Finance Fundamentals for Nonprofits

Building Capacity and Sustainability

Woods Bowman

• Publisher: Wiley
• Year: 2011
• Print ISBN: 9781118004517
• eBook ISBN: 9781118114001
• Edition: 1
• Topic: Business
• Subtopic: Nonprofit Organizations & Charities
• Index: Business

A complete guide to the financial requirements a nonprofit organization must follow to indefinitely maintain the volume and quality of their services

An organization may have plenty of capacity in the long run, but in the short run, donor restrictions and limited financing options are constraining. Here-and-now liquid assets are the only resources available. Finance Fundamentals for Nonprofits: Building Capacity and Sustainability shows how to measure a nonprofit organization's financial capacity in different time frames and how to measure its ability to sustain capacity in each case.

• Explains how nonprofits differ from businesses and how they promote values-centered management
• Reveals how to improve financial capacity and sustainability
• Written by a nonprofit scholar

Filled with real-world case studies and actionable advice relating financial health to financial capacity and sustainability, this book is essential reading for every nonprofit professional.

CHAPTER 1
Introduction:
How Nonprofits Are (and Are Not) Like Businesses

It is not enough to do good. It must be done well.

—Vincent de Paul (1581–1660)

What are we to make of for-profit charities like Google.org or nonprofit corporations like the furniture purveyor IKEA¹ and (before 2006) that icon of American capitalism, the New York Stock Exchange? These crossover examples serve to remind us that nonprofits and for-profit businesses have much in common. However, their rarity also indicates fundamental differences.

Finance Fundamentals for Nonprofits sheds light on similarities and differences between nonprofits and for-profit businesses. It is intended to provide a foundation in nonprofit finance for graduate students, assist nonprofit managers, and instruct corporate executives on nonprofit boards. It does not delve into finance techniques that are the same in nonprofit and for-profit businesses.

The book’s subtitle (Building Capacity and Sustainability) signals its emphasis on two concepts of particular importance to nonprofits. Whereas for-profit managers are concerned with maximizing their firm’s market value, nonprofit managers may have many financial goals.² Finance Fundamentals for Nonprofits proposes that nonprofit managers should be primarily concerned with having the financial capacity their mission requires and sustaining it over time.

Financial capacity for a nonprofit consists of the resources necessary to seize opportunities and respond to threats.³ The amount needed depends on its mission, service delivery method, operating environment, and risks of potential adverse economic events. Maintaining assets takes time, effort, and money, so managers choose a capacity level that balances the costs of maintaining capacity with its benefits.

Financial sustainability is simply the rate of net change in financial capacity. It is a clear-cut issue for most profit-maximizing businesses. By maximizing profit, assets grow as fast as possible and sustainability takes care of itself. However, sustainability is an issue for nonprofits that trade off surpluses (the profits of nonprofits) in favor of serving more people and serving them better. They must take care not to spend too much on such worthy objectives because over the long run they must be able to keep their assets in good shape and maintain their reserves at a level commensurate with anticipated economic risks. A sustainability principle requires consistency between the short run (as measured by annual surpluses) and the long run (as measured by asset growth). This is the subject of Chapters 6 through 9.

A major difference between nonprofit and for-profit financial management is that many nonprofits generate income from sources other than selling goods and services as for-profits do. Such alternative income includes gifts, grants, dues, and income from endowments. Even if a nonprofit has no sources of alternative income it can choose to develop them, which gives it strategic options foreclosed to a for-profit firm.

Financial models used by for-profit managers must be modified before applying them to nonprofits, because alternative income reverses financial logic. In for-profit firms production creates revenue through sales; but in nonprofits with alternative income the amount of income determines how much can be produced.

This chapter introduces the book’s agenda, beginning with a discussion of alternative definitions of nonprofit—or not-for-profit, as accountants call them—attempting to discern the essential character of “nonprofitness.” Then it describes the intrinsic similarities and differences between for-profit and nonprofit corporations, highlighting the advantages and disadvantages of the nonprofit type.

A few technical terms are necessary for this discussion. Later chapters on related topics will define them. In the meantime, readers may consult the Glossary at the end of the book to clarify unfamiliar terms.

What Are Nonprofits?

The simplest and most common definition of a nonprofit organization is one that is “barred from distributing its net earnings, if any, to individuals who exercise control over it, such as members, officers, directors, or trustees” (Hansmann 1980).⁴ The prohibition on distributing net earnings to private parties is widely known as the nondistribution constraint. The principal shortcoming of this legalistic definition is that it makes no reference to noneconomic values, which is the social justification for nonprofits. The United Nations (UN) uses a more robust definition, which defines nonprofits as:

organizations that do not exist primarily to generate profits, either directly or indirectly, and that are not primarily guided by commercial goals and considerations. [They] may accumulate surplus in a given year, but any such surplus must be plowed back into the basic mission of the agency and not distributed to the organizations’ owners, members, founders or governing board. (United Nations 2003, 18)

This definition is not explicit about the noneconomic values because it must apply in all countries despite their cultural differences. Finance Fundamentals for Nonprofits uses the UN definition because it implies the primacy of values. In the United States, tax exemption laws address nondistribution through intermediate sanctions and keep nonprofits mission-focused by specifying acceptable exempt purposes (see Chapter 5).

For-profit firms may espouse social values, but these values usually are secondary to maximizing a firm’s economic value or they are instrumental toward that end. The Body Shop and Ben & Jerry’s are well-known examples of values-centered for-profit firms, but it is significant that they earned their reputations before going public—meaning before selling stock on a public exchange—and acquiring investor-owners.

Social values are the business of nonprofits. As Rose-Ackerman says, nonprofit customers “...

Table of contents

• Cover
• Table of Contents
• Title
• Copyright
• Dedication
• Preface
• Acknowledgments
• CHAPTER 1: Introduction: How Nonprofits Are (and Are Not) Like Businesses
• CHAPTER 2: Accounting: Measuring Past Performance
• CHAPTER 3: Investing: Looking to the Future
• CHAPTER 4: Budgeting: Taking Control of the Present
• CHAPTER 5: Nonprofits in History and Tax Law: Why Nonprofits Do What They Do
• CHAPTER 6: Ordinary Service Providers: Serving the Public Today
• CHAPTER 7: Membership Associations: Serving People with a Common Purpose
• CHAPTER 8: Endowed Service Providers: Serving the Next Generation, Too
• CHAPTER 9: Grantmaking Organizations: Serving Service Providers
• CHAPTER 10: Beyond Sustainability: Managing Revenue to Maximize Growth
• CHAPTER 11: The Nonprofit Difference: Doing Good Well
• Notes
• Glossary
• References
• About the Web Site
• About the Author
• Index
• End User License Agreement