Financial Management of Non-Profit Organizations

The field of public administration and management (PAM)

The field of public administration and management (PAM) identifies financial resources as the foundation of public entities. Public financial management is effective in the management of NPOs as it informs the organizations on the appropriate models, research and practice to be applied. This article discusses financial management as a concept of public choice theory using financial management questions to provide empirical insight to the management of NPOs. Financial resources and availability are discussed as effective tools that shape organization and how tools of financial management can enable NPOs to be accountable.

Keywords: Financial Management, NPOs, Revenue Income

Comparative Analysis of U.S and International NPOs

Introduction

NPOs are exposed to different financial issues due to their reliance on external funding resulting in reduced social welfare expenditure. The financial crisis has affected the operation and financing of NPOs in the US and globally, thus introducing extreme financial problems to these organizations. Strydom (2014) asserts that financial management is essential for the economic functioning of an NPO – and the existing financial issues put emphasis on the significance of financial management in running of NPOs during harsh economic periods. (Strydom, 2014), however, argues that financial management is a challenging task that NPOs managers have to address. Thus, the concept of financial management is viewed as part of public choice theory – that provides NPOs with rational choice methodology that ensures that these organizations account for donor funds and other financial resources.

Purpose of Study

The study in this paper analyzes how of financial management assists the public in understanding the relationship between NPOs, practical application of financial management strategies, and the economic vulnerabilities experienced by NPOs.

The Role of Financial Management in NPOs

The primary objective of financial management for NPOs is to maximize shareholders’ contributions by accumulating the share price of the organization. This entails minimizing risks by increasing profits or decreasing costs or both (Strydom, 2014). The goal of financial management for NPOs is to ensure that the profits are sustained while managing an organization’s essential purpose (Strydom, 2014). Therefore most NPOs aim at maximizing donor funds by ensuring that the donated resources are appropriately managed with minimal mishandling.

In a research conducted on 288 religious NPOs in the United States from 1992 to 1994, 38.4% of these organizations confirmed that their primary financial goal is to break-even, while 20.5% claimed that maximizing revenue income was their primary objective (Strydom, 2014). It is therefore evident that the financial management of most NPOs is to exist merely and minimize losses rather than increase profits. This is a significant difference that is likely to be associated with the practice of financial management of NPOs and the financial crisis experienced in NPO settings.

Literature Review

Financial Ratio Analysis

This part evaluates the financial performance of organizations using ratio analysis to investigate the anomalies concerning the mission, stakeholders, and money of NPOs. The discussion will focus on; the implementation, limitation and financial performance model for NPOs – internationally and in the USA.

The implementation of Financial Ratio Analysis

Ratio analysis is a model that is used in evaluating a company’s financial performance. According to McKinney (2015), financial ratio analysis focuses on examining the revenue income, liquidity, and financial capability. As a result, the ratio analysis model can be used in addressing various questions concerning the financial stability of an organization.

The primary goal of financial analysis and valuation of an organization’s operations is influenced by its mission. The framework used in measuring an organization’s financial performance using the ratio analysis suggests four sub-questions (McKinney, 2015). The proposed questions include; What financial capitals are available to fund the company’s mission? Are the available financial resources enough to support the organization’s mission? In what ways are the available financial resources used to fund the mission? Are the financial resources effectively utilized to support the mission? The ratio analysis model is applied to address four questions: Are the objectives of an organization aligned with the financial resources? Does the organization practice intergenerational equity? Do the financial sources appropriately match with the organization’s investments? Are the available financial resources reliable?

The above series of four are not directly linked to the mission statement of an organization, but they are concerned with the goals and vision of an organization – which are impacted by the approach that is used in utilizing the financial resources. A question worth investigating is: Does the organization match its resources to meet the current and future needs of its stakeholders while providing long-term strategies to sustain the organization (Perez et al., 2016). The subject of NPO financial management and NPO efficiency and efficacy is crucial due to the role of NPOs in social development, considering the current global financial issues.

NPOs organizations budget its activities in alignment to its mission statement and do not revise the mission to fit in a budget. Therefore, there is no direct link between the funds and donations received by an organization and the operational objectives of an NPO (Mendel, 2013). Moreover, NPOs do not have similar financial management goals as other for-profit organizations and often describe their financial sources differently. As a result, the importance of ratio analysis in NPOs is decided by the organization’s mission – which centers on stewardship and accountability.

Irrespective of the questions used as a foundation for financial management, ratio analysis measures and formalizes financial information – which will assist an organization in evaluating its internal and external performance. Financial ratio analysis is an efficient method that NPOs can use to better understand the economic situations and operational performance of their organization. Secondly, it is an approach that is implemented to assist the decision-maker in identifying essential strategies and business relationships (Besley & Ghatak, 2017). Thirdly, it creates a platform which enables the organization to forecast its risks, and ability to pay debts and manage its resources consistently with its mission and objectives. Thus, financial ratio analysis facilitates an organization to utilize its resources and eliminate current and future deficits.

Each financial ratio is designed to identify specific types of deficiencies

Each financial ratio is designed to identify specific types of deficiencies that limit the performance of an organization while suggesting suitable strategies to address these limitations. Ratios are useful when examining the extent of financial vulnerability and performance of the organization (Strydom, 2014). The table below explains the function of ratios in the financial management of NPOs financial resources.

Table 1: Function of Financial Ratios in Financial Management

Ratio

Role in Financial Management

Asset turnover

Aligns the investment assets with the goals. Substantial asset investment decreases flexibility and reduces the number of turnover assets.

Revenue income and return on capital investment

Evaluates the intergenerational equity and equates the utilization of financial resources and how funds are invested. Hence balancing profits and losses in an organization.

Liquidity and wealth

Examines whether an organization mishandles its financial investments in the short-term or the long-term?

Size of profits, by source

Investigates the profitability of an organization consistent with the mission. Is the organization excessively reliant on limited revenue sources? Are revenue sources aligned with the organization’s mission?

Size of an expense account, by type

Questions quantity of expenses and relation to mission. Are costs aligned with the organization’s mission? Large expense account limits an organization’s flexibility.

Discussion

Application of Financial Analysis Ratio on NPOs

To calculate the financial performance of NPOs, it is imperative to first account for the organization’s mission. The set of questions discussed above can be applied in an attempt to evaluate the organization’s financial and operational performance. The analytical abilities of ratio analysis are useful in analyzing an organization’s present economic status, develop strategies to address future problems and devise plans to achieve its mission. Additionally, ratio analysis enables NPOs to evaluate its performance over time while identifying approaches that an organization can implement to meet future expectations.

Turk et al. recommended specific ratios that can be adopted by NPOs for effective financial management (McKinney, 2015). However, the recommended ratio cannot be absorbed directly into the operations of NPOs since many of these organizations are membership-based. As a result, some ratio analysis methods have been utilized while others have been disregarded depending on an organization’s mission and structure as dictated by its membership. Consequently, NPOs have been careful to ensure that not all ratios are implemented for financial management, but also to meet the mission of the NPO and its stakeholders.

The rest of this section will use a set of four questions to understand how NPOs can utilize the ratio analysis model to unite the mission, stakeholders and financial management of NPOs. Each section highlights how financial ratios are used to evaluate member-based NPO’s operations, financial management, and achievement of its mission.

Q1. Is the NPO’s financial capacity adequate to support its mission?

This question is mainly concerned with how sufficient and flexible financial resources are while balancing the balance sheet and the income report. The balance sheet provides evidence on how an organization utilizes its resources and if it is healthy to conduct its businesses. On the other hand, the income statement reveals the operating costs through its surplus and deficit while indicating whether the NPO is operating within its financial means. If this is not the case, it is concluded that the NPO is financed by past financial resources, rather than the present donors – which introduces the issue of intergenerational equity.

Q2. Which financial sources are present to support the NPO’s activities?

This question addresses the challenges associated with long-term financing. It evaluates how an organization invests its debt in supporting its mission and goals and the degree to which it generates profits through internal and external resources. It is vital for NPOs to re-evaluate the investments that distract it from its mission to avoid mishandling of resources and financial income. Contextual factors may dictate that fixed assets be generated to develop investment opportunities that would produce external revenue sources which will benefit the organization (McKinney, 2015). Nonetheless, critiques may argue that NPOs have a specific mission that cannot be developed using such strategies. This has resulted in different debates about NPOs that own underdeveloped assets. The argument involves a balance between the specific mission of an organization and pursuing other investment opportunities.

Q3. How can the NPO mission be aligned with the available financial resources?

This question mainly focuses on the economic allocation of resources. An NPO must consider its mission, the organization’s needs and align them with its primary and secondary activities – and determine the manner in which funds will be allocated to achieve the set goals. This is a contemporary issue that affects many NPO around the US and globally especially those that belong to a specific member-group – which have started releasing their revenue income and expenditure depending on the classification of an activity. However, in the past, such events would have been accumulated.

Q4. Is the utilization of financial resources efficient and effective?

This last question addresses the challenges of accountability and financial performance of NPOs. It questions the strategies used in the allocation of resources and whether these approaches meet the organization’s mission and goals (McKinney, 2015). Besides the main concern is the performance of an organization’s productivity. Furthermore, different NPO organizations focus on the varying features of organizational performance and accountability. As a result, the strategic plans of an organization called for careful assessments of the organization’s revenue, efficiency, and effectiveness. This way the main components of a balanced financial management ratio is to balance the revenue income, satisfy stakeholder’s needs and meet the internal measures of efficiency. Nonetheless, it can be challenging for NPOs to address these elements since they focus on the organization’s mission as opposed to its profits.

Conclusion

The financial ratio analysis measures specific areas of an organization’s financial performance and overlooks the rest. It is crucial to interpreting the financial data in the correct perspective considering the changing economic environments, the unique features of NPO industry and the market position of the organization being examined about its historical performance. On the other hand, since NPOs are not required to respond to the accounting regulations, their financial reports are discrete and can only be understood by those who have prepared them. Hence, it is difficult to measure the financial performance and have uniform financial reports. Thus, the financial report of an NPO may be difficult to interpret since the operations of an NPO vary depending on the current social, political and economic conditions.

References

Besley, T., & Ghatak, M. (2017). Public–private partnerships for the provision of public goods: Theory and an application to NGOs. Research in Economics; 71, 356–371

McKinney, J. B. (2015). Effective financial management in public and nonprofit agencies. ABC CLIO

Mendel, S. (2013). “How Nonprofit Organizations Create Public Value.” Urban Publications. https://engagedscholarship.csuohio.edu/urban_facpub/686

Perez, M., von Schnurbein, G., & Gehringer, T. (2016). Comparative research of Non-Profit Organisations: a preliminary assessment. CEPS Working Paper Series, (9), 32.

Strydom, B. (2014). Financial Management in Non-Profit Organisations: An Exploratory Study. Mediterranean Journal of Social Sciences. Retrieved from: DOI: 10.5901/mjss.2014.v5n15p55