Financial Management in Nonprofit Organizations - Research Paper Example

?FINANCIAL MANAGEMENT IN NONPROFIT ORGANIZATIONS Executive Summary Several aspects form the basis of financial management in nonprofit organizations.The nonprofit organizations can operate with more independence than the profit making organizations. They are free from the influence of government, financial institutions or other parties. Managing a nonprofit organization requires a proper blend of providing quality services and careful administration that can help in cost reduction. The management needs and requirements of different types of nonprofit organizations can differ depending upon their goals and objectives. As for example, social service organizations are required to be more specific with their financial reporting practices so as to comply with the existing rules and regulations. Next, religious nonprofit organizations have vital issues related to the complex requirements of its memberships. Management of finances in nonprofit organizations is quite a challenging task. The sources of revenues of nonprofit organizations are very much vulnerable to changes in political environment or economic issues. Nonprofit organizations being accountable to public require more accurate and reliable presentation of information by the financial management team. The fiscal health of nonprofit organizations can be inferred from its financial statements prepared by the financial mangers. This essay gives a descriptive view about the application of financial management in nonprofit organizations by taking into account various aspects like their fund sources, utilization of its debts, performance evaluation techniques used by them and the governance mechanisms used. It ends with a conclusion and a few recommendations that can be suggested. Table of Contents Table of Contents 3 Introduction 5 Sources of Funds 5 Use of Debt 7 Performance Evaluation 8 Efficient use of contributions 9 Fulfilling organizational objectives 10 Government Mechanisms 11 Conclusion 11 References 13 Introduction A nonprofit organization can be defined as a group which operates for purpose like public services and are not driven by profit motive aspect. The incomes that are generated from nonprofit organizations are usually not shared with the members of the organization. Nonprofit organizations can be in the fields of education, health, human services, environment, etc. Individual grants and donations are the primary sources of funds for nonprofit organizations. Both equity and debt can form the capital structure of the nonprofit organizations but equity is preferred more. This is because loans are not easily available for them due to the unavailability of sufficient collateral and cash flow requirements sought by the banks. Several plans can be employed by the nonprofit organizations for their sustainability and achieving their objectives. Many performance evaluation techniques are also available to help boosting their performance and maintain it for a long term. Government funding can also form a key component and most nonprofit organizations are engaged in several contractual agreements with the government. Hence, managing finance is a vital issue for the continued growth and sustainability of the nonprofit organizations. Sources of Funds Any organization’s plan is the basis of formulation of a successful fund raising strategy. Understanding of the proper funding requirements of an organization and its sources constitutes a good organizational plan. The formulated plan should be balanced too. For any nonprofit organization, the primary sources of funds are as follows: a. Grants: Funding through grants is available from either the charitable trusts or from the public sector. These funds are not meant to be repaid and are usually tax exempted. In most of the cases grants are associated with some conditions like, attainment of particular results, achievement of certain milestones that have been agreed upon, excess unutilized money are to be returned back, providing regular progress report of the utilization of the money, etc. Hence, before accepting any grant, nonprofit organizations should look into certain factors like, 1) whether the grants received will have greater benefit than the cost of availing the grant or not, 2) whether it is capable of meeting all the grant conditions or not, 3) whether it is in accordance with the mission and motive of the organization or not, etc. b. Gifts and Donations: In general, companies, charitable trusts and individuals provide donations. It is an important source of income for nonprofit organizations and in most of the cases the organization is free to utilize the fund according to their requirements, without any prior conditions. They are exempt from taxes too. However, it can take time to raise these types of funds and can be quite costly for the organization. Few factors that should be kept in mind before raising these types of funds are: 1) Whether it is beneficial and effective or not. 2) Whether it complies with legal provisions or not. 3) The fund raising activity should be ethical too. 4) These activities should not affect the reputation of the organization. c. Loans and Equity: Raising funds through debt and equity financing are common practices for profit making organizations but not for nonprofit organizations. Loans are usually borrowed from banks and other financial institutions and have to be repaid (Collaborative Partnership on Forests, n.d.). Loans may be either secured or unsecured loans. Before borrowing money, nonprofit organizations should ensure if it is the best option available to them. On the other hand, external investors supply equity capital in return of a stake in the organization and enjoy the share in profits earned. The nonprofit organizations should be careful in determining the objectives of the potential investors, before raising money through equity capital. d. Contracts: A contract is a commercial agreement between two parties to do something and is covered by contract law. Nonprofit organizations mostly make contracts with public sector to perform certain services. A major disadvantage while performing such public services is that the organization may get diverted from their main objective and loose its independence. e. Trading: Many nonprofit organizations resort to practices of trading goods and services to earn income. The income generated can be utilized by the organizations according to their requirements. However, excessive involvement in these trading activities may distract the organization from its primary objectives and can lead to certain tax implications being imposed on it (Know How Non Profit, 2010). Use of Debt The capital structure of a nonprofit organization should be equity capital and not debt. This is because cost of equity is less than that of debt. Use of debt by nonprofit organizations is quite common (Young, 2007, p.244). While attempting to raise funds through debt financing, a nonprofit organization should keep in mind some of the key issues to help meet its objectives. Firstly, it should ensure that enough liquid cash is available to counter increase in expenses or fall in revenues. Secondly, a better working relationship should be developed with the depository banks. Thirdly, the organization should have an action plan ready to counter situations of cash crisis. Finally, excessive dependence on short-term borrowing should be avoided (Zietlow & Seidner, 2007, p.214). Banks determine the capability of nonprofit organization servicing the debt offered through the measurement of its financial ratios. Other non-financial indicators also matter like, consistency in growth of demand for the services offered by the organization, its reputation, etc. Nonprofit organizations often face difficulties in obtaining short-term loans from banks because banks are mostly driven by cash flow operations of organizations. Moreover, banks take into account, inventories and accounts receivables as collateral for loans given. These are again not so common in nonprofit organizations. However, it is easier for profit making business concerns to get loans from banks because of their abilities of easily fulfilling these criteria. Performance Evaluation The performance evaluation of a nonprofit organization can be effectively done based on its efficiency in the utilization of the contributions and its ability to meet the organizational objectives. These are discussed in details below: Efficient use of contributions A nonprofit organization can be effective in its operation to an extent it is efficiently using the contributions received. Nonprofit organizations make use of several plans to effectively measure the employee performance that result in efficient use of contributions. One such plan is management by objective. It is a plan in which employees and managers coordinate and cooperate with each other to formulate certain objectives that can evaluate employee performance. Next, there is a plan of achieving special awards. In this case employee who makes an outstanding contribution to the organization gets rewarded. Cash awards are quite common. Another plan involves organizing contests by the organization. These contests help boosting employee efforts and create a competitive environment within the organization. The contests can be in the form of promotions or games and related to topics like quality improvement, increasing productivity, means of reducing costs, etc. Furthermore, Memorial Employees Retirement Incentive Trust (MERIT) is there to reward employees based on the amount saved which is in excess of the expenses that have been budgeted previously. The rewarded amounts are deposited in a trust which can be withdrawn at the time of retirement of the employee. This is again a good plan that can be employed to measure the contribution of employees. Fulfilling organizational objectives Top management officials in an organization play a pivotal role in achieving the goals of an organization and influencing a cultural change within the organization. Well coordinated efforts of the top leaders can promote and facilitate the cultural change that is required. The following practices can be considered as the pathway towards achieving the desired objectives of an organization: 1) In order to maximize accountability, a control system can be developed that creates a link between external reporting and internal method of decision making process of the organization. 2) Promotion of executive leadership which is clear and strong can help in creating effective financial management throughout the organization. 3) Strategy of imparting training can be a good idea to introduce cultural changes. 4) Continuous evaluation of performance measurement using benchmarking strategy can help in easily achieving organizational objectives. 5) Removal of inefficient practices of accounting through monitoring of daily activities and its results. 6) Organization of finance function which can lead to value addition. 7) Use of efficient management information system set up in the organization. 8) Practice of reengineering methods within the organization. 9) Organizing financial data in line with information required by the users. 10) Employment of efficient finance team. 11) Finally retaining the best talents in the organization is key to the accomplishment of organizational objectives (McKinney, 2004, p.22-24). Government Mechanisms In order to expand the business and to maintain the fiscal base, presently most of the nonprofit organizations have to get themselves engaged with the government. Government funding can be critical for a nonprofit organization and they should not let go those opportunities. It is vital for maintaining their survival. Government funding is considered to be the most stable source of funding for the nonprofit organizations. However, collaboration between the state and the nonprofit organizations may create some issues like finance management, board governance, maintaining effectiveness of the mission set by the organization, etc (Agard, 2010, p.530). In general, profit making organizations face lesser challenges while interacting and operating efficiently with the government than the nonprofit organizations. Furthermore, the nonprofit organizations are faced with challenges of fiscal crisis due to withdrawal of government funding that served for the purpose or requirements of human resources, education, development of community, etc. Moreover, government is now more in favor of providing subsidies to consumers rather than producers. Conclusion It can be concluded that grants and donations are the main sources of funds for nonprofit organizations. Efficient capital structure of nonprofit organizations includes equity rather than debt. Nonprofit organizations do not get access to the loan facilities provided by the financial institutions because cash flow and collateral security forms the basis of those loans. Performance evaluation and fulfillment of objectives are done by the nonprofit organizations by employing several plans that are best suited for the purpose. Government funding is also available for the nonprofit organizations but it also have some difficulties associated with it too. Hence, it can be recommended that nonprofit organizations can invest more on assets that can serve as the purpose of collateral. This will enable them to get loans easily when required. Government funding should be the key, and the nonprofit organizations should be more involved in contractual agreements with the government to get access of the same. Utilization of funds generated from individual grants should serve as a major source of finance as they will be available in large volumes. References Agard, K. A. (2010). Leadership in Nonprofit Organizations: A Reference Handbook, Volume 1. California: SAGE. Collaborative Partnership on Forests. (no date). Types of Funds. Retrieved on March 15, 2012 from http://www.fao.org/forestry/6113/en/. Know How Non Profit. (2010). Funding sources for charities and nonprofit organizations. Retrieved on March 15, 2012 from http://www.knowhownonprofit.org/leadership/governance/getting-started-in-governance/raisingmoney. McKinney, J. B. (2004). Effective financial management in public and nonprofit agencies. (Ed.3). USA: Greenwood Publishing Group. Young, D. R. (2007). Financing Nonprofits: Putting Theory into Practice. USA: Rowman Altamira. Zietlow, J. T. & Seidner, A. G. (2007). Cash and investment management for nonprofit organizations. New Jersey: John Wiley and Sons. Read More