1 Chapter 1: Introduction Financial Management for Nonprofit Organizations: Policies and Practices Zietlow/Hankin/Seidner © 2007, John Wiley & Sons. All rights reserved worldwide.

2 Learning objectives: 1) Define nonprofit organization 2) Describe the primary characteristics that distinguish nonprofits from businesses 3) Define key nonprofit terms 4) Distinguish between policy and procedure 5) Explain and defend the primary financial objective of noncommercial nonprofit 6) Discuss the survey evidence regarding primary financial objective of nonprofits

3 1.1 Nonprofit Organizations Defined Nonprofit = organization allowed to make a profit but prohibited from distributing profit to those in control Most nonprofits are 501(c)(3) Corporations – “charitable,” tax- exempt, may receive tax-deductible donations (religious, education, social welfare, private foundations) Put the mission first No stock, no payout to “owners” of net revenue No direct control by outsiders (including donors) Not steward to shareholders, so pursue and fund the mission, not concerned about stock price Articles of Incorporation (Charter) and Bylaws (Operating Rules – trustees, meetings, reports)

4 Three Emphases in our Treatment Distinct and integrated decision-making emphasis on achieving a liquidity target as the primary financial objective Establishing the right financial policies Defining current “state of the art” in nonprofit financial management practice, including in many cases “best practices” The “Nonprofit Financial Management Golden Triangle:” Primary Objective, Policy, and Practice

5 1.1 Nonprofit Organizations: Vital Statistics (#1 of 2) Nonprofits in U.S. account for…* 7.5% of GDP 9% of all paid employees 6% of all organizations $665 billion in revenue (38% from private dues and services, 31% from government grants and contracts, 20% from private contributions, and 11% “other”—primarily investments-related) Source: Johns Hopkins Institute for Policy Studies, Independent Sector, and the Urban Institute

6 1.1 Nonprofit Organizations: Vital Statistics (#2 of 2) About 2/3 of all nonprofit sector revenue in U.S. is earned by health care and education organizations About 35% of all private contributions in the U.S. go to religious organizations (congregations and other religious entities) Source: Johns Hopkins Institute for Policy Studies, Independent Sector, and the Urban Institute

7 1.2 Nonprofit Organizations: Characteristics (a) Organizational Mission For a business, make money for the owners/shareholders For a nonprofit, serve a broad public purpose, no “private inurement” “Any unjust enrichment of a private individual, whether out of gross or net earnings, may constitute inurement. See People of God Community v. Commissioner, 75 T.C. 127 (1980)…any transaction between an organization and a private individual in which the individual appears to receive a disproportionate share of the benefits of the exchange relative to the charity served presents an inurement issue.” [Source:

8 1.2 Nonprofit Organizations: Characteristics (b) Organizational Structure* - roles and responsibilities of board, committees, staff; partly linked to type of organization *IRS statistics, FY 2005 (updates Exhibit 1.2, p. 5)

9 1.3 Language of the Nonprofit Organization Officer of Corporation is legal representative of the board: president, vice-president (and/or treasurer), secretary Secretary is board officer responsible for agendas, minutes and other board business documents Treasurer is the one tasked with (and held responsible for) being the chief financial officer of a nonprofit, but larger nonprofits have staff person doing the CFO role and duties Chief Financial Officer (CFO) is the staff member most responsible for financial analysis and decision-making; in smaller organizations without finance staff this role may be jointly assumed by the CEO and the bookkeeper or board treasurer.

Language of the Nonprofit Organization Board has a fiduciary role and acts as a steward of the organization’s assets Fiduciary is one legally bound to oversee another’s affairs, using same standards as would use if it was fiduciary’s own assets Stewardship means holding something in trust for another

11 Our Two Focuses Financial Policies Financial Practices

Financial Policies Definition: set of guidelines, laws, rules, or principles for how day-to-day business should be performed; guiding principles on how organization does certain things Examples: investment policy, internal control policy, debt policy Not same as procedures: “steps or actions to comply with a certain policy”

Financial Practices What is the “state of the art” regarding: Primary financial objective Organization of the finance function w/i organization Use of technology in treasury area Cash and liquidity management Budgeting Forecasting and financial ratio analysis Capital project evaluation Accountability and internal controls

Principal Financial Objective: Not Same as a Business (#1 & #2) Difference from Business #1:* Business: Maximize Stock Price Nonprofit: No Single Success Indicator Number Difference from Business #2: Business: Price Services, Sales = Success Nonprofit: No Price, Revenues ≠ Services * Conceded: some nonprofits are commercial nonprofits, really more like businesses than most other nonprofits

Principal Financial Objective: Not Same as a Business (#3 & #4) Difference from Business #3: Business: Know Identity of Customers, Owners Nonprofit: Donors or Clients = Customers? Society or Founders = Owners? Difference from Business #4: Business: Cash Position Related to Timing of Inventory, Credit Sale, and Credit Payment Flows Nonprofit: Often Start with Cash Stockpile, Disburse Cash, Await Donations or Reimbursement

Principal Financial Objective: Survey Evidence Percent Responding: Financial Objective 35.7%Break even (revenue = expense) 21.4%Maintain target level of cash reserves, financial flexibility 14.3%Maximize cash flow 7.1%Minimize costs 7.1%Maximize net revenue 7.1%Maximize net donations 7.1%Make a small surplus 0.0%Avoid financial risk Related Source: 2002 Survey of member organizations of the Evangelical Fellowship of Missions Association (EFMA)

Principal Financial Objective: Does it only apply to “Purely Financial Decisions?” Richard Wacht: For purely financial decisions, objective should be “cost minimization, subject to the absolute constraint of maintaining organizational liquidity and solvency over time” For other decisions, consider program and mission aspects primarily

Principal Financial Objective: Achieve Liquidity Target Strive to reach an “approximate liquidity target over time” (see Appendix 1A) Keys: Manage Cash Flow and Cash Position Related sub-objectives (William Hopkins): Cost effectiveness Financial accountability Cash flow maximization and protection Maintain liquidity to assure organization’s future

Principal Financial Objective: Achieve Liquidity Target Cash flow refers to the difference between cash inflows and cash outflows in a given period. Cash position is the amount of amount of cash and near- cash investments held by the organization. Liquidity management includes forecasting, and managing cash flow and the cash position, and ideally should include setting and managing toward a preferred cash position, or liquidity target. A liquidity target includes the elements of the cash position, including unrestricted short-term investments, along with unused short-term borrowing capacity. An organization may have a pre-approved line of credit with a bank, some of which has not been borrowed or “taken down” at present.

20 Conclusion A nonprofit organization’s primary financial objective is to achieve its liquidity target. Stated more broadly, it should ensure that financial resources are available when needed (timing), as needed (amount), and at reasonable cost (cost- effectiveness), and that once mobilized, these resources are protected from impairment and spent according to mission and donor purposes.