Non-Profit vs. for Profit Organizations
This paper seeks to examine the financial management relationship between non-profit and for-profit organizations. A recent surge to push non-profit organizations to behave in a more business-like manner has resulted in an evaluation of the financial management practices. This paper examines a few of the similarities and differences amongst the two organizational types in relation to source of funding, performance evaluation measures, and governing mechanisms. The analysis of non-profit organizations leads to an understanding that many of the same methods used in examining for-profit organizations are suitable.
However, it is important to take into consideration that the goal of a non-profit organization is the overall mission. Therefore, the evaluation should be based upon this fact. The Small Business Encyclopedia defines a non-profit organization (NPO) as an institution with a purpose directed at assisting individuals and groups without regard for turning a profit (Nonprofit, n. d. ). They are classified as any organization whose charter explicitly prohibits the distribution of profits to members. Moreover, non-profit organizations must demonstrate that they provide a public benefit (Moxham, 2009).
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Not all non-profits are charitable organizations. NPOs cover many areas of expertise including churches, hospitals, and the arts to name a few. Recently, there has been a push for non-profit organizations to behave more business-like (Moxham, 2009). Because of the organizational structure, the financial management of NPOs must be examined in order to achieve this objective. There are many similarities in relation to financial management that exist between for-profit and non-profit organizations. However, there are some differences between the financial management of for-profit and NPOs that require a different approach.
These similarities and differences are explained in their source of funds, performance evaluation measures, and corporate governing structure. Sources of Funds The source of funding for non-profit and for-profit organizations is closely related to the goal of the organization. The main goal of a for-profit organization is to maximize shareholder capital. The shareholders, in turn, are willing to provide equity to support the firm’s mission. The firm will take the financing from shareholders and invest in opportunities that will increase the firm’s future cash flows.
A portion of this cash flow is returned to the stockholders in the form of dividends and stock options (Bauer, Richardson, & Collins, 2009). The survival of non-profit organizations, however, is based on their ability to obtain resources. The main source of equity for non-profit organizations is charitable donations. This is also supplemented by grants, contracts for service and the sale of goods (Carroll & Stater, 2008). Whereas most for-profit organizations are evaluated on the basis of their ability to maximize shareholder capital, non-profit organizations are often evaluated on the relationship between contributions and expenses.
This relationship will indicate to potential contributors the amount of funds that will be used to meet the mission of the organization. Because of this, it is important that non-profit managers seek out opportunities that will reduce administrative costs and increase the social return of stakeholders. Unlike for-profits, NPO cash flows as the result of operations are recycled back into the organization to further the group’s mission (Bauer, Richardson, & Collins, 2009). Although each organization relies on a different equity source, both can be affected by the economic downturn.
A recession or economic decline can result in the shortage of financing for both firms. Investors and contributors may not have the capital available to supplement the organizations efforts. In addition, the risk to investors may be too high to guarantee a return on their investment. A for-profit organization can rely on the constant production of goods and services to maintain a moderately steady cash flow. On the other hand, a nonprofit must rely predominately on their cash flow reserves to support the organization’s mission (Bauer, Richardson, & Collins, 2009).
Performance Evaluation Due to the increased pressure for non-profits in operation and attitude to become more business-like, an increased emphasis has been placed on NPOs to measure their performance. Because of this increased pressure, performance evaluation has become increasingly important in the non-profit sector. As with the private and public sector, this had lead to the creation of performance measurement systems (Moxham, 2009). Claire Moxham (2009) examines the use of public and private sector performance measurement systems in nonprofit organizations.
She argues that while literature on performance measurement is predominately based upon public and private sectors, the unique characteristics of NPOs does not prevent the use of the same evaluation methods. The predominant method of evaluation has historically been the external audit. However, the use self-assessment has become increasingly widespread. With any type of organization financial accountability has been the main driver of performance evaluation (Moxham, 2009). This has driven the use of ratio analysis in both the for-profit and non-profit sector (Abraham, 2006).
Measurement of financial performance by ratio analysis has been a widely used tool in the for-profit sector. In recent years, the emphasis being placed on accountability has lead to an increased focus on ratio analysis in evaluating the performance of non-profit organizations. This analysis is used to evaluate an organization’s profitability, liquidity, and financial stability. In the case of non-profit organizations, ratio analysis can be used to determine how financial resources are being used, if there are sufficient resources, and if financial resources are being applied efficiently and effectively to support the organization’s mission.
Because NPOs and for-profit organizations do not share the same financial management objectives and characterize resources differently, ratio analysis is mission-centered and directed towards stewardship and accountability (Abraham, 2006). This increase in accountability for non-profit organizations has lead to an examination of the governing structure as well as an institution of regulations that directly affect NPOs along with for-profit institutions. Corporate Governance Corporate governance is the system by which organizations are directed and controlled.
The corporate governance structure specifies the distribution of rights and responsibilities among different participants in the corporation, such as the board, managers, shareholders, and other stakeholders, and spells out the rules and procedures for making decisions on corporate affairs. By doing this, it also provides the structure through which the company objectives are set and the means of attaining those objectives and monitoring performance (Jegers, 200, p. 144). Corporate governance originally was developed based on the functions of for-profit organizations.
It has since been used is explaining the structure of NPOs and is no longer confined to for-profits. In the past there has been little knowledge on the governing structure of non-profit organizations until recently (Jegers, 2009). Since then, different approaches are being used to evaluate the governing mechanisms of NPOs. Among them is the economic approach, which evaluates governance from a transaction cost point of view (Speckbacher, 2008). In analyzing the governance mechanisms of profit organizations, the economics approach has proven successful.
However, very little research has applied the same approach to NPOs. It has been argued that the economics approach is not suited for the governance of organizations with multiple objectives like NPOs, but better suited for single objective organizations like for-profits. Speckbacher (2008) discusses the use of economic theories for the study of non-profit governance. Specbacher states that having multiple objectives does not prevent the use of the economics approach in examining the governance mechanisms of NPOs. The purpose of governance from an economics point of view is to ensure efficient contribution.
The single objective of a non-profit organization is for people, in cooperation with others, to contribute their time, assets, and idealism to others. In the case of NPOs, maximizing the value of contributions is achieving efficiency. In doing so, this will reduce such inefficiencies such as power-seeking activities. Because the purpose nonprofit governance is to provide a clear set of rules and guidelines to reduce these inefficiencies, the economic approach proves to be a valuable tool in evaluating corporate governance.
The push for non-profit organizations to become more business-like has resulted in an evaluation of the financial management of the sector in relation to for-profit organizations. NPOs and for-profit firms obtain equity in different manners. However, the end result is to ensure that investors receive maximum return on their investment whether social or monetary. After reviewing the similarities and differences between for-profit and non-profit organizations, many of the same approaches can be used in evaluating the performance and governing mechanisms for both organizational types.