Financial Management in Non-Profit Organizations - Essay Example

Financial Management in Nonprofit Organizations of the Executive Summary A nonprofit organization maybe defined as one that utilizes its surpluses for the purpose of achieving the organization’s objectives rather than distributing the additional income among employees and directors in the form of dividend. As these types of organizations give less emphasis on the monetary incentives of self or the internal stakeholders, such organizations are facilitated with various financial exemptions from income tax structure through obtaining charitable status and various other means. A large number of non profit firms exist in the business market such as member serving, community serving, trade unions, sports clubs, association for retired servicemen etc. Community serving entities are more inclined towards serving the society such as eradication of illiteracy and establishing health consciousness, medical research and many more. Though, it is expected from the nonprofit organizations to strive for the betterment of the society and continue their noble work accordingly, in recent times it has become prominent that many companies are opting for such organizational status for obtaining tax benefit and other financial facilities in the name of non- profit organizations. Even if such considerations are kept aside, naturally the method of accounting and other aspects of financial management techniques of non-profit organizations are very much distinct to the “for-profit” organization. In this paper the differences between financial considerations of profit making and non- profit organizations will be compared and contrasted in terms of sourcing of funds, use of debt, financial performance evaluation, efficiency and organizational, governance mechanism etc. Introduction The motivation of operation of the non- profit organizations is different as compared to those organizations that operate with a profit maximizing motive. Various charities, non-governmental organizations (NGO), health clinics and other educational foundations, social welfare committees that function with a purpose for betterment of the greater society are categorized under non-profit organizations (Anheier, 2014). In contrast, those organizations, the main objective of whom is to enhance their sales and revenue which in turn increases their profitability year on year are classified as for-profit companies (Pinho, 2014). Therefore, the nature of financial management tends to be distinct between the two types of organization. Internal control standards, audit standards and reporting standards also appear to be different for such organizations. In the next segment of the paper, detailed research will be done on the financial management practices of non-profit and for-profit organizations (Anheier, 2014). For the purpose of analysis, different aspects of financial management such as main sources of funds and utilization of debt by the finance department of both types of organizations, degree of strictness in governance mechanism, indicators for performance evaluation and many other attributes will be compared and contrasted. Discussion Though some of the accounting aspects of non-profit and for-profit organizations are similar such as payroll taxes as well as tracking and reporting of income and expenses, in broader financial perspective, both set of organizations clearly incorporate distinct financial techniques. For instance, in a for-profit organization, profit and loss statements and stock prices are considered as the metrics for evaluating financial performances whereas for a non-profit organization, importance is given on budgetary allocations and cash flow projections. In fact, reporting of functional expenses is of utmost importance for non-profit organizations so that effectiveness in cost allocation can be monitored and alteration can be brought in next year’s budget (if required). Sales is the main source of income for the for-profit organizations where non- profit organizations perceive the revenue as contributions received from restricted and unrestricted sources and donated goods (Xu, Peng & Song, 2014). In the next segment, some of the key financial considerations will be highlighted for better understanding of the differences between the two types of organizations. Source of Funds The source of funds for the “for-profit” organizations is their recurring operations, revenue generated from business practices over a certain period of time as well as from financial capital market. In contrast, apart from sourcing funds from current operations, the non-profit organizations also collect funds from various grants, charities, pledges and other philanthropies. Selling goods and services are the primary source of revenue generation and fund construction for the for-profit organizations. Non-profit oriented organizations earn funding through selling of existing services, resources and capabilities such as hiring out venues of their own property, selling of in house expertise such as publications, consultancies and training programs to the interested parties. In fact, for-profit organizations design their operating cycle in such a way that facilitates them to receive funds from the customers in a shorter period of time (Xu, Pen & Song, 2014). The cycle also allows the organizations to pay its dealers and suppliers within the maximum possible time interval. In this way, the companies restrict the outflow of funds as much as possible, maximizing their interest income out of such current operations. However, such provisions are limited for non-profit organizations as they do not operate with a business objective. Therefore, they largely depend on gift and donations coming from individuals and corporations or trusts as well as various kinds of grants sanctioned by public sector authorities or private corporate entities (Adelino, Lewellen & Sundaram, 2014). Use of Debt Debt is an important component of the capital structure of the companies operating in profit maximizing motives. Debt financing mainly includes loans and overdrafts which are required to be repaid over a certain period of time. For a business operating with profit maximizing motive, especially start-up businesses, debt financing is inevitable because such finances ascertain the companies to meet their short term obligations. In fact, big corporate and other companies also opt for debt financing because of the tax exemptions they gain from the obligation of interest payments (Brigham & Ehrhardt, 2013). However, in non-profit organizations, use of debt is less frequent. Debt financing involves certain amount of riskiness due to obligation of interest payment. Considering the case of non- profit organizations, the source and amount of revenue generation are comparatively uncertain to them and a large part of the revenue is contributed towards achieving organizations’ mission and social goals. Therefore, using debt capital does not hold relevance for such organization because a large part of revenue goes in vain in the form of interest payment which is not viable or desirable for any non-profit organization (Vermeer, Edmonds & Asthana, 2014). Governance Mechanism Clear distinction between for-profit and non-profit organization is also present in the governance mechanism. In non-profit organizations, it is experienced that the board is often larger, consisting of a large number of heterogeneous members. The number of directors in the board can vary from 25 to 130 members among which part of members are invaluable ambassadors (Puyveldea, Caersb & Boisc, 2014). The motivation behind including such pseudo governance members is to attract opportunities for acquiring more and more funds. In fact, most of the governance members are financially compensated by the non-profit organizations and not directly included in the decision making process (Thomsen, 2014). In contrast, the governance committee of for-profit organizations includes a small board with few committee members. The Chief Executive Officer (CEO) of the company is assumed to be the leader of the organization who along with other board members takes strategic decisions regarding the organization’s future operations and communicate such decisions through his supervisors and other departmental head. Such CEOs and other board of directors are salaried entities of the for-profit organizations (Pinho, 2014). Performance Evaluation Profitability, market share, sales figures, profit and loss statement as well as capital market performance etc., are used as indicators for evaluating the performance of a for-profit firm. Such parameters are quantifiable. Hence, overtime evaluation of such parameters and comparing those with their competitors provides the for-profit companies an additional incentive to drive more aggressively in order to maximize their market share and profitability. In fact, healthy competition among for-profit firms compels them to use superior technology and produce better quality products and services so that the consumers opt for one company’s product, leaving the competitors behind. Conversely, in a non- profit organization, optimum utilization of budget allocation, degree of accomplishment of integrated organizational mission are used for measuring performance. Timely review of the performances of NPOs is a rare consideration. Therefore, the organizational mission and vision, being qualitative and less constructive in nature, the level of motivation for achieving such organizational objective is comparatively less among the personnel associated with such non- profit organizations (François, 2014). Tax Liabilities The business of for-profit organizations is taxed in several ways. Corporate tax and income tax are imposed directly to the profits made by the company. Several excise duties, service tax and value added taxes are applied on transactional basis. In fact, small proprietorships and partnerships business are also counted under personal income and taxed accordingly. Conversely, the income of non-profit organizations are exempted from payment of income tax under section 501(c)3. People, who have contributed to the funds of non-profit organizations in the form of donations, are also offered tax benefits. From the taxation point of view, non-profit organizations are treated as legal entities in which if the founders are found to be leaving the organizations, no matter for what reason, they are not held responsible for the payment of debts of the organization (Wellens, 2014). Recommendations As the underlying objective of non-profit organizations involves some noble causes, the governments of most of the countries provide huge considerations and exemption in the financial management of such organizations. Whereas, the workings and financial statements of for- profit organizations are bound to undergo internal audits and close supervisions, the non- profit organizations enjoy certain benefits so that they can carry out their responsibilities without much hassles (Xu, Peng & Song, 2014). However, it has been noticed that the in many cases, the non- profit organizations take unethical advantages of the facilities provided to them and involve into many such activities that tends to destroy the societal and economic equilibrium, rather than improving it. In the next segment all such unethical practices of the non- profits will be highlighted and suitable recommendations will be stipulated so that such organizations continue their functioning without forgetting their main agenda of operation (Wellens, 2014). Evidences are there that the directors and CEOs and other important personnel associated with the non-profit organizations often tend to maximize their income in terms of salaries, perks and other monetary and intangible benefits from the fund which were supposed to use for the betterment of the society. As the number of directors involved in the boards is large and provision is very less to explicitly scrutinize their financial incentives, such actions are performed very easily. As a consequence, many times the NPOs go underfunded and the societal needs for which the organizations are working, remains unsatisfied. Therefore, it is recommended to the managers and directors of NPOs that they should not disregard the fundamental principles behind running such organizations and manage the organizational functioning in such a way that it can create example for the larger society as a whole (Xu, Peng & Song, 2014). As the board members engage themselves in such unethical considerations and exercising their power of position for gaining personal interests, conflict among the members is inevitable. Lack of transparency in the corporate governance, privileged treatment to those who are responsible for providing lucrative contract to the organizations are very common practices in the non- profit industry. Therefore, sometimes the conflicts regarding personal gains become so adverse that the directors or founders often exit from the organization. Such practices are also very common in the non- profit industry. Now as per the legislation, if the person responsible for raising debt for a non- profit organization leaves the organization, he is not liable for repayment of the debt. As a result, the organization has to take the burden of amounting debt that seriously affects the actual functioning of the NPOs. Therefore, the directors are recommended to understand their responsibilities towards the society as well as the world and work accordingly to serve the needs in the grass-root level, rather than maximizing their own wealth under the shelter of non-profit organizations (Puyveldea, Caersb & Boisc, 2014). Apart from all these, in spite of having huge income tax benefits, tendency of tax evasion is one of the most important unethical practices exercised by non- profit organization. Bribing the external auditor and presenting false and misleading financial statements, taking faulty investment decision and defective accountability in strategic management hurts the sentiment of general public and the problem of the societies remains unsolved. Hence, recommendation should be provided to the non-profit industry is to eliminate such fraudulent activities as much as possible in order to ensure financial stability and economic well- being in the global world (Pinho, 2014). Conclusion Unlike the for-profit organizations, the non- profit industry is structured in such a way that they should contribute towards accomplishing the societal objectives, rather than maximizing organizational profit, similar to any for- profit organization. In fact, the for-profit organizations as well are performing their corporate social responsibilities deliberately with full concentration. In contrast, the NPOs who are primarily designed to meet the societal requirement are deviating from their objectives to a great extent. Studying the financial management techniques of for-profit and non-profit organizations, it can be inferred that distinctness exists in all the aspects of financial management between the two types of organization. Such differences arise from the disparity in operational motive of the organizations. Though the financial management of non- profit organizations appear to be less aggressive and tranquil as compared to for- profit organizations, relevance is established behind such financial behavior of the two. Moreover, the for- profit organizations are advised to perform their duties and responsibilities more ethically so the two types of organizations existing in the world financial and economic framework together can bring efficiency and effectiveness in the whole universe. References Adelino, M., Lewellen, K. & Sundaram, A. (2014). Investment Decisions of Nonprofit Firms: Evidence from Hospitals. The Journal of Finance, 2(2), 1-28. Anheier, H. K. (2014). Nonprofit Organizations: Theory, Management, Policy. London: Routledge. Brigham, E. & Ehrhardt, M. (2013). Financial Management: Theory & Practice. Boston: Cengage Learning. François, E. J. (2014). Financial Sustainability for Nonprofit Organizations. Berlin: Springer Publishing Company. Pinho, J. C. (2014). The role of corporate culture, market orientation and organizational commitment in organizational performance: The case of non-profit organizations. Journal of Management Development, 33(4), 374 – 398. Puyveldea, S. V., Caersb, R. & Boisc, C. D. (2014). Managerial Objectives and the Governance of Public and Non-Profit Organizations. Public Management Review, 2(1), 123-136. Thomsen, S. (2014). Comparative Corporate Governance of Non-Profit Organizations. Danish National Research Database, 1(1), 15-30. Vermeer, T. E., Edmonds, C. T. & Asthana, S. C. (2014). Organizational Form and Accounting Choice: Are Nonprofit or For-Profit Managers More Aggressive? American Accounting Association, 89(5), 1867-1893. Wellens, L. (2014). Effective governance in nonprofit organizations: A literature based multiple stakeholder approach. European Management Journal, 32(2), 223–243. Xu, H., Peng, X. & Song, W. (2014). Would For-profit benefit rather than destroy Non-profit? 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