Financial Management in Nonprofit Organizations - Coursework Example

Financial Management in Nonprofit Organizations al Affiliation) Executive summary Accounting is an integral partin any business as this is usually used to determine the financial position of the business. The accountants prepare the financial statements such as the balance sheet and the income statements that are vital in determining the performance of any business entity. This information is important to various stakeholders of the business such as the shareholders, suppliers, customers and the financiers. The type of financial information presented is not universal but depends on the specific type of business entity. There are two types of businesses and these are for profit organizations and nonprofit organizations. These have different agendas and as such there is a difference in their accounting methods. Profit organizations usually strive to generate profits for their owners while on the other hand nonprofit organizations have an aim of providing a particular service or product with a nonprofit agenda. This feature results in the difference in their accounting standards. In this paper, I have discussed these differences with the aim of trying to establish whether indeed it is true that they are completely different. For this comparison, I will consider the various aspects of accounting such as the source of funds, debt, performance evaluation, and how each type of organization treats its assets and liabilities. The difference in these factors is what will indicate how each type of organization has a specific mode of operation. Management of both of these types of organizations also have different expectations of the businesses and therefore what they require from their accounting teams is very different. The aim of this paper is therefore to indicate the financial management in nonprofit organizations and how they differ from that of profit organizations. Introduction Not for-profit organizations are organizations whose primary obligation is not to generate profits to their shareholders but uses the profits generated to enable it to achieve its various objectives. The organisation is headed a management team and none of the shareholders benefit financially from the business operations although they can be paid a management fee for their roles in running the organization (Periasamy, 2009). There is a difference between the operations and the running of not for profit and profit organizations. The main objective for profit organizations is to generate returns for the shareholders and therefore all their operations will be guided towards increasing the returns and increasing the value of their firms. The financial management of both these organizations is also different and this is evident from the way their accounting is done. Type of Activities The decision making criteria for both of these organizations differ greatly. Profit organizations base their decision making on the basis of whether the activities in question can generate additional revenues for their business (Oppermann, 2012). Any line of business that does not contribute to profits of the company is done away with and other modes of operation are carried out. For non for profit organizations the activities they are engaged in depend on the main goals of the organization. Activities that the organization is involved in should be within the allocated funding and any activity that exceeds this can be restructured or discontinued. Source of Funds All types of organisation s require funding so as to facilitate the running of their various functions. Profit organizations have various by which they raise the necessary capital for running their businesses. Most is by capital that is invested in the business by the shareholders or been borrowed from financial institutions (Oppermann, 2012). These types of organizations do not receive donations or any grants. Not for profit organizations also require capital but the sources for these funds are varied. Income is obtained from the membership fees and various sources of income. They receive donations and grants from outside bodies and these form a crucial part of their funding. This requires that there are adjustments that are made in the accounting systems of the organization. These include additional fund accounting and an allowance for special audits for the grants. This means that there are additional requirements in regards to financial planning. There should be sufficient checks to ensure that the money given by the donors is only used for the uses that are outlined by the donors. Use of Debt Most profit organizations use debt as one of their main sources of funds. Mostly this is done by borrowing from financial institutions in the form of loans or overdrafts when the need arises (Oppermann, 2012). This money is repaid from the profits that are generated by the business. Non for profit organizations on the other hand do not rely on debt finance to run their operations. This is because use of debt is an expense to the organisation and is only permissible if the business is generating some form of income. Not for profit organizations do not generate profit from their operations and as such may not raise the money required to repay any form of debt (Brigham, 2013). They therefore rely on other sources of funds such as donations and grants and when this is not available they might have to cut back on some programs or the organization may simply close shop. Performance Evaluation Most of the accounting systems for profit organizations are simple are direct because they usually operate one or only two lines of business. The cash flow statements are easily outlined as these are used by the management to evaluate the performance of the organizations. However, non for profit organizations usually operate a number of activities that have to be accounted for. This means that the financial statements for each of these lines of business must be prepared differently before being put together so that the management can evaluate the spending patterns and cash flow. This means that the financial accounting systems of these types of organizations are much more complex (Oppermann, 2012). Accounting of profit organizations must include an allowance for taxation expense. It is the duty of the business’ accountant to withhold the taxes for all the employees to be forwarded to the relevant authorities. The business is also required to pay a certain amount of taxes on the overall profits that it received after deduction of expenses. This accounting does not apply to not for profit organizations because most of them have been exempt from paying of income tax. As such, this section is not present in the accounting systems of the non for profit organizations unless there are exceptions that are made There is a difference in the accounting of revenues in these two types of organizations. In profit organizations most of the revenue is recorded as soon as they are generated. This is crucial as it will determine the balancing of the statement of financial position that is prepared at the end of the financial year (Oppermann, 2012). Nonprofit organizations on the other hand receive a different type of revenue. This is in the form of contributions from the various stakeholders. This is what is accounted for as revenues and there are clear outlines of when this should be recorded in the financial statements of the company. Accounting for non for profit organizations also involves procedures for dealing with donations, internal contributions, pledges and other restricted funds. Another difference that arises in the treatment of incomes and revenues is in the use of cash basis and accrual basis accounting models. Most nonprofit organizations make use of cash basis accounting methods. As such they only record the expenses and the revenues when the cash is actually received or cash is actually paid out. There is also a modified form of cash basis accounting that is used in some nonprofit organizations and this is used to record taxes or other revenue on an accrual basis. On the other hand, most profit organizations track their business revenues and expenses by making use of accrual accounting methods (Paramasivan, 2009). Governance Mechanisms In all profit organizations there are personnel who are employed to manage the activities of the company. These are properly remunerated and this cost is indicated in the income statement as an expense that the business incurs on a regular basis. This is not the same for not for profit organizations. Most of the staff who works in not for profit organizations does not get any form of salary or if they do it is just a basic allowance. They are however given more rights in regards to decision making within the organization. As such, the income expense is not included in the financial statement of the company at all unless there are exceptions (Pandey, 2009). According to the law, not for profit organizations are required to set their differences in various categories that form the functional expenses such as management expenses and the relevant program areas. These should be clearly reported in the financial statements as a requirement by the law. There is an emphasis of cost allocation by these types of businesses to show how the funds of the business are allocated to various business areas and the varied type of programs. This is important as it shows clearly how much a specific program actually requires in terms of costs. Profit organizations on the other hand usually have only one running mode of operation and this does not require keen cost allocation procedures. It is not a requirement in the law for these types of organizations to have this segment clearly defined in their financial statements (Oppermann, 2012). Profit organizations at times take on board volunteers for certain durations of time. This is the norm in most non for profit organizations and therefore this has to be recorded in the financial statements under the category of donated services. The services that are recorded in this category include those that create non-financial assets or any activity that requires the use of skilled labour (Shim, 2008). These have to be recognized because had it not been for the volunteers these would have to be purchased and that could have marked an expense to the business which would have to be accounted for. Treatment of assets All types of businesses whether profit organizations or not for profit organizations are required to record purchase of assets in their records and to give allowances for depreciation on a yearly basis until the asset is disposed off. Capitalization and depreciation of assets is an important factor in financial reporting and is taken seriously at it is used to show a true representation of the value of the business. However, not for profit organizations usually have certain assets that receive special treatment. These include historical collections or buildings. Other donated items do not have to be recorded in the financial statements as formal assets because in the event that they are sold the organisation will not recognize the revenue but will use the proceeds gained to purchase another item of equal value (Correia, 2007). In conclusion, there is a big difference in the accounting methods of both profit and nonprofit organizations and this is represented in the final financial statements. As such, accounting professionals should take note of the areas of difference and make sure that all the costs of the business are allocated appropriately to the specified sections. This is due to the fact that this information is used for different purposes, in the profit organizations they are used to show whether the business is making profits from the operations while in the not from profit organizations they are used to indicate if the activities outlined are being carried out effectively and there is sufficient capital allocation to allow this. References Brigham, E. F. (2013). Financial management: Theory and practice. Mason, Ohio: South-Western. Correia, C. (2007). Financial management. Cape Town: Juta. Oppermann, H. R. B. (2012). Accounting standards. Lansdowne: Juta. Pandey, I. M. (2009). Financial management. Delhi: Vikas Publishing House. Paramasivan, C., & Subramanian, T. (2009). Financial management. New Delhi: New Age International (P) Ltd., Publishers. Periasamy, P. (2009). Financial management. New Delhi: Tata McGraw-Hill. Shim, J. K. (2008). Financial management. Hauppauge, N.Y: Barrons Educational Series. Read More