Financial Management in Nonprofit Organizations - Essay Example

? Financial Management in Nonprofit Organizations Executive Summary The financial management technique for a nonprofit making organization is markedly different from that is a profit making organization. There are several advantages and privileges for a nonprofit organization which are otherwise not present in profit making organizations. For example donations to the nonprofit organizations are tax deductible. Apart from that, the organizations are exempted from paying any taxes. This kind of tax exemptions are at heart of the strength for a nonprofit organization. In fact the source of the strength of the nonprofit organizations comes from such tax exemptions. Another important difference in the financial management of the two types of organizations is the constraint of non distribution. Nonprofit organizations cannot distribute the profit generated to the owners. Nonprofit organizations do not have any owners. Thus the people who fund the organizations do not necessarily gain any kind of control over the firm. The nonprofit organizations have board just like profit making organizations. Although there is one major difference, that the boards of the nonprofit organizations are self appointed. Thus the board members are not accountable to the shareholders. There is considerable debate in these two matters, one is the bringing in accountability in the actions of the board members and other one is granting the investors with the rights to control the firm. It is advisable that the board members be held accountable for the actions taken, since this will help to bring in controllability and responsibility in the actions. The second recommendation is to grant the investors who provide the firm with specific and important investments, the right to control the firm to some extent. Introduction The mode of operations for a nonprofit organization is markedly different than that of a profit making organization. The difference in operations is noticeable in the financial management of the two types of organizations (Parker, 2011). Since the topic of financial management is vast and it will not be possible to include all the aspects of the financial management, so only the important ones are chosen for further discussion. The topics which are chosen for further discussion are difference in the sources of fund, difference in the use of debt, difference in the evaluation of the performance and the difference in the mechanism of governance in the nonprofits. Sources of fund In case of debt financing a nonprofit organization organization has options to raise funds from grants, debts, overdraft and line of credit. Whereas an organization that works for the generation of profit are allowed to raise funds from the operations and financial capital markets. The concept is very simple, the net income is income left after deducting all kind of expenses from the total revenue is utilized in two ways, either it is given away to the investors or is utilized for the purpose of the business (Stephen, 2012). A nonprofit organization organization can only retain the profit for its business purposes and cannot distribute profit to the equity holders. Thus it is not able to finance using equity shares and thus it is barred from raising money from the capital market. Unlike a FP organization, a nonprofit organization organization sets short term goals and objectives. This is the same reason for which the debts are used in a different way in both the organizations. A for profit organization may use short term debt for both long term as well as short term purposes. For example the for profit organization which is in need of $ 10 million, can resort to short term financing of $ 2.5 million in four equal installments (Stigler, 2011). The cost of financing through such short term borrowing will be considerably more, producing a debt burden over the organization. For profit organization can still manage to pay for the interest as well as the principal due to the fact that they enjoy a steady flow of cash (Subramanyam, 2011). Whereas due to unsteady flow of cash in the nonprofit organization organizations, the organizations do not usually take the risk of financing the long term requirements of loan with the short term loan disbursements. Use of Debt In case of performance evaluation the two types of organizations differ in various aspects. The evaluations of the performance are measured across two important verticals, one is the efficiency in the use of contributions and the other one is meeting the objective of the organization. In case of a for profit organization, the first and foremost duty of the organization is to work towards the benefit of the investors and then comes the benefit of the organization itself. This is because of the reason that if the organization does not work for the benefit of the investors, they will lose confidence and trust over the organization (Subramanyam, 2011). This also makes it important that the for profit organizations put considerable effort to make sure that the objectives like the marketing objectives and other financial objectives are met accordingly. In other words a for profit organization has to make sure that the wealth of the investors are maximized as well as the profit. Thus if the organization is not able to meet the different objectives set then it may not be able to maximize the wealth investors as well as increase the profits. So a FP organization has to make sure that the financial as well as the marketing objectives are met accordingly (Teoh, 2013). A nonprofit organization has to work towards the generation of profit only, thus it is not burdened with the responsibility of maximizing the wealth of the shareholders. Thus the nonprofit organization has to concentrate upon few objectives only. Though the objective set may not be important but the mission set is very important. This is because of the reason that the nonprofit organization organizations are set for a greater purpose, where as the mission of for profit are not as broad as that of for profit organizations encompassing various aspects. Performance Evaluation The financial management of nonprofit organizations can be discussed across 6 different heads which are managing profitability and cash flow, working capital management, financing, transactional banking, and financial controls and board financial management (the last two forms part of the financial management governance). While assessing the profitability and cash flows for nonprofit organization, special consideration is given to ensure that the profits are not decreased by increasing the prices in expenses and stock (Verrecchia, 2011). Apart from that, it is also important to set the selling prices correctly when there is an increase in the mark up cost. Apart from that it is also important to assess the amount of products that need to be sold before the organization reaches a break-even point. In case of a FP organization the only thing that needs to be considered most importantly is the stock price. Unlike a FP organization the cash flows for a nonprofit organization can be sometimes sporadic or lumpy in nature (Verrecchia, 2012). In other words the cash flow may not be even throughout the year. Whereas for FP organization the cash flows are more or less stable in nature. The short term liquidity for a NONPROFIT ORGANISATION organization does not need to be assessed on a daily basis or weekly basis, rather a monthly basis evaluation will serve the purpose. For a profit making organization which has a steady flow of cash, it is important that the cash flows are evaluated on a daily basis or at least on a weekly basis. The working capital management is another aspect of the financial management that is markedly different for a nonprofit organization and for profit organization. Unlike for profit organization, the management of the working capital is dependent these four factors which are management of the stock, payment for the suppliers, work in progress, collection of cash from the customers. Governance The difference in the governance mechanism between the for profit organizations and the nonprofit organization organizations is explained in the light of transaction cost economics and economic theory of contracts. One of the prime differences in the governance mechanism is that the primary stakeholders are regarded as the owners in the profit seeking organization. While in non profit seeking organizations the boards and the managers are regarded as the primary stakeholders (Vincent, 2012). The nonprofit has one very important aspect that is not present in the organizations which are run for profit; these are competitive advantage of the organizations. The nonprofit organizations are able to bring down the costs by bargaining significantly and in this helps to supply better incentives to the stakeholders. In the governance mechanism of nonprofit organization organization, the most important responsibility is the protection of the specific investments which are highly valuable. This is done to ensure that the people who are providing such investments are endowed with required right to control. This is not so in the case of organizations which are run for profit. The governance mechanism also states that the people who are providing the specific valuable investments are allowed to enjoy rights of control which are residual in nature. This is done in order to keep the costs associated with bargaining as low as possible (Watts, 2013). The governance statute also indicates that the group who provides such valuable and important investments should be homogenous in character. In other words the governance statutes for the non-profit organization indicates that there should be a tradeoff between the objective to protect the investors and the objective to keep the costs of bargaining as low as possible. One very important difference in the governance mechanism between for profit and non-profit organization is that the laws and codes governing the operations of non-profit organizations are formed under state corporation statutes. This is not the case for the organizations which are run for profit (Wernerfelt, 2013). This is the same reason for which the state enforced statues pose as a serious constraint or barrier on matters of corporate governance. This is the same reason for which the federal tax code has acted as the main rulebook for several decades for the nonprofit organizations. The federal tax code as the principal rule book based on which the judgments are passed or disciplinary actions are taken. The reporting structures of the governance ports are markedly different for profit making organizations and nonprofit organizations (Wiggins, 2011). The governance structure of the profit making organizations includes several categories which are absent in the report structure of the nonprofit organizations. In general the main differences in the financial governance between the two types of organizations are noticed in existence, handling of the errors and the segregation of duties. In nonprofit organization it is absolutely necessary that the goods and services that has not yet been executed or received are recorded properly. Reference List Parker, H. (2011). The statistical handbook of nonprofit organizations. 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