Financial Management in Non Profit Organizations - Term Paper Example

? Financial management in Non Profit Organizations of the Executive Summary The need to portray effectiveness in any kind of organization requires the utilization of resources and transforms them into valuable products, services and offerings. There are several ways of yielding profits for a profit generating entity but the methods are limited for a nonprofit organization. Nonprofit organizations have adopted several financial and accounting techniques to determine the present financial performance of the organization. The report is prepared with the sole intent to study the various financial management practices in a non-profit organization. The author of the study will highlight the various financial management practices that ensure smooth operations of the business. It also highlights the difference in the financial management practices between profit and nonprofit organizations. The author of the study will also provide certain inputs which will help in the betterment of the nonprofit organization and help in achievement of goals and objectives. It was essential to conduct this study to understand the impact of financial management practices on the organizational performance of NPO. Introduction: Financial Management in Non-Profit Organization Nonprofit organizations form an essential part of the society and exist to provide certain benefits for the members of the society. They actually vary in size from large to small clubs and the operations are based on receipt of grants, donations, fundraising or receipt from members as the principal source of income. In certain instances nonprofit organizations (NPO) supplement income with the trading activities. Although, NPO operate on a nonprofit basis suitable practice of financial management ensures that there are sufficient resources and cash meant for operations of NPO. Attaining profitability is not the main objective of NPO it is necessary to ensure that it is sustainable, capitalized and funded. It should be ensured that the NPOs should have an adequate cash flow to support their technical operations over the duration of the lives and help in contribution to the achievement of goals and objectives. Sound practice of financial management is needed to ensure that the human resource of NPO utilize the resources effectively. The operations and activities of NPO vary and organizations where trading activities are not present stock management practice will not be relevant. Implementation of effective management practices will enable in attainment of strategic goals of the organization easily. Implementation of sound financial management practices would require understanding the current financial position of the NPO which is important for the provision of NPO services. Sources of Funds in NPO Gifts and Donations: The donations in NPO usually come from companies, charitable trust, foundations after a fundraising appeal. Gifts and donations are regarded as an important source of income and also attract tax reliefs (Green, 2013). Fund raising activities are time consuming and expensive. Grants: The grants are made by charitable trust and public sector. The donated money is not returned and is usually exempted from tax (KnowHow Non Profit, 2013). Loan financing & equity capital: Loan is the sum of money borrowed to be repaid back with interest and loan financing is potentially used widely in NPO. Equity capital is provided by external investors in return for a stake in the organization (KnowHow Non Profit, 2013). Contracts: A form of trading activity which involves agreement between two parties and each party has to abide by the terms and conditions failing which will attract penalty or fine (KnowHow Non Profit, 2013). Trading: Many NPO generate income by selling goods and services to the members of the organization (KnowHow Non Profit, 2013). Financial Management Practice in NPO Analyzing the financial position of the organizations will enable the smooth operations of NPO and also help in providing excellent services. Firstly, sound management practice will start with good record keeping and maintenance of accurate financial statements. Maintenance of accurate financial statements requires the knowledge of record keeping and the correct way of using these financial statements to improve the organizational activities. The correct usage of historical financial data will help in long term planning of the organizational activities that will be viable and would support the long term sustainable operations. Understanding of financial statements would require recording of financial performance of the organization and provide a snapshot of the strength and weakness of the organization. The financial analyst of NPO needs to study the income and expenditure, profit and loss & balance sheet to understand the present financial position (CPA, 2009). This is important because the managerial decision making depends upon the review of the financial statements done by the financial analyst. Apart from the correct analysis of financial statements it is necessary for the preparation of the accurate financial reports which helps in assisting of making informed financial decisions. One of the most simple and effective ways of recording financial information is through the usage of financial management software system. The chart of accounts, segment reporting and cash and accrual accounting is used by NPO for the successful recording of financial transactions. Sound financial management practice would include obtaining of funds for the smooth operations of the organization. It also includes utilization of financial information to undertake a detailed review of information. Cash Flow Management Cash Flow Management is regarded as one of the most important ways of recording financial information which is critical and sporadic (CPA, 2009).The main objective of cash flow management is to ensure that the financial objectives are met and there is preservation of liquidity so that debts can be paid off easily when they are due. Cash flow management helps in detecting whether the organization is liquid or not and to maintain a tight control on the movement of cash. Short term liquidity would be assessed on a daily, weekly, monthly basis to monitor the cash and preparation of strategies that have the ability to dealing with sudden liquidity crisis in the organization (The Wallace Foundation, 2013). These strategies will help in regular monitoring of cash flow and the preparation of a cash management plan which ensures there are adequate cash reserves in times of emergency (The Wallace Foundation, 2013). A cash management plan is prepared which helps in the management of short term liquidity funds. The cash management plans are prepared one month in advance and within a stipulated time frame Working Capital Management Apart from cash flow management working capital management also forms an integral part of the financial management practice. In NPO cash flow management can be lumpy and sporadic, grants and donations are received on an annual basis. Working capital management constitutes an important part in NPO and ensures the setting up of effective strategic goals and plans which ensures that Cash is not caught up in the cycle unnecessarily. Working capital in an organization comprises stock management, payment to suppliers, work in progress and cash collection from debtors. It helps in efficient stock control, review, buying policy and operational issues. Planning & Budgeting: This process helps the organization to set specific goals and objectives, allocate resources among the different activities and decide upon how these activities will be operated. Budgeting relies on the past and future financial performance (Queensland Government, 2009).The concerns in these activities include involving people in an appropriate manner and considering both external and internal factors in the budgeting development (CSH, 2001). Transaction Handling & Receipt handling: This is the book keeping and accounting area of the financial activities. Cheque must be written for payment of bills, commitments of the organization and organizational commitments must be recorded, ongoing record of financial activities and information must be presented to the executives of the organization in an understandable and useful way. The concerns in this area include: Hiring and selecting the suitable staff Prompt and accurate authorization of payments Prompt and accurate deposit of receipts and timely preparation of financial statements (CSH, 2001). Financial Management: It is the management of the financial operations based on the financial analysis of financial information and knowledge related to organizational plans and objectives. The financial analyst and managers will monitor the accounting process and also prepare the budget development process. The financial manager is also responsible for the activities like cash flow management, cost analysis and cost allocation and asset management. The main activities of the financial manager would include Anticipation of financial problem and maximization of financial resources Ensuring with tax obligations and funder requirements Ensuring compliance with the Generally Accepted Accounting principles (GAAP) which is applicable to nonprofit organizations (CSH, 2001). Financial Management Standards in NPO There are many alternative methods of implementing a financial management system and the organization should choose a suitable method for a scale of operations. If the grantee is unable to meet the standards that are covered in the financial management’s standard then the NPO funding will be terminated forever and the organization will be regarded as ineligible for receipt of financial assistance or any other forms of alternative funding. The financial management standards for NPO suggests that They should have strong accounting structures that provide accurate and complete financial information about all the financial transactions. The grant expenditure records should be detailed in the cost categories as indicated in the approved budgets. Actual budgets are to be compared with the budgeted accounts. The accounting records should be maintained on a current monthly basis. The costs may be incurred only during the grant period and all the obligations will be liquidated within 90 days at the end of grant period. The accounting records should be supported by genuine documentation such as cancelled cheques, invoices etc. Internal Control Standards Organizations must safeguard for the entire grant property whether in cash or other assets and should ensure that it is utilized for authorization purposes (NEAIOG, n.d.).The control of the member will be enhanced when the duties of the members of the committee or organization is equally divided. Some of the important techniques of internal control are as follows: Cash receipts and transaction should be recorded immediately and on a daily basis. The bank accounts should be reconciled on a monthly basis by someone who does not sign the cheques (USGCAO, 1999). A petty cash fund should be entrusted upon a single custodian and used for payments other than through cheque. Financial Reporting in NPO Functional Reporting of Expenses GAAP requires the NPO to present accurate financial information about their expenses in their financial statement by functional classification. Program Services: These activities involve selling of goods to beneficiaries and customers for achieving the mission of the organization. The functional reporting classification varies from one organization to another as per their nature. Supporting Services: These activities support the program services and include activities like fund raising administration and membership development. Administrative activities: These are not identifiable with a singular NPO activity and are indispensable to the conduct of various activities like general record keeping, budgeting, other financing activities etc (Queensland Government, 2013). Fundraising activities: They include the potential contributions like money, services, securities, material etc from donors on time (Blackbaud, 2013). They also include fundraising campaigns, maintaining donor mailing lists, preparation of fundraising manuals and conducting fundraising special events. Membership Development Activities: These include soliciting for potential members and various membership dues, relations and other similar activities. There are no significant duties or benefits associated with membership. The membership developmental activities include fund raising and other related costs which are reported under heading fund raising costs. Difference between Nonprofit & Profit Organizations The various sources of revenue of the organization are governmental grants and contract, endowment income, contribution from members, donation, income from investments etc (Idealist, 2013). The revenue in profit organizations would be unit sales, serves revenue, right of goodwill, right of trade name, education fees, health fees, research revenues, etc. The nonprofit organizations are exempt from taxes which enable them to provide services meant for the interest of public services. In exchange for these privileges the organization are expected to perform their regular functions. In exchange for such privileges as exemption from federal and state is provided. At a first glance the NPO respondents ranking the success factors were somewhat surprising, considering the goals and missions of NPO. The profit organizations reflect the availability of assets for the distribution of shareholders as retained earnings (Our Community, 2013). A nonprofit organization records the financial transactions through the financial statement to show the financial position. It reflects the availability of those assets for future services or net assets. The financial transaction record signifies a collection of funds each having a different purpose and should be balanced individually. This also provides a method of segregation which is not a physical segregation of resources. Financial reports detail the expenditure and revenues for each fund and summarize the financial activities across all the funds (Meade, 2010). In nonprofit organizations the stakeholders are concerned with the optimum utilization and allocation of resources. The stakeholders in a profit organization would rather focus on the sustainable accounting practices which lead to profitability. The profit entity would rather have a general ledger than have multiple ledgers for separate resources to identify the varied sources of funds and their utility. The major difference between the financial statements of profit and non profit or profit organizations is as follows: Profit Organizations Non Profit Organizations Statement of operations or income statement Statement of operations Balance sheet Statement of financial position Statement showing retained earnings Statement showing changes in net assets Retained earnings Net Assets Net Income Excess of revenue over expenditure Statement of cash flow Statement of cash flow Profit & Loss account No Profit & Loss account (Source: Haddad, n.d.) Corporate Governance Mechanism in NPO Corporate governance mechanism helps in supporting the policies and procedures that ensure the preparation of accurate financial information. Corporate governance is a mechanism which helps in directing, controlling of the accounting procedure. It is usually concerned with the overall organizational structure and processes for managerial decision making, accountability, control and behavior should be directed by the management committee or board. It is the core component of corporate governance. There are usually two type of corporate governance mechanism like financial control and board of financial management. Financial Control It is about understanding the financial information and utilizing the information to improve the organizational procedural system. It also ensures that accurate policies and procedures are implemented to protect the financial investment (Keller, 2011). Financial control is a procedure which helps in detection and prevention of errors, fraud, theft, policy non compliance in a financial transaction process. This process is implemented either by an individual or is a part of an automated system within the financial system. The financial control is designed to accomplish at least one of the criteria: Completeness: It ensures that all the financial records and transactions are included in the financial reports of the organization. Accuracy: It ensures that the right amount is accurately recorded. Authorization: It ensures that the correct authorizations are placed correctly to cover elements like approval, payments, data entry and computer access. Validity: It ensures that invoice is prepared accurately and the organization has incurred liability accurately. Benefits of Financial Control It helps in understanding the financial position of the organization and regular accurate financial reporting will provide accurate financial information. The organizations can make informed managerial decision making on budget and spending. It helps in providing documentary proof for compliance requirements. It also helps in setting up of organizational standards which comply with the results of financial reporting. Board Financial Management One of the major responsibilities of board management is to ensure that organization constitutes of good financial management committee that ensures good financial management practice to achieve organizational objectives. The main responsibility of the committee is to provide benefits to the members of the community in a financially sound manner. Conclusion It is observed that NPO have the flexibility to choose their source of income and also decide how to utilize and allocate the funds. It is also observed that the organizational structure, sources of revenue, cost allocation and the financial management practice of NPO varies considerably from the profit organizations. Smooth financial management practice will ensure the accomplishment of goals and objectives of NPO in a systematic manner. References Blackbaud. (2013). What are the differences between nonprofit and for-profit accounting? Retrieved from http://www.resources.blackbaud.com/nonprofit-financial-management/differences-between-nonprofit-and-for-profit-accounting.html CPA. (2009). Financial management of not-for-profit organizations. Retrieved from http://www.cpaaustralia.com.au/cps/rde/xbcr/cpa-site/financial_management_of_not-for-profits.pdf CSH. (2001). Financial management for nonprofits. Retrieved from http://www.in.gov/ihcda/files/Financial_Mgmt_for_Nonprofits_Guide(1).pdf Green, J. (2013). The major accounting differences between profit & nonprofit organizations. Retrieved from http://smallbusiness.chron.com/major-accounting-differences-between-profit-non-profit-organizations-26257.html Haddad, M. R. (n.d.). The difference in financial accounting between profit and nonprofit organizations. Retrieved from http://somooil.gov.iq/en/images/stories/OKKK.PDF Idealist. (2013). “Nonprofit" vs. "Not-for-profit" — does it make a difference? Retrieved from http://www.idealist.org/info/Nonprofits/Basics1 Keller, G. F. (2011). Comparing the affects of management practices on organizational performance between for-profit and not-for-profit corporations in Southeast Wisconsin. Retrieved from http://worldmanagementsurvey.org/wp-content/images/2011/03/Comparing-The-Affects-Of-Management-Practices-On-Organizational-Performance-Between-For-Profit-And-Not-For-Profit-Corporations-In-Southeast-Wisconsin-Keller.pdf KnowHow Non Profit. (2013). Funding sources for charities and nonprofit organizations. Retrieved from http://knowhownonprofit.org/leadership/governance/getting-started-in-governance/raisingmoney . Meade, S. (2010). Accounting for the differences in profit and nonprofit accounting. Retrieved from http://www.bdo.ca/en/Library/Industries/not-for-profit/pages/Accounting-for-the-Differences-in-Profit-and-Nonprofit-Accounting-.aspx NEAIOG. (n.d.). Financial management guide for non-profit organizations. Retrieved from http://www.arts.gov/about/oig/fmgnpo.pdf Our Community. (2013). What is the difference between for-profit and not-for-profit groups? Retrieved from http://www.ourcommunity.com.au/boards/boards_article.jsp?articleId=1309 Queensland Government. (2009). Financial and performance management standard. Retrieved from http://www.legislation.qld.gov.au/LEGISLTN/CURRENT/F/FinAccPManSt09.pdf Queensland Government. (2013). Financial and economic policy. Retrieved from http://www.treasury.qld.gov.au/office/knowledge/financial/index.shtml. The Wallace Foundation. (2013). Resources for nonprofit financial management. Retrieved from http://www.wallacefoundation.org/knowledge-center/Resources-for-Financial-Management/Pages/default.aspx. USGCAO. (1999). Standards for internal control in the federal government. Retrieved from http://www.gao.gov/special.pubs/ai2131.pdf. Read More