or to fulfill its stated mission, the management should demonstrate its stewardship of these funds or resources. This stewardship can be demonstrated through the use of effective financial accounting and reporting systems. The financial accounting systems require the not-for-profit organization to divide resources across two or more financial and accounting entities (Bauers, 2006).

Accounting:

Fund accounting is basically defined as an accounting system that focuses on accountability instead of profitability. Therefore, this accounting system is mainly used by governments and not-for-profit organizations. In the fund accounting system, a fund is a self-balancing set of accounts that have been set aside for the achievement of particular purposes based on the organization's regulations and restrictions. As previously mentioned, fund accounting in not-for-profit organization involves dividing current resources into at least two financial and accounting entities. Consequently, each of these divisions of funds will consist of resources and obligations based on the legal and contractual agreements or specific activities or objectives.

In addition to the segregation of each division of funds based on specific programs and activities, fund accounting also requires self-balancing of every fund accounts that enable the preparation of financial statements. This means that there are no restrictions on the number of funds used provided that the purpose of the fund is logical or mandated. Fund accounting plays a crucial role in financial management of not-for-profit organizations because it promotes the control and accountability of limited resources to enhance the evaluation of organizational performance. While fund accounting contributes to better evaluation of the organizational performance, not-for-profit organizations use it as a tool for internal accounting and management control (Bauers, 2006).

In some instances, not-for-profit organizations are required by law or regulation to generate financial statements based on Generally Accepted Accounting Principles ("Understanding the Basics of Not-for-Profit Accounting," 2002). Actually, many states require such organizations within the state to file annual reports (including financial statements prepared based on GAAP) with the state charities bureau. The preparation of financial statements in accordance with GAAP by not-for-profit organizations enhances the credibility of their financial statements and the fund accounting system.

As a method for recording resources whose utilization may be restricted by some organizational stakeholders, each fund developed by the fund accounting system will contain a self-balancing set of asset, revenue, net asset, liability, and expense accounts. Net assets or fund balances should be categorized as unlimited, temporarily limited and permanently limited net assets on the statement of fiscal position. The classification is mainly dependent on the existence and kind of donor-enforced limitations or restrictions. Apart from promoting the segregation of financial resources, the fund accounting system offers an audit trail as the finances spent for intended objectives and thus released from the limitations.