Finance Financial Management in Non-Profit Organizations Financial

Finance

Financial Management in Non-Profit Organizations

Financial management of not-for-profits is comparable to financial management in the commercial sector in a lot of respects; but, certain key variations shift the focus of a not-for-profit financial manager. A for-profit company focuses on prosperity and capitalizing on shareholder value. A not-for-profit organization's main goal is not to augment shareholder value; rather it is to offer some socially attractive need on a continuing basis. Budgeting and cash management are two parts of financial management that are very important exercises for not-for-profit organizations. The company must pay close attention to whether it has sufficient cash reserves to go on to providing services to its clientele. Cash flow can be tremendously challenging to forecast, because an organization relies on income from resource providers that do not anticipate receiving the service provided.

Non-profit leaders and managers have to build up at least basic skills in financial management. Expecting others in the company to manage finances is clearly asking for problems. Basic skills in financial management start in the serious areas of cash management and bookkeeping, which should be done in accordance with certain financial controls to guarantee truthfulness in the bookkeeping process.

The management and guard of financial resources must be a concern for all non-profit organizations, from the smallest all-volunteer group to a large, national organization. Without sufficient financial resources, an association is not capable to attain its mission and may not endure. Financial resources or assets can be categorized into three buckets, money, goods, and services. One key to regulating financial management risks is the development and utilization of effectual internal controls. All nonprofits have to have policies and procedures in order to manage the access to and use of its financial resources (See Appendix for definitions).

Introduction

Financial management of not-for-profits is comparable to financial management in the commercial sector in a lot of respects; but, certain key variations shift the focus of a not-for-profit financial manager. A for-profit company focuses on prosperity and capitalizing on shareholder value. A not-for-profit organization's main goal is not to augment shareholder value; rather it is to offer some socially attractive need on a continuing basis. A not-for-profit usually lacks the monetary flexibility of a commercial endeavor because it depends on resource providers that are not employing an exchange deal. The resources provided are aimed at providing goods or services to a customer other than the actual resource supplier. Therefore the not-for-profit must show its stewardship of donated resources, like money donated for a precise purpose must be utilized for that purpose, and only that purpose. That purpose is either set by the donor or implied in the not-for-profit's stated mission. The management and reporting actions of a not-for-profit must highlight stewardship for these donated resources. The employees must be able to show that the dollars were utilized as directed by the donor. The shift to an importance in external financial reports on donor constraint has made the use of fund accounting systems even more vital (Financial Management of Not-for-Profit Organizations, 2011).

Budgeting and cash management are two parts of financial management that are very important exercises for not-for-profit organizations. The company must pay close attention to whether it has sufficient cash reserves to go on to providing services to its clientele. Cash flow can be tremendously challenging to forecast, because an organization relies on income from resource providers that do not anticipate receiving the service provided. In fact, an augment in demand for a not-for-profit's services can lead to a management crisis. It is hard to predict contribution revenue in a consistent manner from year to year. For that reason, the control of expenses is an area of amplified emphasis. Budgeting therefore becomes a serious activity for a not-for-profit (Financial Management of Not-for-Profit Organizations, 2011).

Management

Non-profit leaders and managers have to build up at least basic skills in financial management. Expecting others in the company to manage finances is clearly asking for problems. Basic skills in financial management start in the serious areas of cash management and bookkeeping, which should be done in accordance with certain financial controls to guarantee truthfulness in the bookkeeping process. New leaders and managers should soon go on to learn how to produce financial statements and analyze those statements to really understand the financial situation of the business. "Financial analysis shows the "reality" of the situation of a business -- seen as such; financial management is one of the most important practices in management. This topic will help you understand basic practices in financial management, and build the basic systems and practices needed in a healthy business" (All about Financial Management in Nonprofits, n.d.).

The leaders and staff of non-profit organizations must make sure that accounting records and financial statements are precise and comply with regulatory requirements. For an administrator of a non-profit organization, managing the company's finances is particularly demanding. A non-profit organization's income sources are often subject to changes in both financial forces and political environment. Yet, it has to vie for labor and additional inputs just like any other company. Precise recording and dependable reporting of financial information are the requirements for financial management. Public answerability also necessitates a high amount of correctness and dependability of financial data. The financial statements of a non-profit organization supply a functional overview of the organization's economic health. Financial management involves both planning and implementation. A non-profit manager will need to be able to examine and understand historical and current financial information in order to organize financial plans that will make certain operations of an organization are competent and effectual (All about Financial Management in Nonprofits, n.d.).

Financial Metrics

The fundamental difference between a for-profit business and a non-profit industry is the profit. For-profits are permitted to realize a profit, non-profits aren't. Non-profits can make a profit, which is called a surplus, but they have to invest it back into the organization. For-profits can take the profit and allocate it to their shareholders, owners, or anyone else they'd like (Why non-profit pricing, 2010). Budgets are the organization's working plan for a fiscal period. They articulate, in financial terms, the board's and staff's choices concerning how the organization will accomplish its stated purpose. The board and staff decide what programs will be taken on for the impending fiscal year. The staff then distributes resources to make sure that those programs are delivered. The budget charts a course for apportioning and maximizing the use of resources. "Ideally it also identifies any financial problems that could arise in the coming year. In addition, the budget should provide indicators for gauging staff performance and give staff goals to reach and steps to achieve them. Methodical tracking and classification of program expenditures enhance management's ability to report on service efforts and accomplishments" (Financial Management of Not-for-Profit Organizations, 2011).

The monetary metrics and incentives are radically dissimilar between for-profit and nonprofit organizations. The income statement, earnings per share (EPS), and growth in market capitalization are all extensively focused performance metrics and significant components of long and short-term decision-making performance assessment and reimbursement in the for-profit world. There are literally no similarities for these items in the nonprofit arena. There's no ceremony of tracking stock price on a constant basis on PC screens in the nonprofit world. There is a need for-profit monetary skills on the nonprofit board, but the individuals have to be responsive to the dissimilar nuances in financial reporting and to the function of finance in the nonprofit. For instance, two financial metrics, free cash flow and revenue growth, are also very pertinent to the nonprofit world. A significant supplementary source of funds for the nonprofit world is charity in its diverse appearances of yearly giving, capital campaigns, and intended giving. "Cash flow is king and annual giving and capital gifts are often critical to financial viability" (Epstein & McFarlan, 2011).

In addition, the accounting structure of nonprofits differs from that of for-profits. For instance, nonprofits don't normally apply standard accrual accounting ideas. As an alternative, they use fund accounting. For those companies that have an endowment, momentous pressures exist on the board to administer it efficiently and have a fitting rate of withdrawal. Finally, debt and its servicing condition are vital issues for those nonprofits that have use of the public debt market. Because of monetary reporting metrics, the for-profit world tends to have a burly short-term performance focus. Meeting the quarterly earnings targets, the yearly earnings goal, and the steady drumming of the stock price all drive a short-term direction. Additionally, the pace of the nonprofit couldn't be more diverse. The heart of its monetary activities is the yearly budget, its estimate of revenues, and the hard choices it has to make about a variety of costs. Monthly reviews center on success in meeting cost and income targets where variances against budget are examined constantly. The reality, though, is that pessimistic variances just don't have the same impact on internal and external views of performance as a missed EPS number does for the for-profit. "Beyond all of this, of course, is the need to peer around the corner and look toward the organization's long-term future challenges, which can be five to 10 years in the future" (Epstein & McFarlan, 2011).

Governance

The make up of the board of directors is another major difference between for profit and non-profit organizations. In both cases the original board is shaped by the same people who founded the corporation and, in both cases, directors are given set terms. Things alter when it comes time to re-elect or replace these board members. In the case of a for profit business each share of stock allows its owner to one vote and owners of several shares have several votes. It is probable for the person or group owning 51% or more of the stock to have power over both the board and the corporation with their controlling votes. In the case of a non-profit business there are no shares and therefore no owners of shares to vote. When a board member's period is up it is the residual board members who decide to either re-elect that person to a new period or replace the person. In companies which have a defined membership, it is typically the members who elect the board. In this case each member only has one vote and relationship does not give them an ownership right in the assets of the organization. "Members also cannot sell their membership like a stock holder in a for profit corporation can sell their stock and the rights that go with it. It is the board of directors or members which makes the decisions and runs the corporation" (Similarities Between For Profit and Not For Profit Businesses, 2012).

Exhibit 1

Key Differences of For-Profit vs. Nonprofit Governance

For Profits

Non-Profits

Mission

Mission Important

Mission Very Important

Financial results

Cash loss generator may be the key to service

Nonfinancial metrics important

Nonfinancial metrics of mission performance very important

Finance

Financial metrics of performance P&L, stock price, and cash flow very important

Financial metrics of meeting budget and cash flow projections also important

Funds come from operations and financial capital markets

Funds come from operations, debt, grants, and philanthropy

Short-term goals very important

Deep focus on long-term goals (as long as cash is there)

Executive

Small board -- paid governance

Often large board -- volunteer governance

Few board committees

Often many board committees

Combined chair/CEO plus lead director

Nonexecutive volunteer chair, plus CEO

Source:

Tax Status

Even though nonprofits have a vast scope of services, elements, and missions, one characteristic that a lot of these organizations share offers another manner to appreciate the sector. Most nonprofit organizations in the United States are recognized as tax-exempt by the IRS. "This status is granted because an organization's work serves one or more of the "exempt purposes" defined by section 501© (3) of the Internal Rev-enue Code. This large group -- nearly one million organizations across the United States -- includes both the "public charities" that provide a broad spectrum of com-munity and public services, as well as the grant making "private foundations" whose work is primarily focused on supporting other nonprofits" (What exactly is a nonprofit, 2009).

Being documented as tax-exempt in this way means that the company does not have to pay corporate income taxes to the U.S. government on the money that it gets from performing actions related to its mission. There are a lot of other taxes that may apply to nonprofits, depending on where they function and what they do, and of course anyone working for a nonprofit must still pay personal income taxes on wages. In addition to the exception from corporate income taxes, acknowledgment by the IRS means that contributions to an association may be subtracted from donors' income when they determine their personal income tax bills. It is also accurate that most foundations will not make grants to organizations that have not been recognized as 501© (3) s by the IRS. Securing and upholding tax-exempt position can be very significant to a nonprofit in gathering the resources it needs to do its job (What exactly is a nonprofit, 2009).

Tax exemption carries with it some compulsions and restrictions along with the apparent advantages. Every exempt association has to report to the IRS yearly to show that it persists to operate within the scope of its exempt purposes. Exempt organizations cannot allocate profits to owners, shareholders, or anyone else, and they must exercise care not to permit anyone to receive unwarranted compensa-tion for work or services performed for them. There are limits on the ways exempt organizations can work to sway the passage or defeat of legislation by lobbying and there is a flat prevention against exempt organizations doing anything that might affect the result of an election for any public office. Keeping the records and filing the reports essential to maintain tax-exempt status requires special-ized knowledge and a momentous amount of effort (What exactly is a nonprofit, 2009).

While 501©(3) status is the most ordinary one for nonprofits in the United States, there are 25 other 501© classifications (as well as 501 (d), (e), (f), 521, and 527 classifications). These other segments of the Internal Revenue Code create differ-ent limitations for what tax-exempt organizations can do. They also grant dissimilar advantages to hold up or encourage their work. "These classifications cover a diverse range of organizations including, to name a few, labor unions, credit unions, mem-bership groups, political action committees (PACs), advocacy groups (the NRA, MoveOn.org), retirement funds, and chambers of commerce"(What exactly is a nonprofit, 2009).

Financial Management Risks

The management and guard of financial resources must be a concern for all non-profit organizations, from the smallest all-volunteer group to a large, national organization. Without sufficient financial resources, an association is not capable to attain its mission and may not endure. Financial resources or assets can be categorized into three buckets, money, goods, and services. Money consists of cash, checking and savings accounts, securities and other savings. Goods engage merchandise or stock, supplies, and equipment. Services are the programs and actions the organization offers to its clients. Accountants categorize goods and services as resources since they have a worth or may be used to generate value or revenues (The Most Common Financial, Management Risks Facing Nonprofits, n.d.).

The risks in financial management are any actions that add to the decrease in value or loss of any of the organization's monetary assets. The diminish can be from the actions of an inside source such as an worker or volunteer, or someone outside of the organization can be responsible for the loss, like a burglar, con man, or client who defrauds the organization. Every organization should be conscious of the likelihood of a financial loss and take the proper defensive actions (The Most Common Financial, Management Risks Facing Nonprofits, n.d.).

A monetary loss can have a remarkable impact on a nonprofit. The loss of funds can generate a cash flow crisis and compel the organization to decrease its spending. The actions may comprise getting rid of staff or dropping the hours worked plus regulating the services accessible to clients. Besides abridged services, the nonprofit may experience negative publicity about the incident. The bad press can lead to a reduction in donations and the willingness of volunteers to work with the organization. Lastly, a financial loss can affect the reputations of the people involved. Frequently, the board dismisses an executive director if a large theft occurs on his or her watch. Members of the board are questioned by family, friends, associates and others about the details of the incident and how could it happen to that organization. All of these factors make it imperative for every nonprofit organization to have the proper financial controls in place (The Most Common Financial, Management Risks Facing Nonprofits, n.d.).