Financial Management in Nonprofit Organizations - Essay Example

Financial Management in Nonprofit Organizations Comparing Financial Management Techniques in Nonprofit and Profit-for Organizations By: Name: Executive Summary The increasing number of nonprofit organizations has raised the concerns regarding the financial management procedures and accounting standards followed in these organizations. In this essay the different financial management practices of profit-for and nonprofit organizations have been discussed. In order to provide both a general and specific perspective, examples of different profit-for and nonprofit organizations have been given and specific examples of financial management techniques used by Save the Children US have been given. The analysis has shown that different objective of for-profit and nonprofit organizations are the major factor which requires the change in financial management processes. It has also found that financial management techniques may vary across for-profit and nonprofit organizations because of different governance mechanisms, tax treatment, stakeholders and accounting requirements. Therefore, for the financial health of nonprofit organizations and to facilitate them in achieving their aims, such changes have become necessary. Comparing Financial Management Techniques in Nonprofit and Profit-for Organizations A nonprofit organization offers public services without any intention of achieving any personal gain or self interest and these organizations are exempt from paying federal taxes (Zietlow, Hankin, & Seidner, 2007). Under the selection 501(c) (3) of the Code, the described organizations are charitable organizations and they are eligible to get tax-deductible contributions and earnings of organization may not inure to private shareholders or individuals (Credit Infocentre, 2006). Actually the number of nonprofit organizations is increasing vary rapidly and it is becoming important to control and monitor the financial practices of these organizations. Although these organizations can earn money however, the money earned has to be used for public service purpose only. Therefore, the differences in financial management techniques appear right from the difference in financial objectives of the two kinds of organizations. The primary financial objectives of nonprofit organizations found through a survey in 2002 highlight that most nonprofit organizations aims to achieve breakeven point, followed by those which aim to maintain a significant level of cash reserves and financial flexibility. Moreover, the other primary objectives identified include maximizing cash flow, net revenues, net donations and surplus and reducing costs (Zietlow, Hankin, & Seidner, 2007). Because of these financial objectives the financial management techniques of not-for-profit and for-profit organizations differ. According to Dreezen& Korza (1998), nonprofit organizations can use three types of accounting methods including cash basis system, modified cash system and accrual based system and selection of any method depends on the period when company records its revenues and expenses (Bourgeois, 2003). Therefore, high dependence of nonprofit organizations on donors, volunteers, different accounting rules and different corporate governance structure makes it difficult for nonprofit firms to follow the same financial management process as followed by for-profit organizations. Therefore, to facilitate nonprofit organizations to achieve their aims, relaxations in financial management practices have become necessary. Sources of Funds Management of cash and budgeting are two crucial areas of focus for nonprofit organizations because organization receives money from various sources including donors, governmental bodies and granting organizations (Blackbaud, 2004). Profit-for organizations generate funds by offering services and products to the customers. Revenues from selling goods and services less cost of goods or services sold give the gross profit to the company. On the other hand, in nonprofit organizations, funds come from different sources. At Save the Children funds come from various sources including multinational organizations (World Bank, United Nations etc), public sources (U.S government and other local government agencies), companies, individual donors and endowment funds. Secondly, the revenue is not always in cash form but it may include commodities such as food & medicine and cooperative agreements. Moreover, like most of the other nonprofit organizations, at Save the Children the funds are of two types including SC undesignated funds and designated funds. The undesignated funds are unrestricted and their use is not specified by the donor, whereas, the designated funds are given for specific purpose. Financial Budget For-profit organizations make budgets for internal use of management whereas; in nonprofit organizations budgets can be also used by external parties. Even if management of nonprofit organization does not choose to develop budget, stakeholders (like donors) may require a formal budget for grant applications, credit extension and making pledges (Clifton Gunderson LLP, 2008). For-profit organizations develop budget which are based on potential sales and expenses, whereas, nonprofit organizations develop their budgets whilst developing proposals for donors and after the approval of grants. The donors can also ask organizations to modify budgets at the time of approval. Once a grant is confirmed, then based on accrual accounting system, it is entered as income (Bourgeois, 2003). At SCUS, a Grant Management System has been developed which ensures the compliance to developed budget. The Grant Management System (GMS) has been developed to facilitate the review and approval of Grant documents as well as to provide a searchable, secure, web-based method to store those documents and supporting information once they have been awarded by the Donor. Based on this system, all functions are done in the companies, for example, before hiring an employee at Save the Children, a Personal Action Form (PAF) is raised which contains the information on the reason of hiring or extension of contract along with the budget codes and grants on which the employee will be charged (Appendix IV). Use of Debt In for-profit organizations, the profit before interest and tax is equal to operating income from core business activities and income from other investments. On the other hand in for-profit organizations to help the funds to grow, organizations develop endowment management and investments services. Some companies have developed endowment management services for nonprofit organizations and most of the nonprofit organizations go for such services. Endowment fund is the separate fund which a nonprofit organization set up so that funds donated by holder directly comes into it (Minneapolis Foundation, 2010). According to code section 501(c3), nonprofit companies have been allowed to manage their cash and investment portfolios through Merrill Lynch Endowment Management Account Service (Merrill Lynch, 2010). To avoid any conflict with creditors, for-profit organizations provide information to the creditors on the uses of funds. However, accountability of nonprofit organizations is higher because the organization operates on the funds provided by donors. The funds used by Save the Children are used for three purposes including program services, general management and fundraising. In 2009, the allocated funds for these three purposes were 90% for program services, 4% general management and 6% fundraising (Save the Children, 2009). Financial Reporting Like for-profit organizations, all nonprofit organizations are required to report their financial performance and transactions. The U.S. church and religious organizations are supposed to be aware of recordkeeping and the contributions made by donors is known as quid pro quo contribution (IRS, 2009). Therefore, whilst developing financial reports the terminologies and techniques of two kinds of organizations differ. Since there are various donors to whom nonprofit organizations are accountable therefore, unlike for-profit organization, in a nonprofit organization, the major donors send their auditors teams, therefore, for financial reporting purpose, audit for each donor is separate. The reporting requirements may also vary depending on the nature of nonprofit organizations. According to IRS guidelines, if a reasonable relief requirement is met, IRS sends written notice to churches and demand explanations of concerns and if church fails to do so then IRS sends a second notice and within 90 days shows a concern of examining records and books (IRS, 2009). On the other hand, all for-profit organizations, no matter small or large develops reports to be used by internal and external stakeholders. The fiscal year of nonprofit organizations may vary depending on the grants for example, fiscal year of SCUS covers October 1 through September 30. The general financial activities scheduled by SCUS in a year have been shown in the table in Appendix I. The financial statements of for-profit organizations are very detailed and comprehensive however, nonprofit organizations usually develop simple balance sheets and statement of activities which lists the sources of funds and expenses. Therefore, unlike for-profit organizations, these organizations are not supposed to follow complex international reporting standards. There are various different accounts which are demanded by auditors of donors from nonprofit organizations however, such accounts are not reported in international reporting standards. For example, at Save the Children, all staff members have to prepare their timesheets every month which show the actual number of hours worked and the grant on which the employee is being charged. After every quarter, the effort report is send to all donors, so that they may get an idea about the employees being charged on their aid. All organizations need to be transparent to attract shareholders whereas; nonprofit organizations face the challenge to strictly report the day to day transactions, budgeted transactions and forecasts to donors. Taxation Unlike for-profit organizations, nonprofit organizations are exempt from paying taxes. Canadian nonprofit organizations do not pay any income tax provided that there objective is not to provide dining, recreation and sports facilities to the members of organization. Moreover, when a nonprofit organization hires one or more employees, income taxes and other deductions are paid on monthly basis (Lang, 1988). In the United States, the organizations which meet the requirements of section 501(a) of Internal Revenue Code are attributed as charitable organizations including both private and public organizations and they are exempt from federal income taxation (IRS Gov, 2009). On the other hand, for-profit organizations have to report net income after deducting taxes. The taxation of for-profit organizations make a huge difference financial reporting mechanisms of organizations. Most of the for-profit organizations have been always complaining about this unfair competitive advantage of nonprofit organizations. The nonprofit organizations which achieve income from investments have to disclose it on Form 990-T which is subject to tax deductions like for-profit organizations. Moreover, such organizations need to report cost allocation for their related and nonrelated activities. It is interesting to note many large corporations are trying to avoid taxes by carrying out public services activities. Unlike for-profit organizations, the nonprofit firms also submit form 990-T show their compliance to reporting standards and tax exemption and this document can be demanded by anyone, whereas, for-profit organizations do not share such documents. Performance Evaluation Like for-profit organizations, nonprofit organizations conduct performance evaluation to achieve best possible performance employees and to increase their ability for achieving highest efficiency of limited resources. However, since the targeted objectives for these organizations differ, therefore, their performance evaluation management system differs. For example, the emergency response teams of national or international NGOs do not have set objectives therefore; performance of employees is rated in the context of job description for the position. The performance evaluation form of Save the Children US (Appendix III) may be very similar to an appraisal form of for-profit organizations however; performance evaluation in for-profit organization evaluates the employees on his efficiency to bring business for organization. For example, appraisal of HR employees will determine the ability of HR staff to hire skilled labor from market in a for-profit organization whereas, in a nonprofit organization it will be more based on the ability of HR staff to hire in need of emergency and compliance to policies . The assessment criteria based on which overall performance of nonprofit organizations is compared with peer organizations has been shown in Appendix II. Governance Mechanisms In 2007, Herranz argued that different organizations behave within a governance mechanism based on the nature of organizations such as for-profit, nonprofit and governmental organizations. And managers face difficulties whilst coordinating multi-sectors governance (Jang & Ha, 2010). In 1997, G. Charreaux developed a typology based on the distinction between governance mechanisms for nonprofit organizations (Rijpens & Mertens, 2008). Governance mechanisms differ in organizations because of different ownership structure in organizations. The aim of for-profit organizations to achieve best governance practices resolves around achieving business success and developing an image of corporate socially responsible organizations. On the other hand, good governance mechanisms in nonprofit organizations increases the ability of corporations attract charitable grants and contributions (McDermott Will & Emery, 2004). Economic theories of nonprofit organizations highlight the features of nonprofit organizations that are very in governance mechanism (Speckbacher & Offenberger). The mechanisms of corporate governance adopted by all public sector organizations should ensure the rights of common shareholders and selection of directors should be a highly credible process because directors’ body should consist of distinguished experts (Anonym, n.d.). At, Save the Children, the manual of policies are distributed to all the offices and management and staff are supposed to take actions according to the given guidelines. FOD and DD/PM are responsible for disseminating the designed policy to all employees in their respective units and for instituting and maintaining a program to ensure that employees understand standards of ethical conduct. They are also responsible for informing employees of the importance of reporting any suspected violation of this code to management, without fear of reprisal. A board of trustees has been developed which controls and manages the procedures of all offices of Save the Children worldwide (Save the Children, 2010). In the case of for-profit organizations, shareholders or the owners of the company have the authority to vote and participate in the decisions of the company. Whereas, in nonprofit organizations a committee is designed to make decisions and no private individual has the authority to challenge the decision made by committee. Therefore, the system of internal control and regular reporting of financial activities are two major area of focus for the management in nonprofit organizations. Most of these organizations have hired a treasurer for this purpose that takes care of financial matters. As long as organizational structure is concerned, a higher level of decentralization is being noticed in nonprofit organizations especially in the area of finance and grants. To increase a sense of ownership in employees, involvement and employees participation is increasing in nonprofit firms. In for-profit organizations, the systems are more organized and decision making process is also standardized whereas, in nonprofit organizations because of frequent changes in activities the rate of turnover was higher previously. However, nowadays, increasing level of decentralized decision making is being seen in nonprofit organizations because high involvement of donors can reduce the health and mission of these organizations. Therefore, based on the above discussion, it can be concluded that nonprofit organizations are showing significant changes in financial management techniques as compared to for-profit organizations. The objective, mission, accountability requirements, tax exemption and stakeholders requirements are the major reasons which are contributing towards the differences in financial management processes. Moreover, adopting changes in financial management techniques have actually facilitated these organizations to achieve their aims and objectives. Bibliography Anonym. (n.d.). Executive Summary. Retrieved August 8, 2010, from http://rbidocs.rbi.org.in/rdocs/PublicationReport/Pdfs/20022.pdf Blackbaud. (2004, July). Financial Management of Not-for-Profit Organizations. Retrieved August 4, 2010, from http://www.blackbaud.com/files/resources/downloads/WhitePaper_FinancialManagementForNPO.pdf Bourgeois, K. (2003, June). NONPROFIT FINANCIAL STATEMENTS. Retrieved August 6, 2010, from Uoregon: http://aad.uoregon.edu/icas/project_thesis_pdf/bourgeois_k.pdf Clifton Gunderson LLP. (2008). Best Practices for Nonprofit Budgeting and Cash Forecasting. Retrieved August 7, 2010, from http://www.cliftoncpa.com/Content/5HQ5OYA9WU.pdf?Name=NonprofitBudgeting.pdf Credit Infocentre. (2006, May). Why a non-profit organization can still make its employees/corporate officers lots of money . Retrieved August 8, 2010, from http://www.creditinfocenter.com/debt/non-profit.shtml Donner Canadian Foundation. (2010). Retrieved August 06, 2010, from http://www.donnerawards.org/main/index.php?page_id=57 IRS Gov. (2009, September 2). Retrieved August 8, 2010, from http://www.irs.gov/charities/article/0,,id=169727,00.html IRS. (2009, November). tax guide for Churches and Religious Organizations . Retrieved August 8, 2010, from http://www.irs.gov/pub/irs-pdf/p1828.pdf Jang, H., & Ha, H. (2010, January 6). Governance of public, non-profit, and private organizations in economic development. Retrieved August 10, 2010, from http://www.allacademic.com/meta/p_mla_apa_research_citation/3/9/6/5/9/p396594_index.html Lang, L. (1988, January). Retrieved August 8, 2010, from Omafra: http://www.omafra.gov.on.ca/english/rural/facts/88-010.htm McDermott Will & Emery. (2004). Retrieved August 8, 2010, from Best Practices: Nonprofit Corporate Governance Merrill Lynch. (2010). Endowment Management Account™ Service (EMA®): Manage a Nonprofit’s Cash and Portfolio. Retrieved August 8, 2010, from http://www.business.ml.com/BCPublic/SpecialtyServices/EndowmentManagement/ Minneapolis Foundation. (2010). Nonprofit Endowment Funds. Retrieved August 8, 2010, from http://www.minneapolisfoundation.org/NonprofitGivingServices/EndowmentFunds.html Rijpens, J., & Mertens, S. (2008, July). Governance in nonprofit Organizations: What Mechanisms are at Work Beside the Board. Retrieved August 8, 2010, from www.istr.org/conferences/barcelona/cd/pdf/.../Rijpens.Julie.pdf Save the Children. (2009). About us. Retrieved August 8, 2010, from http://www.savethechildren.org/about/ Save the Children. (2010, March 3). Board of Trustees. Retrieved August 8, 2010, from http://www.savethechildren.org/about/board.html Speckbacher, G., & Offenberger, P. (n.d.). THE DESIGN OF MANAGEMENT CONTROL SYSTEMS IN NON-PROFIT ORGANIZATIONS: HOW CAN TRUST AND CONTROL BE BALANCED? Retrieved August 8, 2010, from http://www.istr.org/Abstracts2010/pdf/ISTR2010_0426.pdf Zietlow, J. T., Hankin, J. A., & Seidner, A. G. (2007). Financial management for nonprofit organizations: policies and practices. John Wiley and Sons. Appendix Appendix I: Annual activities of Save the Children October 1 New fiscal year begins October 31 Annual Finance Report with inventory of assets due November Annual Reports due November Individual performance reviews and objectives for U.S-paid staff due December First budget revision request for current fiscal year due (including amended grant forecasts for the fiscal year) April POP narrative guidelines for the coming fiscal year issued (IP only) April Program planning for the coming fiscal year begins (IP only) April Second budget revision request for current fiscal year due (including amended grant forecasts for the fiscal year) June POP budget guidelines and budget marks for coming fiscal year issued July POPs (both narrative and budget sections) for coming fiscal year due September Budget packets for coming fiscal year sent to field offices September 30 Fiscal year ends Appendix II: Assessment Criteria for Nonprofit Organizations By Canadian Donor 1. Financial Management 2. Income Independence 3. Strategic Management 4. Board Governance 5. Volunteers 6. Staff 7. Innovation 8. Program Cost 9. Outcome Monitoring 10. Accessibility Source: Donor Canadian Foundation Awards Appendix III: Performance Evaluation Form Performance Evaluation Form Name of Employee: Name of Supervisor: Title of Employee: Title of Supervisor: Employee ID # Date of hire: Evaluation period: Date of receipt by HR section: Please tick if YES: JD Attached □ Targets Attached □ Form signed by Employee & Supervisor □ Section 1: Performance during past year 1.1: Employee’s self-evaluation Using your Job Description, please attach and last year’s Performance Objectives as a point of reference and briefly comment on how well you (the employee) performed during the past year. Performance Objectives: 1.2: Supervisor’s evaluation of the employee Using the employee’s Job Description and last year’s Performance Objectives (attached) as a point of reference, briefly comment on how well the employee performed on the responsibilities assigned to her/him during the past year, and rate the employee’s performance on a scale of 1—5. (5=outstanding, 4=exceeds expectations, 3=meets expectations, 2=meets most expectations, 1=below expectations) Tasks Assigned Please attach extra sheets (if needed) for up to 2~3 Major Tasks, and 3~5 routine tasks assigned for the period 2~3 Non-routine tasks, specific only to the current evaluation period: Deadline Deliverables (Optional)       3-5 routine tasks: Deadline Deliverables (Optional)       2.2: Supervisor’s comments on the employee’s objectives: Please comment on the employee’s performance objectives for the coming year. (If supervisor recommend any changes in the employee’s Performance Objectives, these should be mutually agreed on and a written copy, bearing those changes, should be provided to the employee as well as one placed in his/her personal file with HR. Section 3: Training / Development Needs Using your Self Evaluation for the past year, and your Performance Objectives for the coming year, please identify areas where you would like to receive further training/development during the coming year. All tasks, deadlines, changes to JD (if any) and staff development needs have been discussed and finalized. Seeking further clarifications and guidance is primarily the responsibility of the incumbent Signatures: (Employee and supervisor have discussed the evaluation together) Employee: Date: Supervisor: Date: Next Level Supervisor: Date: Appendix IV: PAF PERSONNEL ACTION FORM (PAF) From: __________________________________________ To: ____________________________________________ Date: ___________________________________________ Personnel Action required: New Hire Depute as acting (position) Promotion Demotion Replacement End of probation Other _________________________ (Please fill in Termination of Employee Worksheet for termination / end of service) New Hiring: Initiate Recruitment For (Position): Reason for hire: Proposed Salary Level / Band: Location (Office): Reports to: Suggested Date of Joining: Change in the Employee Status: Employee Name: Current Position/Job Level: Current Salary Level / Band: Location (Office): Reports to: Current Proposed Proposed Change(s): Reason for change: Effective Date: Budget Code(s): ______________________________ Supervisor: _______________ Date: ___________ DD/PM: _______________ Date: ___________ DDAF: __________________ Date: ___________ FOD: ______________________________ Date: ___________ Read More