Financial Management in Nonprofit Organizations - Literature review Example

FINANCIAL MANAGEMENT IN NONPROFIT ORGANIZATIONS Introduction The management and administration process of nonprofit organizations is quite challenging. Therefore, financial management is a very essential practice in these types of organizations as it plays a significant role in their success. In order to be successful both nonprofit and for-profit organization must incorporate financial management practices and techniques in their habitual activities. A nonprofit organization not only requires offering quality products and services but a careful and effective administration to ensure the realization of the organization’s goal. This paper aims to expound on the appliance of financial management in nonprofit organizations, while comparing the financial management techniques in these nonprofit and for-profit organization (Weaver & Weston, 2008). Financial management in nonprofit organizations According to Weaver and Weston (2008), a non-profit organization is an entity with a main objective of offering services and products to the society without a profit motive. Charitable, educational, scientific or religious organization can be characterized as nonprofit organizations. Generally, the quality and efficacy in providing services measure the worth of nonprofit organizations. Therefore, these organizations are not gauged by their financial prowess but by how their goals and objectives are realized. To ensure effectiveness in their performance, nonprofit organizations have turned to effective practices like financial management techniques that lead to success. In the past few decades, organizations have chosen to focus on financial management techniques, as they prove efficient in ensuring quality services (Weikart, Chen & Sermier, 2013). Therefore, effective management relies heavily on financial management techniques. However, research estimates that even successful nonprofit organizations fail to utilize these practices effectively as management of their activities like financial issues is characterized by inefficiencies. Consequently, nonprofit organizations fail to incorporate effective financial practices in their missions even though financial matters are very vital in any type of organization as they ensure a sustainable way of meeting goals and expectations. Studies indicate that this is as a result of the manner in which nonprofit organizations operate. These organizations, with a low profit index, they seek to operate in a monopolistic environment that offers products and services at a low profit rate. Moreover, non-profit organizations depend on outside investors and donors for finances. According to Weaver and Weston (2008), the nonprofit sector is on the rise and thus requires effective administration. Therefore, there is need to incorporate financial management practices as effective administration is vital to its donors, stakeholders and relevant tax authorities. Therefore, the administrators of nonprofit organizations should guarantee that fiscal statements and accounting records comply with prevalent requirement of fiscal accounting. Even though nonprofit organizations are not motivated by profits, finances drive the projects of these entities. Accurate and well-managed fiscal documents, investments and budgets ensure long-term success of the organization and growth, while mismanagement of finances poses risks and has a significant impact on the realization of goals. To ensure effective financial management, nonprofit organizations must ensure that they develop essential practices in their finances. Even though managers in the administrators in these organizations are not professionals in fiscal matters, they need to have a knowledge and understanding of the real cost of their respective projects and programs. They must ensure the calculations of their direct costs involved in the running of their respective programs and services including expenses, equipment and salaries among others, including the total cost of running the entire organizations. The financial status of the organization and its respective projects must be monitored at all levels. This will assist the organizations in alleviating problems that arise from time to time as expenses vary. Even though, nonprofit organization rely on funding from donors and rarely project when funds may come, managers can monitor the cash flow ensuring that liquid assets to meet the needs of the organization including, emergencies, rent, payroll and maintenance. There are various determiners of effective management practices. Resources required in financial management are essential to ensuring that best practices are maintained including human resource characterized by a skilful financial staff as well as material resources. Effective methodologies and procedures that are able to generate indicators of the organization’s financial status should be formulated. Consequently, management systems that communicate fiscal information and data to the administrators and staff should be in place in order to disseminate up-to-date and accurate monetary information, which is vital to the organization. Consequently, financial management strategies determine the success of a nonprofit organization. A weak fiscal management approach can lead to the failure in numerous ventures of organizations while strong and effective financial practices improve the quality and impact of the projects and performance of the non-profit entity. With the contemporary economic environment, organizations are threatened by late funding which are characterized by big budget cuts and thus organizations should adopt effective financial management techniques to ensure long-term survival (Weaver and Weston, 2008). Financial management techniques in nonprofit and for-profit organizations In the management of any type of organization, the techniques in financial management determine success. Therefore, it is imperative for both non-profit and for-profit to incorporate effective financial management techniques. Even though these organizations can be distinguished by their motives, the application of financial strategies in their relevant projects is vital for success. Over the years, the management of nonprofit and for-profit organizations had differed by a huge margin due to the assumption that differing missions affect organizational goals and thus strategic and management capabilities. However, in recent years, there has been a shift in this assumption due to highly competitive environmental conditions and the approach to the realization of organizational missions has been quite similar. Therefore, NP and FP organizations may at times employ similar financial management techniques to meet their specific needs. As corporations, the nonprofit and for profit entities are both legal enterprises that transact and operate business activities. Therefore, these entities utilize accounting practices and financial reports, hire employees, control expenditure and formulate ways to generate revenues (Weikart, Chen & Sermier, 2013). According to Brinckerhoff (2009), up-to-date and accurate financial statements, information and reports are the determiners of financial management. Moreover, due to public accountability, a high level of reliability and accuracy in financial reporting is required. The financial reports of both a non-profit and for-profits enterprises are an essential element of providing an analysis of the financial health of the organizations. As financial management requires both effective execution and planning, managers need to analyze fiscal information from current and historical data to plan operations vital to the organization effectively. . The goal of an enterprise can determine the application of financial management strategies. The sole mission of a for-profit organization is the maximization of profits as stakeholders and owners characterize these organizations. However, nonprofit entities are not driven by wealth maximization. Consequently, the financial management goals of the two types of entities are quite similar even though they are driven by varying objectives as both entities seek to maintain fiscal viability at the same time acquire financial resources to provide new services and products (Bowman, 2011). The difference in management goals leads to contrasts in financial management in the two types of organizations. Cost of capital estimation is a firm’s total or weighted cost of capital (WACC). It is the total costs for various capitals the organization. The cost of estimation for nonprofit and for-profit organizations differs in two main ways. As nonprofit organizations are not mandated to pay taxes, they are immune to tax effects associated with borrowing. Moreover, nonprofit entities raise their equity capital from grants, profits that are entitled to remain in the business, and contributions from individuals. Consequently, for-profit organization equity capital can be raised by selling stocks. The cost of capital is used by organizations for the purpose of capital budgeting-decisions and thus is essential to the business and it is utilized as an opportunity cost whereby organizations can only employ it to acquire fixed assets. In the case of for-profit firms, the opportunity cost is usually divided to stakeholders as dividends if capital is not required for fixed assets, while in non-profit firms the capital is not returned to the stakeholder but is retained for future utilization. According to McKinney (2004), capital budgeting decisions elements (3) can be affected by the conditions of non-profit organizations. These elements include the aims for project analysis, cash flow decision approaches and risk analysis. The primary goal of a non-profit organization is not motivated by wealth and hence the capital budgeting decisions includes many determiners like the welfare of the society beside profit maximization. Due to the goals of the organizations, the noneconomic factors may overshadow financial aspects. However, good judgment entails considering the future of the firm and hence the financial impact of every project should be recognized. if the fiscal impact of the capital investments are recognized, the non-profit organization will fail to sustain its operations. For-profit organizations usually put the financial aspects of every project first in order to make decisions, which will not hinder the success of the company. The approach utilized in Cash Flow Estimation in both nonprofit and for-profit organization is generally similar with the exception of two conditions. In non-profit decisions in project analysis are as a product of both social and cash flow value as for-profit organizations consider economic value to make a decision (McKinney, 2004). Many organizations require financing to guarantee survival in the market. Managers should ensure that all the finances are well managed to meet the requirements of the firm’s goals. At one point in the running of a business entity, additional funds will be required to meet additional needs. For nonprofit entities, these additional funds are from grants, donations, membership contributions and fundraisings (McKinney, 2004). Consequently, for-profit entities have two sources of finances, including borrowing and stockholders contribution. Borrowing from banks require payment return with a given amount interest. Even though it is difficult to raise money through grants and charities, the managers in nonprofit organizations have the freedom to raise funds while for-profit managers do not. Consequently, funds from charities and grants are often little amounts and are restricted to a given purpose, and thus cannot be utilized for other effective projects (Bowman, 2011). In both nonprofit and for-profit organizations, forecasting is an important aspect of financial management. This is an estimation of events that are most likely to occur in the near future and hence can identify problems and risks that will affect the firm, and thus solutions can be formulated early on. Cash budget can be employed in the forecasting process as it tracks the movement of funds. Cash budgets are generally utilized to monitor funds, which will be utilized for investment, indicating the time it will be available and the duration. Without the budget, an organization lacks the ability to identify a long-term pattern of the cash flow and thus fail to predict and plan future cash needs (Bowman, 2011). Conclusion Therefore, financial management entails approach and techniques for analyzing the long-term financial needs of organizations. Due to the importance of nonprofit and for-profit organizations in the economy and society, it is essential for financial management techniques to be utilized in organizations. Financial management is vital as it identifies future organizational needs and assists in the making of decisions, in investment, capital and borrowing. References Bowman, W. (2011). Finance fundamentals for nonprofits: Building capacity and sustainability. Hoboken, N.J: Wiley. Brinckerhoff, P. C. (2009). Mission-based management: Leading your not-for-profit in the 21st century. Hoboken, N.J: John Wiley & Sons. McKinney, J. B. (2004). Effective financial management in public and nonprofit agencies. Westport, CT: Praeger. Weaver, S. C., & Weston, J. F. (2008). Strategic financial management: Applications of corporate finance. Mason, OH: Thomson/South-Western. Weikart, L. A., Chen, G. G., & Sermier, E. (2013). Budgeting and financial management for nonprofits organizations: Using money to drive mission success. Los Angeles: SAGE ; CQ Press. Read More