Financial Management in Nonprofit Organizations - Case Study Example

Financial Management in Nonprofit Organizations of the of the Executive Summary The report has highlighted details of financial management in the Non-Profit Organizations (NPOs) and compared it with the profit organizations. Besides that, it has laid down details regarding the sources of funds; use of debt; governance mechanisms; efficiency in use of contributions; and fulfilment of objectives of non-profit organizations. The differences and details are discussed extensively in order to clarify the abovementioned aspects. The analysis will help to judge the financial management techniques and methods used by NPOs in a better manner. In addition, loopholes in the functions of NPOs are mentioned in a concise manner for gaining a better understanding. Introduction The project describes financial management of the non-profit organisations (NPOs). Non-profit organisations are those, which use surplus revenue for achieving the desired goals, instead of distributing them as dividends or profits. NPOs can be in form of a trust, foundation, service or charity organisations. The NPOs are neither allowed to distribute surplus to owners as profit nor do they pay the donated money back to donators. Whenever a non-profit organisation is associated with international issues, they are termed as non-government organisations (NGO). These are quite different from the profit organisations (Bringham & Ehrhardt, 2013). Differences between the various aspects of non-profit and profit organisations are explained in details in this essay. Financial management technique The book keeping system of a NPO, unlike that of a profit organisation, should be on cash basis and not accrual basis. Most of the new NPOs use the cash-basis system and maintain cheque-book for tracking the transactions. With growth of non-profit organisations, ledgers are being increasingly used. Financial tracking systems of profit organisations are more sound and advanced since incorporation (Gnan, Hinna & Monteduro, 2013). Sources of funds There are various sources of funds for NGOs that differ from that of profit organisations. Few of them can be discussed as follows: Donations and gifts The donation for NPOs mostly comes from companies, individuals, foundations and charitable trusts. The gift and donations are a very important source from which non-profit organisations are able to generate most of their income and this attracts tax relief as well. The whole process of raising funds from these sources can be costly and time consuming. The profit based organisations do not receive any donations and gifts as compared to NPOs (Davila, Epstein & Manzoni, 2012). Grant funding  This is another mode for the NPOs to raise fund. These are generally provided by charitable foundations or trusts and the public sector. The money received from grants does not need to be repaid and is mostly exempted from tax. Most of the grant providers fund only those organisations, which have a charitable status. There are again few grant providers who prefer to fund entities with significant reserves and ability to generate surplus of cash. This acts as a disadvantage to companies, which have a businesslike approach (Worth, 2013). Equity capital  Equity finances and debts are usually used in profit sectors. The use of debts and equity finances are quite rare in the non-profit sectors. Debt finances consist of overdrafts and loans, which need to be repaid. Equity finances, on the other hand, need not be paid back; instead, investors acquire a stake that entitles them to share the risks and rewards of the organisation (Worth, 2013). Loan financing Loans are borrowed money that needs to be paid back with interest. It is a useful source of financing for non-profit organisations. It is quite easy and flexible to secure loans as compared to grants. Loans are secured against certain property or assets; but again, they might be unsecured at times (Worth, 2013). Contracts Contract is an agreement that takes place between two or more parties, where each party agrees to perform as per requirements; and on failing to do so, they are covered by the law. This is a commercial agreement, the income generated from which is liable for Vat and tax (Worth, 2013). In the recent times, number of NPOs contracting with the public sector has increased.  Use of Debts The non-profit organisations generally face a situation where the current need for cash exceeds that in hand. Sometimes, it takes time to raise funds from charity and grants. In such situations, managers of these organisations issue bonds, stocks or acquire loans from banks to solve this problem (Bringham & Ehrhardt, 2013). As non-profit organisations do not have access to equity markets, they have to raise funds from the debt market for generating cash needed for purchasing building, equipments or lessening the time gap between grant receipts and expenses (Ahmed, 2012). The use of debts by non-profit organisations is pervasive in nature. In the analysis of Internal Revenue Service (IRS), their statistical file reveals that very few non-profit organisations borrow from the related parties. Almost 18 % of non-profit organisations have outstanding debt of municipal bonds. The municipal bonds of these organisations account for 57% of total non-profit debt, in terms of dollar. The sole reason for excessive amount of debts outstanding in this sector is the high amount of fixed cost associated with it. The combination of debt obligations like, bank loans, mortgages, leases and lines of credit, constitute almost 43 % of the total amount of non-profit debt (Appendix-1). NPOs are not profit making organisations; so, they do not need to worry about their debt margins. They can take comparably more amount of debt than profit organisations. As normal organisations seek out profit, they need to have a control on their debts and cannot increase their leverage rate beyond a certain extent. If these organisations fail to maintain the right amount of debt, then they might be taken over or merged with another company with less debt (Drucker, 2012). Performance evaluation The NPOs contribute a lot towards self-development and welfare of others who are affected by them. So, in order to achieve this, NPOs give importance to both effectiveness and efficiency in carrying out their work. For well-being of the community, they pay considerable attention to both the above factors. Efficiency is required in both production and allocation, but the latter is more important for welfare of the donors. Management of NPOs need to focus more on choosing the right options as per need. Cost effectiveness is more important for the NPOs compared to production efficiency (Hopkins, 2012). The most vital challenge related to allocation faced by NPOs is selection of the right mixture of activities, which can provide the necessary benefits to the community. Here, donors play a vital role in influencing allocation through contributions that they make. The decision of the government on tax concessions can also affect the process of allocation, especially during direct funding decisions. The NPOs generally use donations in a proper and ethical manner. The private NPOs and corporate foundations need to disclose details about all the grants and funds received by them in the annual tax filling. Non-profit organisations are entitled to enjoy tax exemption for contributions that are tax deductible. This is a unique trait of the non-profit sector (Bringham & Ehrhardt, 2013). There are different treatments for various types of contributions received by an NPO. Unlike NPOs, profit organisations do not need to display usages of their funds and can present only the financial statements and their details in the annual report. The level of transparency in maintaining the funds is higher in NPOs as compared to profit organisations. The organisational objectives of NPOs are proper allocation of funds received from donations and satisfaction of donors through efficient utilisation of funds. The welfare of the community is also one of the primary objectives of NPOs. Many NPOs also try to abide by practices laid down by the corporate governance laws (Boubaker & Nguyen, 2012). Governance Mechanisms Corporate governance mechanisms of NPOs are quite different from that of public companies. The advisory and governing boards are the primary mechanisms of governance for NPOs. The internal structures of control for NPOs are also responsible for detecting and preventing fraud, errors and irregularities, especially employee embezzlements (Kratz, 2012). The emerging corporate rules, regulations and reforms have significant impact on corporate governance of NPOs. There are many provisions of Sarbanes Oxley Act (SOX), which are applicable to the NPOs, even though they are intended for public companies (Davila, Epstein & Manzoni, 2012). The provisions of SOX that are appropriate for NPOs are: 1. Establishment of an audit committee, which consists of independent directors only. 2. Prohibition of shredding of valuable records. 3. Establishment of whistle-blower programs. 4. Establishment of codes of conduct, which are ethical. The NPO sector can be broadly divided into organisations that are well-funded with sound corporate governance and ones that are poorly funded voluntary associations with less technical expertise and inadequate mechanisms of corporate governance. As per various studies conducted by the Department of Social Development, approximately 82.1% of NPOs are not aware of the Code of Good Practice, which lays down guidelines for good corporate governance practices. As a result, almost 80% of the NPOs have lower level of awareness and poor corporate governance practices (Davila, Epstein & Manzoni, 2012). Conclusion The financial management techniques of NPOs are quite sound and similar to that of profit organisations. Need for transparency in the financial statements is more in NPOs compared to profit organisations. The book maintained by profit as well as non-profit organisations should conform to the accounting principles. The management should ensure that funds are utilised in an ethical manner. Besides that, number of NPOs that follow the governance practices should increase. The NPOs should be more aware of these practices so as to incorporate a sound corporate governance mechanism within the organisations. Recommendation The NPOs should give more importance to efficiency in fund allocation as compared to productivity. Time and again, usage of funds should be reflected in the tax statements and other financial statements without failure. Transparency in maintaining these funds is imperative. The debt burden of NPOs should also be reduced. Excessive debt burden can hamper functioning of these organisations. The management and board members of the NPOs should try and meet organisational objectives and governance practices in a better manner. Those who fail to abide by rules and regulations according to the requirements should face stringent punishments as per law. References Ahmed, M. (2012). Effective Non-Profit Management: Context, Concepts, and Competencies. Florida: CRC Press. Boubaker, S., & Nguyen, D.C. (2012). Board directors and corporate social responsibility. Palgrave Macmillan. Bringham, E., & Ehrhardt, M. (2013). Financial management: Theory and practices. Connecticut: Cengage Learning. Davila, A., Epstein, M.J., & Manzoni, J.F. (2012). Performance measurement and management control: Global issues. Bingley: Emerald Group Publishing. Drucker, P. (2012). Managing the non –profit organization. London: Routledge. Gnan, L., Hinna, A., & Monteduro, F. (2013). Conceptualizing and researching governance in public and non-profit organizations. Bingley: Emerald Group Publishing. Hopkins, B.R. (2012). Starting and managing a Nonprofit Organization: A legal guide. Hoboken: John Wiley & Sons. Kratz, T. (2012). Good governance and Non-Profit Organisations. Retrieved from http://www.ifaisa.org/Newsletter/Good_Governance_and_Non-Profit_Organisations.pdf. Worth, M.J. (2013). Nonprofit Management: Principles and practice. London: SAGE. Appendices Appendix 1 Read More