Non-Profit Issues in Financial Management
Non-profit entities pursue a fundamentally different mission than their for-profit relatives, which is characterized as a providing a socially beneficial service to society. There are no shareholders and any surplus in funding must be reinvested into the organization’s core mission. Despite these traits, it is still crucial for non-profits to maintain highly controlled accounting policies and ensure that safe financial management policies are followed at all times. The following essay will compare and contrast the effects of the following topics on nonprofit organizations: ethics, capital budgeting, strategic planning, financial ratios, EFN, and cash flow statements. As an example, the American Society for the Prevention of Cruelty to Animals (ASPCA) will be used to demonstrate the importance of financial topics for a well-known non-profit organization.
The primary purpose of a non-profit organization is to provide a beneficial service to society. In order to achieve a socially responsible goal, it is crucial that the organization places a high importance on the topic of ethics. In many cases, non-profits receive a large portion of their financing from 3rd party donors that wish to support the organization’s mission. Managers of the organization have the responsibility to ensure that donations are used in a highly ethical manner. The mission of the ASPCA is stated as “to provide effective means for the prevention of cruelty to animals throughout the United States” (ASPCA 2014). The organization leaders are obligated to use donated funds to support this mission the most effective way possible. Using this funding for excessive management salaries or unnecessary discretionary projects would be a violation of accepted ethical standards. Following high ethical standards is of utmost importance in a non-profit because the mission is often centered on making social progress.
Both nonprofits and for-profit firms can take a similar approach to capital budgeting. They each use measurements like NPV, IRR, and discounted cash flow to measure the viability of a certain project. However, nonprofits have the luxury of being able to select projects with lower returns because they do not need to generate returns for shareholders. They also receive preferential tax breaks and special debt financing programs that significantly reduce the weighted average cost of capital. Another key difference in capital budgeting for nonprofit firms is restricted assets. Donors have the ability to place contractual restrictions on the use of certain assets to ensure they are used for the intended project. For example, a donor may provide $1 million for the construction of a new ASPCA facility, but restricts this donation to solely this project. This will provide the nonprofit with additional cash, but it must receive special accounting treatment and could change capital budgeting outcomes.
Nonprofits must contend with a variety of risks and environmental factors that could affect their pursuit of the stated purpose. Unlike for-profit firms, a strategic goal will never be related to profit maximization. Instead, a nonprofit is likely to pursue strategic goals related to the growth of donations, human resources, asset acquisitions, etc. In order to plan for these goals, it is common for nonprofits to use tools like a SWOTT analysis or balanced scorecard (Friskics 2011). The ASPCA could use these tactics to identify its strengths and weaknesses to develop strategies that complement its mission. If the organization experiences a trend of declining donations, it may be financially beneficial to spend on television advertisements that inspire new donors to participate. Overall, the use of the strategic planning tools can be applied to nonprofits with equal effectiveness to that of for-profit firms.
Financial ratios play an important role in the financial management tactics of nonprofits, which must remain solvent and financially viable to pursue their goals. Perhaps the most important financial ratios are those dealing with liquidity and cash flow. If a non-profit is unable to maintain positive working capital, meaning current assets exceeding current liabilities, it runs the risk of becoming insolvent. Nonprofits in this situation may be forced close their doors and liquidate assets to pay creditors. Monitoring the current ratio and acid test ratio can help organizations determine their relative liquidity and risk of becoming insolvent. An important difference, however, is that restricted assets must be treated differently. Having a large amount of restricted cash will not necessarily be able to save an organization from liquidity issues. “The stronger the restrictions on a grant, or the greater the fixity of assets acquired with that grant or loan, the higher the risk to the organization” (Miller 2003). Having a larger amount of restricted assets on the books presents a higher risk to potential donors and lenders.
External Financing Needed (EFN)
Operational costs can eat away at the assets of a nonprofit firm, which requires the use of external financing to continue working towards the primary mission. The ASPCA has a great deal of overhead to run the facilities that provide services to prevent the suffering of animals. Debt financing can be used to ensure that these facilities remain operational even during times of lower cash flow. Nonprofits can look at total receipts from operations and total donations to determine cash inflow. This amount can be compared to the growth in assets and liabilities on the statement if financial position to calculate the need for external financing. In the context of nonprofits, debt financing is usually not ideal because donated funds do not require repayment of any financial return. Therefore, debt financing is typically used as a safety net to ensure working capital needs are covered.
Cash Flow Statements
Positive cash flow is essential for the long-term survival of a nonprofit organization. This becomes especially true where there are significant overhead costs to cover each period; such is the case with the ASPCA. The purpose of the statement of cash flow is to show which activities are producing cash inflows and cash outflows. This gives managers an effective tool to determine the most effective ways to limit cash expenditures and grow cash receipts. In addition, it allows donors to see how the organization’s cash is being managed and decided if it is acceptable based on their personal standards. For example, some ASCPA donors may want to see their donations being used on marketing and promotion, while other donors may want to see cash being used to create new facilities for housing orphaned animals. Any perceived cash flow imbalances can be used as a decision making tool for users of financial statements. Although it is not required by law to be released publically, many non-profits voluntarily cash flow statements to the general public.
In the big picture, nonprofits face very similar financial issues to for-profit companies. Both types of entities must set high ethical standards, maintain positive cash flow, and engage in strategic planning. The key difference is that the primary stakeholders have contrasting requirements. For-profit firms are required to generate financial returns for owners, while non-profits are required to pursue their stated purpose and effectively manage donated funds. The ASCPA highlights these differences by working towards a mission that is not profit-driven, but rather driven by the social demands of society. In summary, the nonprofits serve an important role in American society by working to improve many underserved community issues.
ASPCA. (2014). ASPCA Policy and Position Statements.
Friskics, K. (2011). SWOT Analysis of Friends of the Orphans.
Miller, M. (2003) Hidden in Plain Sight: Understanding Nonprofit Capital Structure.