Financial Management in non-profit making organizations
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Executive summary
In this paper, the focus is on the importance of maintaining good financial management techniques in the nonprofit making organizations. Since these are charitable organization, they rely on the funds from the members’ contributions and donations by the service beneficiaries. They provide stewardship of the funds. Good budgeting and appropriate cash flows ensure trust of the organization by the donors and hence its continuity in service provision.
The paper discusses the major issues in various sections. The first section provides an overview of the financial management in the nonprofit organizations by comparing it with the private and public commercial enterprises. The second part discusses three sources of funds in a nonprofit organization namely the member motivator, public provider and beneficiary builder. The third section discusses the use of debts and debts level a nonprofit organization should maintain. The performance evaluation and governance mechanisms are discussed in the last section.
It is recommended that there is need have structured governance in the nonprofit organizations so that the funds are adequately managed to ensure continuity in service provision and develop trust in stewardship of funds.
Introduction
A good financial management technique should be maintained in a non-profit making organization similar to the commercial public and private enterprises for their continued operation. Non-profit organizations are beneficial to the members of the community. These organizations exist in different sizes ranging from large complex units to the small local clubs. Their main source of income includes generous contributions, fundraisings and grants from the members of the organization. They sometimes engage in commercial trading activities to add up to their income.
Despite the fact that they are not for profit making, there should be an appropriate financial management policy. These techniques ensure that the organization achieves its aim and serve the community at all times (Barned, 2009). NFPs are important parts of the economy especially in the provision of health services, education sector, the arts and social amenities. Many nonprofit organizations provide goods and services at a fee that are also offered by the commercial enterprises. Profit making and nonprofit making organizations compete in other areas explicitly or implicitly. Nonprofit organizations lack stronger governance mechanisms compared to the profit making enterprises (Bolton & Mehran, 2009).
Financial management techniques
Financial management techniques for the nonprofit making organizations are the same as the financial management of the profit making organizations in many ways. However, there are a few differences between the two. A commercial enterprise aims at making profits and the maximum value of the shareholding whereas nonprofit organizations do not aim at maximizing the shareholder value. Instead they focus on meeting the social needs continually.
A nonprofit making organization’s finance is not stable and flexible because the organization relies on the generous contribution of the members and beneficiary of the services they provide because the organization and these beneficiaries are not in an exchange transaction business. The funds received are channeled to the provision of goods and services to the client. Their main duty is to keep the resources donated and channel them to the receiver specified by the donors or as spelt out in the mission and vision of the organization.
The accounting and finance department of these organizations manage these resources as specified by the donor and report the use to the donor. These reports sent to the donors make the fund accounting system of the nonprofit organizations more crucial to handle. In contrast, profit making financial sectors manage their own resources and do not report to any external donor unless specified by the organizations goal. They do not rely on the donations and contributions from the beneficiary of the goods and services they provide but rather they are in an exchange transaction with the customer (Boor, 2011)
Nonprofit making organizations focus on two areas of financial management to achieve their goals effectively, which are the budgeting and cash management. The organization must ensure that there are adequate funds in their accounts so that they can offer their services to the clients throughout their course of operation. Cash flow and budgeting in such organizations present some problems since they depend on the resources from the service beneficiaries who actually may or may not need the services. In contrast, commercial sectors sell their final products to the customers by undertaking thorough market analysis; their cash flows do not have so many challenges as the resources are received almost every day from the customers. For a nonprofit making organization, an increase in the demand for the services by the beneficiaries might present some management problems because the contribution from the members and beneficiaries are not reliable every year. Budgeting and control of expenses in a nonprofit organization is a critical issue, in contrast, an increase in the customers for the goods and services offered by the profit making organization do not present a management crisis but rather beneficial to them as more revenues received are channeled to the production of more goods and services (Boor, 2011).
Sources of funds in non-profit making organizations
Non-profit making organizations do not aim at making profits but it is important for the organizations to have a sustainable capital and funds to achieve their aim. Such organizations should have a day-to-day cash flow to implement their plans throughout their existence. Auditors, contributors, donors and other stakeholders of the organization need to see how the organizations utilize their funds hence a need to have a financial management (Barned, 2009). NFPs utilize the money sourced from the following kitties.
Some nonprofit making organizations obtain their funds from the reimbursement for the services they render to specific individuals, communities, states and other beneficiaries when they decide to donate to the organization after they are served. This funding model is referred to as the beneficiary builder. The main examples of the beneficiary builders are the hospitals and institutions of higher learning. Beneficiaries of the services offered by these organizations pay fees for the services they have received. The fees they pay for the service does not equate to the services the beneficiaries receive. NFPs build a lasting relationship with these beneficiaries so that they can supplement the income through fee payment and other generous contributions (Christiansen, Foster & Kim, 2009).
Other nonprofit making organizations rely on a funding model called the member motivator whereby members of the organization willingly donate money. This contribution is motivated by the critical nature of the issues in their daily life so that they can benefit as a group. The organizations do not suggest for the members/donors the activity they should do but rather they support the activities already identified by the members. Such organizations are largely found in the religious sector and environment conservation or the humanities sector (Christiansen, Foster & Kim, 2009).
Many nonprofit making organizations work in collaboration with the government agencies and other public bodies. They offer social services to the public servants for example housing, waste management, health and education. In such service sectors, the government allocates funds annually to support them. Such organizations that provide these services rely on a funding model called the public provider. In most cases the government outsources such services to the non-profit making organizations and formulates a policy that such institutions should be funded for providing the services (Christiansen, Foster & Kim, 2009).
To ensure good financial management, a nonprofit making organization should keep its financial records well. These include the statements of financial position and comprehensive income as shown in the appendices.
Use of debt in non-profit organizations
To maintain trust by the donors and achieve the goals, nonprofit making organizations should maintain a debt level of thirty percent of their total income and below every year. This benchmark according to Pensley is arbitrary but is derived from the financial standards of industries. These standards spell out that for commercial enterprises and personal finances, the debt to income ratio should be maintained at 30% for continuity in business or personal transactions.
Nonprofit making organizations therefore should ensure that the debts owing in a particular financial year is less than 30% of the donations from the contributors. If they engage in huge debts every year, the resources received will only be used to repay the debts and the interest accruing from the preceding financial period. Interest rates tend to rise every year apart from the principal debt; this may continue until the closure of the services by the organization. Nonprofit making organizations normally borrow loans to finance infrastructure projects and as a result, the management should take care not to involve in large projects that will make them exceed the 30% benchmark (Pennsley, 2012).
Performance evaluation of non-profit making organizations
There are standards for gauging the performance of the not-for-profit making organizations to ensure that the resources contributed by the donors and members are properly utilized to meet the goals and objectives of the organization. For a non-profit making organization to perform highly, the financial department managers must understand how to manage the money. These organizations must ensure that they are trustworthy to continue receiving the funds and operate throughout their lives. They have to stick to the budget and reduce the debts as much as possible. Paul Pensley posted the following standards of measuring the performance of NFPs at alliance magazine.
Non-profit making organizations should structure their budgets according to the resources in the cash reserves; they should not spend money like the commercial private and public enterprises who engage in an exchange transaction with the customer do. Drafting of the annual or any periodic program should be done in line with the current and projected budgets. The board and management gauge the success of this standard by ensuring that the debt level always stands at 30% of total revenue or below and ensure that there is ways more than six months of cash reserves at hand (Pensley, 2012).
To achieve the stated goals effectively, non-profit making organizations should ensure that the external independent auditors check their financial statements every year. The work of determining fraud and funds embezzlement should be left to the experienced auditors since many of the donors are not financial experts or do not have time. Research shows that a nonprofit making organization reported to have a financial misconduct must have avoided the external independent audits of their financial statements (Pensley, 2012).
In a non-profit making organization, performance indicators are the effectiveness of the utilization of resources. This is a qualitative measure of how a specific resource has been used to achieve a particular goal. Since non-profit making organizations do not gauge their performance basing on the profits, performance evaluation is normally gauged from the efficiency in offering the services to the clients as directed by the donors or as stated in the mission of the organization (Duan, 2010).
Governance mechanisms in non-profit making organizations
There is need to understand the efficiency and the governance mechanism of the nonprofit making organizations. This is critical for the donors, beneficiaries, stakeholders and tax authorities of the NFPs. Governance mechanisms and the directions any organization takes dictate how the organization runs, output quality and its functioning. The basic characteristics of the organization governance include the composition of the executive board, managerial roles and behaviors, competence of the board and management, and the relationship between management and the board, which determine the success of the organization in the achievement of their aims (Scarozza, 2011).
Many financial analysts argue that nonprofit making organizations are not managed efficiently due to the fraud and office abuse by the management. The governance problems in nonprofit organizations originate from the lack of motivation and disciplining devices as those in the profit making organizations. Disciplining devices in the profit making enterprises include hostile takeovers and the directors who stand by themselves independently (Bolton & Mehran, 2009).
Nobody claims the ownership of the non-profit making organizations compared to the profit making organizations. In the commercial sector, investors and major shareholders can claim the rights of ownership of the enterprise whereas in NFPs, founders, donors or even the founding charter do not have a right to claim for the ownership. The charter loosely protects the board and management of the NFP. The rights of owning and controlling NFP lie in the body that perpetuates the organization, which is actually the organization itself. The non-distribution regulatory board protects the potential abuse of the office by the management of NFPs to restrict them from engaging in self-dealings (Bolton & Mehran, 2009).
Conclusion
Non-profit making organizations operate like a business but do not intend to gain financially. They provide goods and services to the public as they receive other rewards such as improved health living standards, quality education, and efficient clean waste management. They operate legally within or without the country and source their funds mainly from the donations by the members and beneficiaries. Proper financial management techniques need be incorporated to ensure that they maintain affordable debt level and high performance at all times. However, they lack good governance structures due the lack of mechanisms and policies.