Financing Nonprofit Organizations

Inigo Garcia-Rodriguez, M. Elena Romero-Merino, Inigo Garcia-Rodriguez, M. Elena Romero-Merino

• Publisher: Routledge
• Year: 2020
• eBook ISBN:
  9780429560439
• Topic: Negocios y empresa
• Subtopic: Negocios en general

The financial issues of nonprofit organizations (NPOs) have increased their importance in recent years, especially after the last global economic downturn. In this way, NPOs have been threatened by a reduction of income, while their work and expenses have not decreased. In this book, the editors bring together several topics that the academic literature has previously addressed, connecting them to each other and evaluating how all these issues are interrelated. Financing Nonprofit Organizations analyses the state of art of all these financial topics and the consequences of the last economic crisis. It dives into the interrelations of these concepts to suggest lines of future research and to reflect on the future of the different sources of funding of the NPOs. It will be of interest to students, practitioners, and researchers interested in initiating and updating their knowledge in the growing field of the financial aspects of the NPOs.

1 A Journey Through the Finance of Nonprofit Organizations

An Introduction

Inigo Garcia-Rodriguez and M. Elena Romero-Merino

The finance of nonprofit organizations (hereinafter NPOs), defined as the efficient generation and management of cash flow (Pajas & Vilain, 2004), has been a topic often relegated to second place by academics and is usually confused with the act of fundraising. Most research regarding NPOs financing is focused on private individual donations as they are considered the most natural and characteristic source of funding for these entities. The consideration of these private donations as essential for the NPOs derives from theories regarding the origin of the so-called third or social sector. For example, according to market failure/government failure theories, the nonprofit sector arises when citizens decide to finance those demands from public goods that are met neither by the state nor by the market (Salamon & Anheier, 1998). As it requires the participation of a large number of contributors to be able to finance the achievement of NPOs’ objectives effectively, this method of financing is considered a paradigmatic example of collaborative financing effort. In a sense, NPOs financing can be seen as evidence that the ‘new’ crowdfunding strategies applied nowadays have been used in the nonprofit sector for several decades without the intervention of specialized platforms through the Internet. Therefore, whereas taxes were related to the public sector, and the sale of goods and services to the lucrative private sector, NPOs were always linked to private individual donations (Weisbrod, 1998).

Considering private contributions as the main source of NPO financing may not be problematic in a growing economy, when it is easy to cover the basic financial needs of organizations. However, it becomes a drawback in times of economic recession, when NPOs are threatened by a reduction of income whereas their work, and therefore their expenses, do not decrease. Thus, in recent years, other sources of financing (both external and internal) have gradually been considered more relevant. In addition, beyond raising money to support NPOs’ activities, there has been increasing focus on the way in which these financial resources are managed (e.g., reserves policy and treasury and cash management). Nowadays, although private donations have increased in absolute terms, they represent a smaller part of the resources that organizations manage in relative terms (Young, 2017), which indicates that NPOs are using a mixture of different sources to finance their day-to-day operations.

The structure of this book follows a similar scheme to that described above. Part I (Chapters 2 to 7) begins with a review of the literature regarding reasons and drivers of donations, especially private individual contributions as well as corporate sponsorship and public subsidies, and the examination of the interrelationships among them. Part II (Chapters 8 to 11) describes how to manage these donations efficiently, the effects of revenue diversification, and their influence on the financial health of NPOs. Finally, Part III (Chapters 12 and 13) outlines the most innovative sources of financing related to new technologies and how this method of managing resources is bringing NPOs closer to the business practices.

Traditional literature on NPO financing is focused primarily on asking why donors donate (i.e., determinants of donations) (Bekkers & Wiepking, 2011; Van Slyke & Brooks, 2005; Vesterlund, 2006), how to increase their donations (i.e., research on fundraising) (Haibach & Kreuzer, 2004; Steinberg, 1986), or the price of these donations (i.e., NPOs’ efficiency) (Callen, 1994; Weisbrod & Dominguez, 1986). This research was initially focused on charitable private giving, but it soon evolved to be also relevant in explaining other common sources of NPO funding such as private corporate contributions and public subsidies. In Part I of this book, we consider all these topics by opening with the general question of why donors donate and concluding with the interrelationships that may exist between the private and public sources of financing.

Specifically, in Chapter 2, Bretos, Díaz-Foncea, and Marcuello outline the main socio-economic motivations of individual private donors and the importance of the organizational factors that influence the way in which donors make their decision; however, the size, age, or legal form of an NPO have been traditionally considered as drivers of private donations (Marcuello & Salas, 2001). In Chapters 3 to 6, we have focused on the analysis of NPO efficiency, governance, transparency, and reputation as they all can be managed by the organization.

In Chapter 3, Martín-Pérez and Martín-Cruz describe the problem of measuring efficiency in the nonprofit sector and, consequently, the price of donations. As the authors point out, improving governance and providing accessible accounting information would be the necessary condition to introduce competition in the market for donations, but the sufficient condition requires a proper assessment of efficiency to calculate at what price the NPO aims are achieved. For this reason, we considered it necessary to include a review chapter on the evaluation of efficiency in the nonprofit sector.

Regarding NPOs’ governance, transparency, and reputation, the literature confirms that an effective design of the governance mechanisms and an improvement in organizational transparency foster donors’ confidence and organizations’ reputation and, therefore, lead to an increase in the volume of financial contributions. Based on this, we address the three interrelated topics throughout Chapters 4 to 6. In Chapter 4, Jegers explains how NPOs’ governance includes all the mechanisms designed to preserve stakeholders’ interests. According to the author, effective governance can generate the perception that the organization is pursuing the ‘right’ objectives, and hence, incite donors to be more generous in their contributions. In Chapter 5, Gálvez-Rodríguez, López-Godoy, and Caba-Pérez describe how an increase in an NPO’s accountability and transparency is welcomed by donors as they not only recognize the professionalism of the organization, but they also understand that the NPO complies with its responsibilities. Furthermore, in Chapter 6, de Quevedo-Puente and Pérez-Cornejo emphasize the role of an NPO’s reputation as it is directly related to the previously described tools (governance and transparency) and it seems obvious to assume that it will help to attract money either from public or private contributors.

Part I of the book concludes by focusing on the consequences of the interrelationships between the different sources of resources. On the one hand, we address the influence of private corporate sponsorships on reputation and other types of contributions (either charitable individual donations or public aids). Apart from individual private donations, which may be periodic or one-time, there is another private source of financial resources—those derived from both for-profit and nonprofit organizations. Large corporations (corporate sponsorships) are a common source of financial resources because they entail tax benefits for contributors and substantial amounts of money for nonprofits. However, there is also some reluctance by NPOs and society in general to accept donations from these entities, especially when they are from companies whose objectives are far (or even opposite) from those of the NPO to which they are donating (e.g., it would be questionable that a company that experiments on animals sponsors a project for an organization whose objective is to avoid the degradation of the natural environment, such as the WWF). In this way, as de Quevedo-Puente and Pérez-Cornejo show in Chapter 6, NPOs have to deal with the potential risk of damaging their reputation (and reducing their supporters) due to negative behaviors of their for-profit partners. On the other hand, in Chapter 7, de Wit, Bekkers, and Wiepking address the interrelationship between public and private sources of NPOs financing. Although neither private individual donations nor public grants are required to be repaid, the first usually have specific conditions attached; that is, they require compliance with specific reporting requirements and are usually linked to a specific project. These grants allow nonprofits to finance large and long-term projects with a high social impact that could not be developed based exclusively on small individual contributions. However, public funding is radically rejected by some organizations that associate it with a weakening of their independence (e.g., Greenpeace), whereas, in other cases, it constitutes the main source of the NPO’s financial support (e.g., The Public Finance Initiative of UNICEF). This twofold perception of public funding is described by de Wit et al., who argue that the impact of public aid on private donations (crowding-out or crowding-in) can be positive or negative depending on the NPO’s contextual factors.

If Part I of this book focuses on how to raise more money, Part II pays special attention to the way in which this money is managed and how it maintains the financial health of the NPO. Along this line, in Chapter 8, Chikoto-Schultz and Sakolvittayanon explain how the use of several sources of financing, the so-called revenue diversification, can assume a key financial strategy for achieving financial stability and surviving in times of economic recession. However, as the authors indicate, this financing can also increase the risk and administrative costs of the NPO.

In terms of the way in which NPOs manage their financial resources, we have included two chapters about slack resources and cash management. In Chapter 9, Calabrese and Ely describe how reserves can help to maintain organizational spending during difficult economic times although, at the same time, they are highly criticized by external stakeholders when they are considered excessive. In Chapter 10, Zietlow highlights the importance of liquidity management, especially when NPOs experience a cash flow crisis due to a shortfall of cash inflows relative to cash outflows. The author reviews previous academic literature on the topic and suggests some ways in which NPOs may measure and manage liquidity to better achieve their missions.

Finally, we introduce the importance of capital structure in NPOs. When these organizations design their funding structure to meet their expenses, it is important to consider the cost and features of each source. In addition to evaluating the possible effects that one type of donation can have on others (as we have seen in Part I), the NPO needs to decide between the use of internal or external funds. There is a clear difference between having to repay the amount of money the organization has borrowed (external resources) or, on the contrary, allocating such money to net assets (internal resources). As Lam, Searing, Prentice, and Grasse explain in Chapter 11, the cost of external financing is higher (repayment of principal and interest), but internal financing should be considered neither free nor unlimited. That is, NPOs incur costs (e.g., fundraising events, staff dedicated to obtaining these resources, cost of goods sold or services provided, etc.) to obtain internal funding and, in many cases, such expenses increase proportionally more than the funding obtained (their efficiency decrease), which could be seen by donors as an improper use of their resources.

Part III is devoted to illustrating how the sector is seeking new sources of funding and introducing new practices derived from the business sector. In addition to using public and private donations as a method of financing, NPOs can carry out commercial activities in service of their social missions. They can therefore sell goods (in many cases products made by the beneficiaries of the entity or related to any of its missions, such as from fair trade) or they can charge fees for some of their services (e.g., membership fees, admission tickets for museums, orchestras, or theaters). This source of income can be significant, but it is not useful for every nonprofit. The use of this option is considered by some as an excessively risky approach to marketing, which would make NPOs very similar to companies and, therefore, could cause them to lose other sources of financing such as that derived from individual donations. The recent phenomenon of adopting business practices in the nonprofit sector is analyzed by Vaceková, Svidroňová, Plaček, and Nemec in Chapter 12.

Moreover, the evolution of technology is also adding new possibilities that NPOs are taking advantage of. We have paid special attention to the use of crowdfunding campaigns (see Hommerová in Chapter 13) as it is one of the latest and most powerful methods to finance nonprofit projects and also because it can be considered a modern adaptation of the original NPO financing through the collaboration of a high volume of charitable private donations.

As a whole, we can observe how there is some kind of interrelationship between all the different topics we have dealt with throughout the book. For example, in Chapter 6, de Quevedo-Puente and Pérez-Cornejo suggest that accountability and governance mechanisms may improve reputation, and this could have an effect on the donations received by the NPO. In the same way, revenue diversification may have an impact on the margin and reserves and on other financial measures (e.g., capital structure or financial health) that also impact private donations or organizational efficiency (see Calabrese and Ely in Chapter 9 and Lam et al. in Chapter 11). In addition, governance mechanisms seem to have an effect on private donations (see Jegers in Chapter 4), but Calabrese and Ely also suggest that they may influence the accumulation of reserves. Finally, as Jegers points out, we cannot ignore the problem of reverse causality, which could be applied in most of the aforementioned relationships. Therefore, all these examples demonstrate how we are dealing with complex relationships that need clearer and more comprehensive theoretical support. In this way, beyond testing direct relationships, scholars may consider more complex connections through moderating and mediating effects.

We can also note the importance of technology in this sector. As long as the use of these new technologies continues to increase in society, NPOs should continue using them in several ways. First, information technology (IT) allows NPOs to reach more people. The Internet allows NPOs to share their activities with the entire society, not only with their current donors, so organizations can take advantage of it and increase the visibility of their activities. Second, IT enables NPOs to involve the different stakeholders in the achievement of their organizational goals. As stakeholders may be more informed, NPOs have to explore how they could participate in a more active way (i.e., social networks may allow NPOs to establish dialogue and obtain other opinions regarding their activity). Similarly, if stakeholders observe how the NPOs listen to them, their engagement will likely increase. Third, IT facilitates an increase in the accountability of NPOs. As different authors have noted (see Chapters 2, 6, 5, 4, and 13), the problems of information asymmetries between the organization and its stakeholders may be reduced by using the Internet. It allows NPOs to be scrutinized by their stakeholders, and, if their analyses are positive, the organizational reputation may increase (and hence, donations). Finally, IT continues to progress and NPOs should take advantage of new financing tools. For example, some NPOs are beginning to use blockcha...

Table of contents

• Cover
• Half Title
• Series
• Title
• Copyright
• Contents
• Acknowledgements
• 1 A Journey Through the Finance of Nonprofit Organizations: An Introduction
• Part I Determinants of Public and Private Income
• Part II Revenues, Funding, and Financial Health
• Part III New Ways of Financing and an Approach to the Business Practices
• Contributor Bios
• Index