Capitalization structures determine how a nonprofit organization generates capital and carries long-term debt and net assets while implementing programs and providing services to its clients or target population. Nonprofit organizations generate capital through profits and borrowing. Further, capitalization structures dictate whether an organization will buy or lease a machine or equipment. A decision to buy or lease has implications for financial sustainability or services. In most cases, leasing may be a more cost-effective option in the short term, but ownership of an asset is less expensive in the long term.
Nonprofit organizations make allocation decisions based on projects and programs prioritized by the board of directors. Financial allocation or appropriation occurs after a budget has been approved. However, the real allocation or appropriation takes place during the budgeting process.
FINANCIAL MANAGEMENT SYSTEMS
A financial management system (FMS) in a nonprofit organization is a systematic process supported by software technology and internal control policies and procedures used by internal stakeholders of such organization to manage income, expenses, assets, and liabilities in a way that is effective, efficient, and accountable to the public. As Figure 8.3 illustrates, a nonprofit financial management system includes four major elements:
2. Policies and procedures
4. Internal stakeholders' roles
Nonprofit organizations are publicly supported entities. They receive money from the public through individual and corporate donations, as well as from foundation and government grants. The public is entitled to know whether its donations or contributions are used in a way that helps fulfill the vision and mission communicated by a given nonprofit organization. Consequently, nonprofit organizations are exposed to greater public scrutiny and expectations to show that income, expenses, assets, and liabilities are managed
FIGURE 8.3 Major elements of a nonprofit financial management system.
efficiently. In other words, nonprofit organizations have to satisfy public expectations of accountability and stewardship. The purpose of a financial management system is to enable a nonprofit organization to maintain internal control, monitoring, and reporting procedures that help meet such expectations. To this end, a financial management system helps perform tasks and practical functions such as:
- Streamlining invoicing and billing (e.g., pledges, service fees)
- Reducing the risk for record-keeping errors and redundancy
- Complying with tax regulations, accounting principles, and financial reporting
- Managing accounting changes
- Monitoring and adjusting organizational budgets
- Ensuring transparency in management of revenues and expenses
- Keeping track of depreciation schedules and liabilities
- Coordinating accounts and financial statements
- Ensuring the integrity and security of financial operations in a way that fosters accountability and greater opportunities for stewardship
- Contributing to environmental sustainability by reducing the use of paperwork
Policies and Procedures
A financial management system is based on written policies and procedures that guide the internal financial control of an organization. Elements of policies and procedures include, but are not limited to:
- Accounting policy manuals
- Whistleblower policies
- Document destruction and retention policies,
- Codes of ethics, including conflict-of-interest policies
- Information technology (IT) control policies (e.g., user access, system, application, and data security)
- Policies for cash management, payroll, and accounts payable
The policies and procedures explain the roles and responsibilities of various internal stakeholders in internal financial control decisions, as well as procedures and principles that apply when
- Developing or adjusting budgets
- Recording financial transactions
- Capitalizing on depreciating assets
- Making deposits, monitoring petty cash and reimbursement, and reconciling bank statements
- Managing accounts payable and receivable and accounting for bad debts
- Preparing and reviewing financial statements
- Conducting an internal audit of financial statements
- Managing payrolls
Nonprofit organizations use accounting and fund-raising software to ensure a systematic functioning of their internal control system. Technology makes it possible to create systems for data input and data management that facilitate data analysis and financial decisions to improve effectiveness and efficiency.
A financial management system includes written job descriptions that define the roles and responsibilities for directors, officers, executives, managers, staff, consultants, and volunteers in the financial operations of a nonprofit organization. Table 8.3 provides a selected list of financial stakeholders' roles in financial management systems.