Class theme was The structure of resource environments

Table of contents

• Chapter 7, Managing Nonprofit Organizations, Tschirhart and Bielefeld (2012)
• Smith - Managing the challenges of government contracts (2010)

Chapter 7, Managing Nonprofit Organizations, Tschirhart and Bielefeld (2012)

• transformation from financial distress to financial empowerment was due to three factors: data, discipline, and dialogue
• proper financial management can help a nonprofit be more successful with its mission, avoid allegations of improprieties, and reduce the risk of unethical and illegal behavior
• Financial management systems are critical for demonstrating adherence to the law and accountability
• in this chapter we discuss seven elements of an effective financial management system:
  • financial policies
  • accounting
  • budgeting
  • banking relations
  • borrowing
  • risk management
  • auditing and financial analysis
• Financial policies
  • Conflict of Interest Policy
    • A 2006 study revealed that 21 percent of nonprofits bought or rented goods, services, or property from a board member
    • In some U.S. states, financial transactions between a nonprofit and its board and staff members are illegal
    • Nonprofits should supply training for board and staff members (paid and volunteer), with specific examples of the ways in which the nonprofit’s conflict of interest policies might be violated and what to do in situations where the policy is unclear
    • should be clear on procedures that will be followed once a conflict of interest is disclosed
    • When board and staff members understand why the conflict of interest policies are important and what steps will be taken to enforce them, it is more likely that they will follow them.
    • Gratuities, kickbacks, and loans are ripe for conflict of interest concerns
    • A kickback, which is a payment from a vendor in return for getting the nonprofit’s business, is illegal.
    • A loan from a nonprofit to a board or staff member can also be considered inappropriate
    • Sarbanes-Oxley Act explicitly forbids private loans to insiders in for-profit corporations but does not extend this rule to nonprofits
    • some states recommend or require that nonprofits not provide loans to board members and executives
  • Whistle-Blower Protection Policy
    • A nonprofit must report in its IRS Form 990 whether it has adopted a whistleblower policy
    • The Sarbanes-Oxley Act makes it a federal crime retaliate against an employee who reports suspected fraudulent activities
    • Nonprofits should give employees and board members options for sharing concerns and should have mechanisms to ensure that the concerns are reviewed and not ignored
  • Budget Reserve Policy
    • should set a policy to budget funds in reserve at a certain level
    • having a reserve fund that is controlled by board vote allows a nonprofit to avoid taking out expensive loans or running a large line of credit.
    • however, funders typically take a dim view of what they perceive as an overly large reserve
    • Having a policy set by the board about the amount of the reserve fund helps in addressing the great variation in opinion that may exist about what it should be
  • Investment Policy
    • The board must decide whether to pursue a passive or active investment strategy and spell out the values that will guide investment choices
    • In addition to designating the investment risk orientation, the investment policy also specifies the types of investments the nonprofit can use.
  • Document Retention Policy
    • Even if the retention period for documents has passed, the Sarbanes-Oxley Act requires that document purging must stop if an official investigation or bankruptcy proceeding is under way
• Accounting
  • Accounts
    • summary snapshot: Assets - Liabilities = Net Assets
    • basic accounting equation: Revenues - Expenses = Net Income or Net Loss
  • The Accounting Cycle
    • refers to a process that allows for the accurate recording and summarizing of transactions by an organization
    • gist of the process consists of three key activities:
      • Documenting
      • Recording
      • Reporting
  • Generally Accepted Accounting Principles (GAAP)
    • Uniform accounting standards help to ensure that the financial statements generated by different organizations are consistent and comparable
    • In 2009, the Financial Accounting Standards Board (FASB) issued the Accounting Standards Codification (ASC, or Codification)
    • One of the most important GAAP standards for nonprofits is Accounting for Contributions
    • nonprofits must record the donor’s intent for the gift in one of three categories:
      • Permanently restricted assets
      • Temporarily restricted assets
      • Unrestricted assets
    • Donors may sue nonprofits to have their gifts returned if they believe their intent for the gift was not honored
    • One complication related to accounting = pass-through contributions ; when a nonprofit collects a donation to turn over to another organization to use, the donation is treated as a liability until it is paid to the other organization
    • GAAP requires nonprofits to report expenses in three categories:
      • program expenses related to service delivery
      • management and general expenses that support programs
      • fundraising expenses
    • some funders, such as the United Way, limit the percentage of total expenses that may be spent on management and general activities
  • Accounting Internal Controls
    • The difference between an error (for example, sloppy accounting) and fraud is that fraud is intentional, but an error is unintentional
    • Conditions that can increase opportunities for fraud include having weak internal accounting controls, not obtaining an independent audit, having poorly trained personnel, installing a new accounting or IT system, changing management organization and responsibilities, and being overdependent on one person in areas with opportunities for fraud
    • The most fundamental accounting control is to separate accounting duties among two or more persons
    • the person keeping the books should not be the person signing the checks.
    • check signer should not receive bank notifications and reconcile bank statement
    • Separating duties is more challenging in a small nonprofit
    • Besides separation of duties, these practices may reduce the likelihood of fraud:
      • background and credit checks on all workers who handle cash
      • positive ethical environment
      • board members who have no financial interests in the nonprofit’s affairs.
      • audit committee
      • whistle-blower protection
      • Educate workers on the consequences
      • internal financial controls
      • Watch tax payments carefully
      • annual audits
      • purchase fidelity insurance
• Budgeting
  • Producing a realistic budget
    • To be an effective tool, budgets need to be realistic, consistent with strategic objectives, flexible, and measurable
    • budget should be a team effort of the executive staff, program staff, and board of directors
    • should reflect the programs and activities that are expected or desired for the coming year
  • Estimating and Reviewing Revenues and Expenses
    • Some revenues are easy to estimate; others are more problematic.
    • Business plans for new and continuing earned income ventures should include financial projections that can be used for budgeting
    • budget calendar sets the timetable for preparing and adopting the budget.
    • For a smaller nonprofit, input for the budget may be more informal, and the individuals who coordinate the programs may be volunteers who are not expected to prepare a detailed program budget
    • A budget is simply a plan for the fiscal year. Very rarely are the final financial statements for the year an exact match
• Banking Relations
  • Periodically seeking banking services encourages banks to “sharpen their pencils” to reduce prices and offer more services
  • Even a small nonprofit should compare what different banks can provide and the banks’ fee structures
• Borrowing
  • For nonprofits with razor-thin reserves, short-term borrowing is commonplace
  • Some nonprofits choose to borrow from a board or staff member. This is not recommended as it creates conflicts of interest and may not be the best business deal
  • A nonprofit’s borrowing options include:
    • line of credit
    • loan
    • bond
    • lease
• Financial Risk Management
  • Financial risks may involve:
    • damage to property due to carelessness, fire, natural causes, or faulty mechanisms
    • lost property due to dishonest acts
    • loss of income or increased costs due to the malfunction of a revenue-producing facility
    • liability losses due to accidents
    • productivity losses due to health problems, addictions, or other performance barriers
  • A hold harmless clause in a contract transfers legal liability, holding the other party liable for a loss
  • Risk may be accepted and addressed through self-insurance or by an insurance policy deductible
• Auditing and Financial Analysis
  • Auditing
    • The financial audit produces the most comprehensive report for evaluating fiscal condition.
    • Audits are required for nonprofits receiving $500,000 or more in a single year in direct or pass-through federal funds
    • In 2005, 67 percent of nonprofits had an external audit conducted by an independent auditor, and 91 percent of these audited nonprofits had annual expenses over $500,000
    • The nonprofit’s key responsibility in an audit is to close the books and prepare the financial statements for the auditor.
    • The auditor will render one of four opinions:
      • an unqualified (“clean”) opinion that the financial statements conform to GAAP
      • a qualified opinion that the financial statements generally conform to GAAP, but with noted exceptions
      • a disclaimer opinion that refrains from expressing an opinion because of material (serious) departures from GAAP
      • an adverse opinion stating that the financial statements do not conform to GAAP
    • four less expensive but also thorough alternatives to an audit:
      • member review - a board member with an accounting, auditing, or finance background reviews accounting practices
      • compilation - auditor compiles financial information into a set of financial statements but does not verify
      • auditor review - auditor renders no opinion on the financial statements but issues a letter stating whether the nonprofit has complied with GAAP
      • agreed-upon procedure - auditor evaluates one or more of the nonprofit’s accounting procedures
  • Financial Analysis
    • can be helpful in determining whether new systems and strategies need to be developed
    • statements may be presented at board meetings to show the financial condition of the nonprofit
    • board should look for any unexplained differences from the normal patterns
    • four key financial statements:
      • Statement of Financial Position
      • Statement of Activities
      • Statement of Cash Flows
      • Statement of Functional Analysis
  • Financial Indicators and Ratios
    • To judge the value of the ratios and any resulting externally derived scores, board and staff need to apply more sophisticated and comprehensive views of the nonprofit’s financial condition
    • program efficiency ratio - percentage of funds spent directly on program services
    • fundraising efficiency ratio - percentage of donations going to the nonprofit
    • unrestricted net assets ratio - measures a nonprofit’s cushion
    • number of days of cash on hand
    • current ratio (current assets divided by current liabilities) - indicator of liquidity
    • acid-test ratio (current assets minus inventories divided by current liabilities) - also called the quick ratio, measures the ability to meet short-term obligations
    • days in accounts receivable ratio (accounts receivable multiplied by 365 and divided by operating revenue) - average number of days that accounts are receivable
  • Financial Literacy
    • Financial literacy is an important key to fulfillment of fiduciary duties. All nonprofit chief executive officers need a sound grounding in financial management
    • Board manuals and learning sessions at meetings can be used to help board members develop their financial literacy.
• Good financial management starts with competent staff and an informed board
• all nonprofits should make the time to review their areas of vulnerability, make decisions on how to handle their identified risks, and have a plan to access funds in an emergency
• all nonprofits should be prepared to be transparent and accountable in their financial management systems

Smith - Managing the challenges of government contracts (2010)

• government contracting can have profound effects on nonprofit organization governance, program innovation, and the relationship of agencies to their local communities
• Prior to the 1960s, nonprofit service agencies in the US were primarily dependent on private revenue from client fees, charitable donations, and endowment income
• this funding mix changed dramatically in the 1960s with the rise of the federal role in social policy
• Many existing nonprofit agencies were initially reluctant to accept government contracts due to concern that government funding might undermine mission and autonomy
• many agencies eventually accepted government contracts
• some of the early federal grant programs had very loose accountability requirements so nonprofit agencies could accept the funds without onerous compliance requirements
• federal funding allowed nonprofit agencies to reduce their dependence on private donations and fees
• federal social service spending soared in the 1960s and 1970s, primarily through contracts with nonprofit human service agencies, almost tripled between 1965 and 1970
• By 1980, federal funds accounted for 65 percent of total government spending at all levels on social welfare services, compared to 38 percent in 1965
• Total spending at all levels of government (in constant 1995 dollars) for social welfare services rose from $45.2 billion in 1965 to $104.79 billion in 1980
• A large percentage of the increase channeled through nonprofit agencies in the form of government contracts
• This increased federal role changed dramatically when the Reagan administration came to power in 1981 with a commitment to reduce federal spending
• first year in office, 20 percent reduction in federal spending on social services, consolidation into block grants, decentralization of administrative responsibility
• Over time federal spending rebounded
• Starting in the 1980s, Medicaid grew as a revenue source for social services
• To an increasing degree, Medicaid also funds mental health, child care, home care, hospices, counseling, residential foster care, drug and alcohol treatment, and services for the mentally ill
• contracting with nonprofits also grew in the aftermath of 1996 welfare reform
• economic crisis that began in 2008 led to severe cutbacks
• government has moved away from the traditional contracts that were the hallmark of the initial period of widespread government contracting in the 1960s and 1970s
• earlier period, most nonprofit agencies did not really compete
• Most contracts were cost-reimbursement contracts paid agencies for their costs based upon the contract terms and budget. Reimbursement was not linked to outcome
• Little incentive existed for agencies to compete with other agencies, since contracts were unlikely to be moved
• current contracting environment is much more competitive, increasingly performance-based
• due in part to the “reinventing government” and New Public Management movements
• From the perspective of the nonprofit, performance contracts are especially consequential because they increase uncertainty and offer the threat of termination
• Nonprofit service agencies also have an incentive to compete
• Increased competition for funding is also a direct and indirect effect of restructuring of government support
• many current forms of government support are tied to the client rather than the agency
• financing arrangement is dramatically different from the traditional cost-reimbursement contract. Under the latter, agencies actually faced disincentives for service expansion because additional services added to an agency’s cost without certainty that these costs would get reimbursed
• increased competition has also been fueled by growing competition from for-profit social and health services firms, although competition varies greatly by service category
  • for-profit firms now compete in child care, home care, community programs for the mentally ill and developmentally disabled
• nonprofit-government contracting relationships can be characterized as a “regime” for the following reasons:
  • regimes tend to have accepted means of resolving disputes and addressing particular problems
  • regime concept helps illuminate regularized patterns of interaction
  • regimes are usually sustained and dominated by a powerful party
• implications of contracting regime for nonprofit management are profound. Managers of nonprofit agencies are not free agents, but are linked in an ongoing relationship, constrains their behavior as well as provides certain incentives for managerial action
• The cash flow problem, as well as the more general challenge of generating adequate revenue, is exacerbated by a common characteristic of the contracting regime: the inability to secure contracts that fully fund the agency’s costs
• Underfunded contracts put nonprofit managers in a delicate position: give up the contract, or continue with the contract, albeit at an underfunded level. Most nonprofits elect to keep the contract
• one or more of several strategies to compensate for revenue shortfalls:
  • diversify their government contracts so they can obtain greater economies of scale
  • seek private donations from individuals or corporations
  • obtain foundation grants
  • increase earned income from more commercial revenue sources (for example, from rental income or technical assistance services).
• desirability of a diversified revenue base and a sophisticated administrative infrastructure is a major reason that large agencies may have a competitive advantage in the current contracting environment
• Another important change is the advent of managed care in many government contracted social and health services
• Managed care is where a third-party organization “manages” the health care of a population of patients with the goal of improving the efficiency and delivery of care
• managed care organization then subcontracts with local nonprofit (and for-profit) service agencies to provide the actual community mental health services
• this contractual arrangement is inherently more uncertain and less reliable than traditional contracting relationships
• greater uncertainty has exacerbated longstanding problems that may occur in the contract process
• The uncertainties of the contract renewal process are masked somewhat by the relatively high rate of contract renewal
• Nonetheless, the renewal process can be highly frustrating. Nonprofit managers may be unclear as to the exact amount of the new contract
• due to government funding cutbacks, a renewed contract might well be for a lower amount
• government officials may decide to rewrite the contract upon renewal.
• change in political priorities might lead state administrators to use contract renewal as an opportunity to restructure the agreement
• Nonprofit managers, at least theoretically, have the option of refusing to accept the terms of the contract or to abide the long delays often accompanying contract renewal But this can be very problematic
• success requires sustained attention to agency governance, effective leadership, broad and sustained community support, and ongoing advocacy
• An effective board of directors serves as a key connecting link between the organization and local community
• Most board members tend to be unfamiliar with contracting and intricacies of the process, may be unwilling or unable to exercise effective oversight
• Significantly, contracting also requires the agency to develop and maintain effective new systems of accountability to document and report on expenditures and clients - requires greater staff specialization and a more formal structure and organization. May need to invest in sophisticated data collection and IT capacity.
• Board may be relegated to a position of supporting the ED’s initiatives rather than the ED implementing the board’s directives and policies
• As board involvement declines, management mistakes or morale problems may go undetected until a crisis develops
• Other types of management problems may develop from conflicts over agency mission
• many boards have successfully addressed the organizational challenges of contracting in ways that strengthen board governance and productive board-staff relations
  • board can recruit individuals with knowledge of contracting
  • board can become more engaged in advocacy on behalf of the agency
  • board can broaden its membership to include more consumer or community representatives
• Given the changing environment for contracting, the quality of executive leadership in nonprofits is more important than ever
• new environment places significant pressure on the executive director to effectively manage both the internal operations and the external network of public and private flinders
• The ideal type of executive for a nonprofit service agency cannot be determined without understanding the particular characteristics and needs of the organization
• An agency needs to strike a balance between a concern for the efficient utilization of resources and the agency mission
• current contracting environment places a primacy on the ability of nonprofit executives to work collaboratively
• many nonprofit organizations are valued in part because of their ability to represent specialized or minority constituencies
• narrowness can become a handicap as an agency develops and obtains contracts
• Successful and sustainable nonprofits with government contracts are able to transcend the initial targeted focus of the agency without compromising their mission or programmatic priorities
• Enlarging an agency’s constituency is not without risks. Clarity about an organization’s mission and the role of new constituency groups is absolutely critical
• Prior to the advent of widespread government contracting, nonprofit agencies tended to operate quite apart from the political process
• The practice of government contracting fundamentally changed this situation; nonprofits with contracts are now inextricably connected to the political process
• the success of nonprofits now hinges, at least in part, on decisions made in the political arena
• Over time, even modest efforts can create a positive public image of the agency and garner favorable political support
• As nonprofit staff and volunteers engage in advocacy, they should also strive to represent the needs of their clients and communities, broadly defined
• Despite the incentives for political engagement, many nonprofit staff and board members are very reluctant to engage in advocacy
  • might spur IRS scrutiny
  • some orgs are small and lack the staff resources to actively participate
  • most board members possess little experience with government policy.
  • concern that such efforts may alienate government contract officials and lead to retribution
• Nonprofit agencies can be effective advocates in spite of these obstacles, but to do so does require persistence and a multipronged strategy
• Nonprofits also should work collaboratively with other nonprofits, as well as through local and statewide associations
• Associations have not generally been involved in issues of contracting
• The capacity of nonprofit associations to be effective advocates for their members may be constrained at times by internal issues
• persistent nonprofit complaints about the contracting process:
  • lack of transparency
  • overly burdensome regulations
  • a general lack of accountability
• Response to these problems has led to important changes
  • many government administrators have adopted policies to make contracting a more equitable process
  • many governments and nonprofit agencies are experimenting with strategies to “rationalize” the regulation of contract agencies
• in practice, performance contracting in the current environment often means much greater attention to outcomes without the reduction in paperwork and staff time
• The accreditation movement is a worldwide movement to adopt practices to improve performance without the need to resort to traditional forms of government regulation
• Increasingly, governments are looking to these accrediting bodies to certify minimum standards of quality in services provided by nonprofit service providers in social and health care,
• growing interest exists in the United States and abroad in developing quality frameworks specifically tailored for nonprofit organizations.
• Their long-term impact remains to be determined,
• since so many nonprofit organizations are now “agents” of government, one could argue that government has an obligation to support training and education and, more generally, capacity building
• In support of improved nonprofit capacity, government can structure contracts to include support for reasonable administrative costs.
• Underfunded infrastructure is a common problem
• contributes to program instability,
• Government can also play an important role in directly and indirectly helping nonprofit contract agencies with their capital costs
• To the extent that nonprofits can improve their capital position, they will be in a better position to manage their cash flow effectively
• nonprofits are often resistant to mergers, so support government (and private funders) is often essential if mergers are actually to occur
• government agencies need contract manager with skills in negotiation and bargaining and knowledge of management, finance, budgeting, and the organization of nonprofits
• Government contract managers with these skill sets would also promote effective relationships with nonprofits,
• Nonprofits for their part should strive to invest in their administrative and programmatic infrastructure, including new technology and qualified administrative staff
• Fundraising may not produce large benefits for the organization in the short term but, in the long term may become very important as a way of cross-subsidizing programs inadequately funded by government contracts.
• Government contracting with nonprofit agencies is in the midst of an important transition phase that is likely to continu
• twin pressures of demands for more collaboration while coping with a more competitive contracting environmen
• Given these trends, larger nonprofit (and for-profit) contract agencies with proven track records and capacity are likely to have an edge in the competition for contracts
• a central challenge for nonprofit agencies that seek contracts is to adapt their management and organizational structure to emphasize flexibility, nimbleness, and efficiency while retaining a commitment to equity, social justice, and community and engagement