FINANCIAL MANAGEMENTFOR NONPROFITORGANIZATIONS

POLICIES AND PRACTICES

JOHN ZIETLOW

JO ANN HANKIN

ALAN SEIDNER

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FINANCIAL MANAGEMENTFOR NONPROFITORGANIZATIONS

FINANCIAL MANAGEMENTFOR NONPROFITORGANIZATIONS

POLICIES AND PRACTICES

JOHN ZIETLOW

JO ANN HANKIN

ALAN SEIDNER

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Library of Congress Cataloging-in-Publication Data:

Zietlow, John T.Financial management for nonprofit organizations: policies and procedures

/ John Zietlow, Jo Ann Hankin, and Alan Seidner.p. cm.

Rev. of: Financial management for nonprofit organizations / Jo Ann Hankin,Alan G. Seidner, John T. Zietlow. c1998.

Includes index.ISBN-13: 9780471741664 (cloth)ISBN-10: 0471741663 (cloth)

1. Nonprofit organizationsFinanceManagement. I. Hankin, Jo Ann. II.Seidner, Alan G. III. Hankin, Jo Ann. Financial management for nonprofitorganizations. IV. Title.

HG4027.65.Z54 2007658.15DC22

2006031245

Printed in the United States of America.

10 9 8 7 6 5 4 3 2 1

www.wiley.com

CONTENTS

About the Authors xxiAcknowledgments xxiiiPreface xxv

1 Understanding Nonprofit Organization Finances 11.1 Definition of Nonprofit Organizations 2

(a) 501 (c)(3) Corporations 3(b) Bylaws and Articles of Incorporation 4

1.2 Characteristics of Nonprofit Organizations 6(a) Organizational Mission 6(b) Organizational Structure 7

1.3 Understanding the Language of the Nonprofit Organization 71.4 Financial Policies 81.5 Financial Practices 91.6 Primary Financial Objective 10

(a) Differences between Businesses and Donative Nonprofits 11(i) Businesses Have a Numerical, Specific Objective:

Maximize Stock Price 11(ii) Businesses Can Price Their Services and Then Use

Revenues to Gauge Their Marketing Success 11(iii) Businesses Typically Know Who Their Customers and

Owners Are 11(iv) The Typical Pattern of Cash Flows Often Differs,

Particularly for the Donative Nonprofit 12(b) Survey Evidence on the Primary Financial Objective 12(c) Financial Objective for Purely Financial Decisions 13(d) Recommended Primary Financial Objective: Approximate

Liquidity Target 131.7 Conclusion 14Appendix 1A The Lilly Study Findings 16

2 Liquidity Management 222.1 Introduction 22

(a) Importance of Liquidity 23(b) Are Nonprofits Overly Risk-Averse? 24

2.2 Donative Nonprofit Organizations 25(a) Guidance from Finance Theory 26(b) Evaluation of Finance Theory 26

v

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2.3 Evidence on Liquidity Management in the Nonprofit Sector 26(a) Liquidity Management in the Healthcare Sector 27(b) Liquidity Management in Colleges and Universities 27(c) Liquidity Management in Faith-Based Donative Organizations 28

(i) Study Findings 28(ii) Short-Term Policies and Planning 28(iii) Executing Liquidity Management 29(iv) Controlling 29(v) Primary Financial Objective: Lessons from the

Field Studies 302.4 Facets of Liquidity Management 30

(a) Layers of Liquidity 30(b) Solvency 30(c) Liquidity 30(d) Financial Flexibility 31

2.5 Importance of Liquidity Management 31(a) Institutional Factors 31

(i) Primary Financial Objective 31(ii) Limited and Volatile Revenue Stream 32(iii) Inability to Issue Stock to Raise Equity Capital 33(iv) Time-Restricted and Use-Restricted Donations 33(v) Operating Characteristics of Donative Nonprofits 33

(b) Managerial Philosophy Factors 34(i) Major Reluctance to Earn Surpluses 34(ii) Resistance to Engage in Short-Term Borrowing 35(iii) Insufficient Liquidity Monitoring, Management,

or Projection 35(c) Liquidity Implications of Institutional and Managerial

Philosophy Factors 35(d) Watchdog Agency Standards on Solvency and Liquidity 36

(i) BBB Wise Giving Alliance Standard 36(ii) American Institute on Philanthropy Standard 37(iii) Charity Navigator Standard 37(iv) Philanthropic Research, Inc. Standard 38

(e) Assessment of Watchdog Standards 392.6 What Is the Appropriate Level of Liquidity? 40

(a) Establishing the Liquidity Position Based on FinancialVulnerability 41

(b) Diagnostic Tools to Assist in Setting the ApproximateLiquidity Target 41

2.7 Conclusion 43

Contents vii

3 Managing Mission and Strategy 463.1 Value of Strategic Planning 473.2 What Is Strategic Planning? 473.3 What Are the Organizations Mission, Vision, and Goals/Objectives? 48

(a) Strategy and the Bottom Line 50(b) What Are Strategic Decisions? 51

3.4 Strategic Management Process 52(a) SWOT Analysis 53(b) What Are Internal Strengths and Weaknesses? 54(c) Using Environmental Scanning to Detect External

Opportunities and Threats 54(d) Strategic Management Is an Ongoing Process 55

3.5 Implementing the Strategic Plan 55(a) Three Steps in Implementation 55(b) Cutback Strategies 55

3.6 Performance Management Systems 60(a) Balanced Scorecard 60

(i) Balanced Scorecard 61(ii) Financial Objectives and Measures/Metrics Useful for a

Balanced Scorecard 61(b) Portfolio Approaches 64

(i) Generic Portfolio Modeling 65(ii) Diagnosing the Services Portfolio 65(iii) Financial Return and Financial Coverage Matrix 65(iv) Three-Dimensional Portfolio Model 66(v) Organized Abandonment Grid (Boschee) 67

3.7 Strategic Planning Practices: What Does the Evidence Show? 673.8 Conclusion 69

4 Managing Structure, Accountability, and Ethics 724.1 Financial Tools and Support Structure 72

(a) Elements of the Financial Structure 73(i) Importance of Financial Structure 73(ii) Development of Financial Structure 73(iii) Financial Structure Soundness 74

(b) Internal Controls 74(c) Financial Policy 74(d) Financial Procedures 74

4.2 Organizational Structure and Governance 75(a) Board of Trustees/Directors 75

(i) Choosing Trustees/Directors 77(ii) Board Financial Responsibility and Liability 77

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(b) Officers of the Nonprofit Organization 80(i) President/Chair of the Board 80(ii) Treasurer/Chief Financial Officer 81(iii) Secretary 81

(c) Board Committees 81(i) Finance Committee 82(ii) Audit Committee 82(iii) Investment Committee 83

(d) Executive Director/Chief Executive Officer 84(e) Staff 85

(i) Program Managers 86(ii) Marketing Director 86(iii) Strategic Management/Long-Range Planning 86

(f) Volunteers 87(g) Independent Contractors 87(h) Constituents 87(i) Finance Function 87

(i) Chief Financial Officer 87(ii) Treasurers Office and Controllers Office 91(iii) Financial Function: Service Center or Profit Center? 95(iv) How Can Finance and Accounting Activities Be Evaluated? 97

(j) Interface of CFO with CEO 97(k) Interface of CFO with the Board 97

4.3 Accountability Structure 97(a) Accountability Structure 97

(i) Definition 97(ii) Purpose 97

(b) Establishing an Accountability Policy 98(i) General Policy Statement 98(ii) Core Principles 98(iii) Interpretation of Policy 98

(c) Checklist for Assigning Responsibility 100(d) Designing an Accountability Structure 101(e) Monitoring an Accountability Structure 103

(i) Types of Reviews 104(ii) Schedule of Reviews 104

4.4 Ethics 104(a) Ethics Check 105(b) Making Ethical Decisions 106(c) Ethical Challenges Faced by Nonprofits 106(d) An Effective Ethics and Compliance Program Goes Beyond a

Code of Ethics/Conduct 108

Contents ix

4.5 Structure, Accountability, and Ethics in Practice 1104.6 Conclusion 111Appendix 4A By-Laws of the ABC Educational Foundation 116Appendix 4B Summary of Responsibilities and Qualifications 130

5 Developing Financial Policies 1365.1 Introduction 136

(a) What Is Policy? 136(b) Why Are Policies Required? 137(c) Complying with and Establishing Policy and Procedure 137(d) Who Sets Policy? 139(e) Where to Start? 140

5.2 Financial Policies 140(a) Roles of Board, Board Treasurer, and CEO/ED 142(b) Financial Policies: Prescriptive or Restrictive? 144(c) Categories of Financial Policies 146(d) Accountability and Regulatory Compliance Policies 147

(i) Accountability Policies 147(ii) Regulatory Compliance Policies 147

(e) Financial and Financial Management Policies 151(f) Data Integrity Policies 153

5.3 Putting Policies into Place 1545.4 Establishing Procedures 1555.5 Financial Policies and Procedures in Practice 1565.6 Additional Resources 158Appendix 5A Nonprofit Financial Policy Examples on the Internet 160

6 Understanding Accounting Basics and Financial Statements 1626.1 Introduction 162

(a) Financial Statement Users and Uses 163(b) What Do Donors Representatives Say? 165

(i) BBB Wise Giving Alliance Standards 165(ii) ECFA Standards 165

(c) External and Internal Financial Statements 168(d) Who Does the Accounting? 168

(i) In-House versus Outsourced 168(ii) Accounting Software 169

(e) Roles of the Controller and Treasurer 1696.2 Accounting Basics 170

(a) Financial Standards and Standards Setters 170(i) Financial Accounting Standards Board 170(ii) Generally Accepted Accounting Principles 170

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(b) Fund Accounting versus Consolidation 171(c) Cash Basis versus Accrual Basis Accounting 171(d) Audit, Review, or Compilation? 171

6.3 Three Financial Statements 172(a) Statement of Financial Position or Balance Sheet 172

(i) Assets 173(ii) Liabilities 174(iii) Net Assets 175(iv) Financial Strength and Target Liquidity 176

(b) Statement of Activities or Statement of Net Revenues 176(c) Statement of Cash Flows 180(d) Financial Accounting Standards 116 and 117 182

(i) SFAS 116 182(ii) SFAS 117 182

(e) What about the IRS Form 990 Tax Return? 183(i) Who Files a 990 or 990-EZ? 183(ii) Do 990s Have the Same Financial Statements as GAAP? 183(iii) Problems with 990s 183(iv) Continued Reliance on 990s by Users 185

(f) Healthcare and Human Service Agency Financial Statements 185(g) Educational Institution Financial Statements 185(h) Cautions for Financial Statement Interpretation 185

(i) Accounting Standards Issues 185(ii) Cost Allocation Choice Issues 187(iii) Comparison Data and Issues 188

6.4 The Audit and the Audit Committee 1886.5 Financial Statement Users and Uses in Practice 1896.6 Social Accounting 1896.7 Additional Resources 189

(a) Sources for Nonprofit Accounting and Accounting Standards 189(b) Source for Nonprofit Accounting Software Reviews 190(c) Source for Nonprofit Accounting Firm Contacts 190(d) Sources for Nonprofit Audit Committee Toolkit 190(e) Sources for Social Accounting Information and Techniques 190

7 Developing Financial Reports and Ratios 1937.1 Introduction 1937.2 Major Differences from For-Profit Business Reports 194

(a) Financial Results Are No Longer the Primary Focus inManagement Reports 194

(b) Primary Financial Objective Is Target Liquidity, Not Profit orShareholder Wealth 195

Contents xi

(c) Fewer External Users, with a Different Accountability Focus 196(d) Different Funds and the (Temporarily or Permanently)

Restricted versus Unrestricted Net Asset Distinction 1967.3 Objectives of Financial Reports 198

(a) Accurate and Timely Representation of Financial Situation 198(b) Mission Attainment Supportive Role 198(c) Evidence of Accountability 199(d) Tool for Turnaround Management 201

(i) Church of the Brethren 201(ii) Church of God Missionary Board 201

7.4 Reporting System Design 2027.5 Major Reports 2027.6 Internal Reports 203

(a) Annual 203(b) Level 1: Budget Variance Analysis 204

(i) Operating Budget 204(ii) Capital Budget 204(iii) Cash Budget 204(iv) Supplemental Report: Deferred Giving 204

(c) Level 2: Annual Financial Statements and Ratios 205(i) Statements of Activity, Financial Position,

and Cash Flows 205(ii) Financial Ratio Analysis 213

(d) Level 3: Fundraising Management and Evaluation 223(i) Setting the Philosophy and Major Objective of

Fundraising 225(ii) Plan and Then Schedule the Campaign Expenditures 225(iii) Assist in the Midcampaign Evaluation and Redirection 226(iv) Oversee Postcampaign Effectiveness and Efficiency

Ratio Analysis 226(e) Level 4: Cash and Liquidity Analysis and Projection 227

(i) Monthly or Quarterly Reports 228(ii) Daily or Flash Reports 228

7.7 External Reports 229(a) Statements of Activity, Financial Position, and Cash Flows 229(b) Form 990 and Other Public Reports 229

(i) Forms 990, 990-EZ, and 990-T 229(ii) Donor Mailings and Publicly Available Reports 229(iii) State Requirements 230(iv) Granting Agency Reports 230

7.8 Conclusion 230Appendix 7A Sample Ratio Calculations 236

xii Contents

Appendix 7B Additional Financial Ratios 238Appendix 7C Credit Ratings Agencies and DOE Ratios 249

8 Developing Operating and Cash Budgets 2528.1 Introduction 2528.2 Overview of the Budgeting Process 2538.3 Are Nonprofit Organizations Doing Their Budgeting Properly? 254

(a) Operating Budgets in Practice 255(b) Cash Budgets in Practice 255

8.4 Developing and Improving Your Budgeting Process 255(a) Preparation for Budgeting (Operations) 255

(i) Function of the Budget Director 256(ii) Procedural Prerequisites 256

(b) Step 1: Establish a Budget Policy 257(i) Purposes of a Budget 257(ii) Uses of the Budget 258

(c) Budget Preparation Philosophy and Principles 259(i) Budget Revisions 262(ii) Interim Reports 262

(d) Step 2: Gather Archival Data 262(e) Step 3: Assign or Begin Collection of Other Area Data Input

or Projections 2638.5 Setting the Budgetary Amounts 263

(a) What Do I Need to Know about Forecasting? 263(b) Revenues 265(c) Expenses 265(d) Extended Example of Actual Budget Development 266(e) Budget Approval 271(f) Budget Variance Reports and Responses 271

(i) Operating Budget 271(ii) Capital Budget 273(iii) Cash Budget 273

(g) Cautions 274(i) Budget Ploys 274(ii) What Hinders an Effective Budget System? 275(iii) Is the Finalized Budget Consistent with Financial Targets

and Policies? 2758.6 Budget Technique Refinements 275

(a) Nonfinancial Targets 275(b) Flexible Budgeting 276(c) Program Budgeting 278

Contents xiii

(d) Zero-Based Budgeting 278(e) Rolling Budgets 279

8.7 Cash Budget 280(a) Uses of the Cash Budget 280(b) Steps in Cash Budgeting 281(c) Forecasting Your Cash Position 281

(i) Determine Cash Receipts 283(ii) Determine Cash Disbursements 283(iii) Put It All Together 284(iv) Use the Cash Budget to Help Set Target Liquidity Level 284

8.8 Managing Off the Budget 286(a) Budget Variance Analysis Revisited 286(b) Cash Position 287(c) Responses to Financial Difficulties 287(d) Internal Measures 288(e) External Measures 288

8.9 Conclusion 289Appendix 8A Case Study: The Cash Crisis at the Childrens Treatment

Center 291Appendix 8B Case Study: Tricity Academy 298

9 Long-Range Financial Planning and Capital Budgeting 3019.1 Introduction 3019.2 Planning for the Future 303

(a) Importance of Long-Range Financial Planning 303(b) CFOs Role in Financial Planning and Capital Budgeting 304(c) Long-Range Financial Planning Process 305(d) Financial Planning Basics 306(e) Develop a Financial Model 311(f) Project and Reevaluate Target Liquidity 316

(i) Scenario Analysis and Sensitivity Analysis 319(ii) Other Financial Goals and the Organizations Life Cycle 321(iii) Based on Our Financial Policies and Structure, How Fast

Can We Grow? 3229.3 Financial Evaluation of New and Existing Programs 325

(a) Simple Portfolio Analysis 327(b) Advanced Portfolio Analysis 327(c) Annual Necessary Investment 328

9.4 Capital Budgeting: Financial Evaluation of Projects that Arise fromExisting Programs 329

(a) Example 1: Net Present Value and Benefit-Cost RatioIllustrated 329

xiv Contents

(i) Approaching a Capital Expenditure Analysis 329(ii) Making the Capital Expenditure Decision 331

(b) Example 2: Equivalent Annual Cost Illustrated 332(c) How to Manage the Total Capital Budget 334(d) Capital Budget and Capital Rationing 334(e) Rationing the Capital 335

9.5 Financial Evaluation of Mergers, Joint Ventures, and StrategicAlliances 335

(a) Mergers and Acquisitions 335(b) Motives for Mergers and Acquisitions 336

(i) Programmatic Synergy 336(ii) Financial Synergy 336

(c) Partnerships, Joint Ventures, and Strategic Alliances 340(d) Strategic Alliances 341

(i) Motives for Strategic Alliances 342(ii) Financial Aspects of Strategic Alliances 343(iii) Financial Projections of Mergers, Acquisitions, or

Joint Ventures 3439.6 Financial Planning and Capital Budgeting in Practice 3459.7 Conclusion 346Appendix 9A Case Study: Kiawah Island Community Association 350Appendix 9B Evaluating Social Enterprises 353

10 Managing Your Organizations Liabilities 35610.1 Managing the Balance Sheet 357

(a) Balance Sheet Management: Benefits and Steps 358(b) Determining Your Organizations Debt Capacity 361

10.2 Payables 36210.3 Short-Term Borrowing 36310.4 Strategic Financing Plan 365

(a) Borrowers Strategic Financial Objectives 365(b) Borrowing Requirements 366

10.5 Steps to Successful Borrowing 366(a) Understanding Debt 367

(i) Risk-Reward Trade-Offs 367(ii) Leverage 367

(b) Loan Approval Process 368(i) Basic Preparation for a Loan Presentation 368(ii) Reasons for Borrowing 368(iii) Immediate Concerns of Lenders 369(iv) Evaluating the Application 369(v) How Lenders Are Repaid 369

Contents xv

(vi) Refinancing 370(c) Alternative Sources of Short-Term Funds 370

10.6 Matching Financial Sources to Strategic Objectives 37110.7 Preparing the Financing Proposal 372

(a) Term Sheet 372(b) Plan Overview 372(c) Presentation Contents 372

10.8 Making the Presentation 373(a) Importance of Questions 373(b) Answering Objections 373(c) Personalizing the Presentation 374

10.9 Other Factors in Borrowing/Lending Decisions 374(a) Borrowing from the Bank 374

(i) Domestic Short-Term Bank Loans 375(ii) International Short-Term Bank Loans 376

(b) Trends in Short-Term Lending 37710.10 Municipal and Taxable Bonds 378

(a) Municipal Bonds 378(i) Selection of an Underwriting Firm 379(ii) Preparation of Bond Documents 379(iii) Municipal Bond Issuers and Purposes 381

(b) Taxable Bonds 382(i) How Can My Organization Use Taxable Bonds? 382(ii) Can I Also Get Short-Term Financing through

Taxable Bonds? 383(c) What Qualifies My Organization to Issue Bonds? 383(d) What If My Organization Is Not Perceived as Creditworthy? 384

10.11 Leasing and Nontraditional Financing Sources 384(a) The Leasing Process 384(b) Leasing versus Borrowing 385

10.12 Developing a Debt and Hedging Policy 38510.13 Liability Management in Practice 38710.14 Conclusion 389

11 Cash Management and Banking Relations 39211.1 Introduction 39211.2 What Is Cash Management? 394

(a) Banking Environment 396(b) Purchasing Bank Services 396(c) Managing Bank Service Charges 402

11.3 Collection Systems: Managing and Accelerating Receiptof Funds 403

xvi Contents

(a) Lockbox Processing 406(b) Checklist of Collections-Related Services and Activities 407

11.4 Disbursements 409(a) Designing the Disbursement System 409(b) Fraud and Internal Control in Disbursements 409

11.5 Structuring a Funds Management System 41011.6 Monitoring Bank Balances and Transactions 410

(a) Balance Reporting and Transaction Initiation 411(b) Account Reconciliation 411

11.7 Cash Forecasting 412(a) Cash Scheduling 413(b) Data Elements for Cash Flow Estimates 413

11.8 Short-Term Borrowing 41311.9 Short-Term Investing 414

(a) Bank Sweep Accounts/Investment Services 415(b) Institutional Money Market Funds 417

11.10 Benchmarking Treasury Functions 418(a) Larger Organizations 418(b) Smaller Organizations 419

11.11 Upgrading the Caliber of Treasury Professionals 41911.12 Security and Risk Management Issues 421

(a) Types of Financial Risk 421(b) Fraud 422

11.13 Trends in Treasury Management 422(a) Reengineering 422(b) Automation and Technology 423(c) Tapping Service Provider Expertise 424(d) Cash Management in Practice 424

Appendix 11A Nonprofit Organization Guide to Direct Payment 426Appendix 11B Direct Payment Case Study 429

12 Investment Policy and Guidelines 43012.1 Investment Policy 430

(a) Short-Term Investment Policy 431(b) Long-Term Investment Policy 432

12.2 Investment Guidelines 433(a) Who Is Responsible for the Investing Program? 433(b) Who Does the Investing? 434(c) How Are Assets to Be Allocated? 434

(i) Investment Instruments 435(ii) Fixed Income Instruments 436

Contents xvii

(iii) Equity Instruments 436(iv) Alternative Investments 436(v) Socially Responsible Investing 437

(d) How Is Performance Measured and Reported? 438(i) Measurement 438(ii) Reporting 439

(e) What Level of Risk Is to Be Assumed? 439(i) Limitations on Maturity 439(ii) Currency Denomination 440

(f) Review and Modification of the Investment Guidelines: WhoIs Responsible for What? 441

12.3 Checklist of Elements for Long-Term Endowment Investment Pol-icy and Guidelines 441

12.4 Investment Policy Summary 441Appendix 12A Sample of Short-Term Investment Policy and Guidelines 444Appendix 12B ABC Foundation Unendowed Short-Term Investment

Pool Policy 447Appendix 12C Short-Term Investment Policy for HIJ Foundation 450Appendix 12D Sample of Investment Policy Statement for the ABC

Foundations Long-Term Endowment Pool 452Appendix 12E Definitions of Fixed-Income Instruments 456Appendix 12F Definitions of Equity Instruments 462Appendix 12G Glossary 463

13 Information Technology and Knowledge Management 46513.1 Introduction 46513.2 How Much Technology and Which to Choose? 468

(a) What Types of Technology Tools Should I Consider? 468(b) Are They Required? 470(c) Do I Need Them? 470(d) What Will They Do for Me? 470(e) What Will They Not Do for Me? 471(f) Can I Afford Them? 471(g) What Changes Will They Introduce to My Organization? 472

(i) Example 1: Slow Integration 472(ii) Example 2: Flawed Integration 473

13.3 Knowledge Management and Information Technology 473(a) How Critical Is Data? 473(b) Knowledge Management 474

(i) Is Yours a Learning Organization? 474(ii) Steps Toward Building a Learning Culture 474(iii) Managing Intellectual Capital 475

xviii Contents

13.4 Information Technology in Todays Nonprofits 475(a) Electronic Commerce 475

(i) Doing Business Electronically 475(ii) Your Organizations Web Site 475

(b) Spreadsheets and Beyond for Data and Decisions 475(i) Spreadsheets 475(ii) Data Warehouse 475(iii) Bank/Financial Service Provider Online Services 475(iv) Application Service Provider 476(v) Treasury Workstation 477(vi) Enterprise Resource Planning System 477

(c) Dedicated Software 477(i) Dashboards 477(ii) Fundraising Software 477(iii) Purchasing, E-Billing, and E-Payment Software 478(iv) Budgeting and Planning Software 478(v) Human Resource Management Software 478

13.5 What Should I Know/Do before Investing in Technology Tools? 478(a) Planning for Growth 479(b) Outsourcing? 480

13.6 Software: Design Internally or Purchase? 48013.7 Disclosure, the Law, and Security 480

(a) A Company Data Policy 480(b) Security Issues and Trends 481

13.8 Needs Assessment and Analysis 482(a) Assess 482(b) Analyze 482

(i) Weighting Table Analysis 482(ii) Return on Investment or Benefit-Cost Analysis 484

(c) Critique 485(d) Decide 485(e) Implement: Getting People to Use The New Tool 485

13.9 Policies and Practices in Knowledge Management and Informa-tion Technology 485

Appendix 13A Glossary of Basic Technical Terms 490Appendix 13B Framework for an Implementation Strategy 493Appendix 13C Case Study: Using Technology to Improve Cash and

Treasury Management 495

14 Managing Risk, Legal Issues, and Human Resources 49814.1 What Is Risk Management? 498

Contents xix

(a) Who Is Responsible for Managing Risk in the NonprofitOrganization? 501(i) Board Duties 501(ii) Leadership Sets the Tone 502

(b) Communicate Risk Management Policy 50214.2 Identifying Risk 50214.3 Primary Financial Risk: Illiquidity 50214.4 Legal Environment 504

(a) Sarbanes-Oxley in the Nonprofit Sector 504(b) Ethical Considerations 504(c) Relevant Agency and Regulatory Rules 504

14.5 Safeguarding People 504(a) Tools for Effective Human Resource Management 505

(i) Job Descriptions 505(ii) Background Checks 506(iii) Bonding 506

(b) Physical and Emotional Safety 506(c) Protecting the Organization from Lawsuits and Grievances 507(d) Dealing with Difficult or Problem Employees 507(e) Grounds for Immediate Termination 508(f) Compensation 509(g) Personal Use of Organizational Resources 509(h) Conflict of Interest 510(i) Getting the Most Bang for Your Buck 510(j) Staff and VolunteersWhat Motivates Them? 510(k) What Qualities Should Leadership Possess? 513

(i) Concern 513(ii) Connectivity 513

14.6 Directors and Officers Liability 513(a) Methods by Which Boards Can Protect Themselves 514(b) Conflicts of Interest 514(c) Executive Pay 515(d) Duties of Care, Loyalty, and Obedience 515

14.7 Safeguarding Your Financial and Physical Assets 515(a) Insurance 515(b) Risk Retention versus Risk Transfer 516(c) Internal Controls 517(d) Fundraising 518

(i) Charitable Solicitations 518(ii) Philosophy and Practice 518

(e) How to Begin the Financial Assessment Process 518

xx Contents

(i) Due DiligenceCompliance with Policies, Procedures,and Guidelines 519

(ii) Solutions: To Reduce Risk and Stay Out of Court 519(iii) Disaster Preparedness and Business Continuity Planning 520

14.8 Risk Management and Human Resource Management Practices 521Appendix 14A Derivatives Checklist 524Appendix 14B Case Study of Associations Foreign Exchange Risk

Management 529

15 Evaluating Your Policies and Progress 53115.1 Introduction 53115.2 Evaluation 53315.3 Evaluating Your Decisions and Ethics 53315.4 Evaluating Your Communications 53815.5 Evaluating Your Mentoring and Supervisory Skills 53815.6 Testing Your Supervisory and Managerial Skills 54315.7 Evaluating the Strategic Nature of Your Role 54315.8 Evaluating the Financial Health of Your Organization 547

(a) Importance and Definition of Financial Health 547(b) Criteria for Measuring Your Financial Health 548

15.9 Evaluating Your Financial Policies in Five Key Areas 548(a) Governance and Accountability 548(b) Investments 550(c) Fundraising 551(d) Risk Management 552(e) Human Resources 552

15.10 Evaluating Quality and Outcomes 55315.11 Using External Consultants and Data Sources 55415.12 Conclusion 555Appendix 15A Moral Competency Inventory (MCI) 557

Index 569

ABOUT THE AUTHORS

JOHN T. ZIETLOW, D.B.A., CTP, is a professor of finance at Malone College inCanton, Ohio, where he teaches corporate finance, investments, short-term financialmanagement, personal finance, and macroeconomics. He previously taught at Lee Uni-versity (Cleveland, TN) and Mount Vernon Nazarene University (Mount Vernon, OH).He is certified through the Association for Financial Professionals as a Certified Trea-sury Professional (CTP). Dr. Zietlow also serves as associate faculty member at IndianaUniversity-Purdue University at Indianapolis (IUPUI), where he teaches graduate non-profit financial management, and as an adjunct instructor for the University of MarylandUniversity College, where he teaches graduate short-term financial management. He hasdone corporate training and consulting in the areas of cash management, treasury man-agement, and investment management and portfolio performance evaluation. He holdsmembership in the Financial Management Association, Association for Financial Pro-fessionals, Association for Research on Nonprofit Organizations and Voluntary Action(ARNOVA), and the Financial Education Association. He may be reached via e-mail at:jzietlow@hotmail.com, and maintains a web site at: www.johnzietlow.com.

JO ANN HANKIN is a nationally recognized consultant in the field of fundraising,and financial/administrative mangement for nonprofits. She has served as Vice Presidentof Finance of The UCLA Foundation, Vice President of Advancement for CaliforniaState Unversity, San Bernardino and has held various fundraising/financial positions withliberal arts colleges. In addition, she worked in the for profit world with several Fortune500 companies.

Jo Ann also continues to be actively involved with her own community and doesvolunteer work for organizations promoting music and education.

ALAN G. SEIDNER was the founder of Seidner & Company of Pasadena, Califor-nia, an investment management and consulting firm whose roster included high-net-worthinvestors, healthcare organizations, major corporations, nonprofit institutions, and munic-ipalities. Mr. Seidner has written many financial reference works and is a frequent speakeron investment techniques and strategies. He has also provided testimony before federalgovernment agencies on the performance of pension fund investments.

xxi

PREFACE

Financial Management for Nonprofits is written for use by those responsible for financialmanagement in the nonprofit organization. There are many titles used to identify personsassigned these responsibilities including, but not limited to, director of finance, chieffinancial officer, treasurer, controller, chief accountant, director of operations, businessadministrator, and financial secretary. In small organizations, the chief executive officer(executive director) may carry out these responsibilities. Actually, the title of the positionis not important; the responsibility is extremely important.

Our book is written from a managerial decision-making perspective for those in leader-ship and day-to-day management positions who have oversight responsibility for financialfunctions or are members of the Board. These leaders and managers may, or may not,be experienced financial managers. Most of the subjects and issues that confront thoseresponsible for financial management and related functions in the small- to medium-sizenonprofit organization are not determined by size but rather by the mix of assets andstrategies employed to accomplish the organizations mission.

Another important focus of this book is to demonstrate that financial managementfunctions are expanding, and when done well, these strategies will make a real differencein the organizations ability to achieve its mission. Effective and responsible financialmanagement contributes toward accomplishing the mission in a number of significantways, including:

Financial policy setting Financial reporting and accountability Establishing liquidity policy and guiding decisions to maintain that liquidity or

rebuild it when depleted

Strategic planning Evaluation of existing and new programs Marketing planning Fundraising evaluating Budgeting and long-run financial planning Debt and other liability management Operational expertise and strategic internal business consulting Empowerment through the sharing of information and harnessing of technology Catalyst for cultural change in the organization Increase in investment income Preservation of investment assets

Depending on your nonprofit organizations size and scope of activities, the natureand complexity of its financial functions will range from simple to highly sophisticatedand complex. In any case, the financial systems used must be designed to provide theinformation necessary to meet management, fiduciary, and legal requirements. This bookis unique among those available on nonprofit accounting and finance in that it develops abasis for liquidity targeting as the primary financial objective of the nonprofitespeciallynoncommercial nonprofit organizations. It then ties other financial decision areas to this

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xxvi Preface

liquidity target throughout the book. We include coverage of five major topical categoriesin order to emphasize the positive contributions of the financial and business functionsto the organization and its mission:

Managing your organizations financial resources Establishing and revising financial policies Accounting, budgets, and financial reports Investing for the short and long term Controlling and managing risk

Working for a nonprofit organization is an exciting and meaningful opportunity. Thereare many similarities and differences between nonprofit and for-profit organizations, andit is important to recognize and understand how they are similar as well as dissimilar. Byvirtue of their mission, nonprofit organizations benefit society by improving the publicgood.

Hundreds of thousands of nonprofit organizations of all sizes exist today, employingmany people. Each nonprofit organization has a responsibility to its mission, its con-stituents, its employees, and its volunteers. The effective financial management of theorganizations resources will enable it to succeed in fulfilling its mission and goals.

As you can see from the material covered in this book, those involved in managingthe finances of the organization have a great deal of responsibility. In the process ofcarrying out these responsibilities, some members of the organization may feel dislikedor undervalued by those they serve on a regular basis. Under these circumstances, itis critical for the responsible financial manager to be fair, to understand the interplaybetween facts and people, and to understand that accountability is not always popularwith those being held accountable.

This book is intended to provide financial personnel with a clear sense of the technicalexpertise and skills needed to manage this function well for their organization. It willalso reinforce the fact that you are part of a larger group in the nonprofit community whofulfill the same set of major responsibilities and uphold the same ethics and values. Wehope that the information contained in this book will enable readers to better manage thefinancial resources of the nonprofit organizations they serve and enhance their overallfinancial health and viability.

Finally, this book serves as a textbook for certificate programs, undergraduate courses,and graduate courses in nonprofit financial management. We believe that the privatenonprofit sector is sufficiently dissimilar to business and public sector organizations tomerit special focus for students in this fascinating arena. We help the student gain anappreciation and understanding of financial decision making in educational, healthcare,and charitable organizations. There is a dedicated course support Web site for studentsand faculty members at www.wiley.com/go/zietlow..

ACKNOWLEDGMENTS

John Zietlow acknowledges and is deeply grateful for the contributions of the followingindividuals who lent their expertise to specific areas of the book: Gregg Capin, DanBusby, Nick Wallace, Bill Hopkins, Steve Dawson, Carolyn King, Wayne Kissinger,Georgette Cipolla, William Michels, John Webb, Darryl Smith, Darryl Deardorff, JerryTrecek, Bob Reynhout, Dave McFee, Phillip Purcell, Rob Licht, David Holt, and EricLane. He also thanks Anna Ellis, student assistant at Lee University, and Gretchen Sudar,administrative assistant at Malone College, for their clerical and research assistance.

A special thanks goes to Lilly Endowment, Inc., for initiating the study of the finan-cial management of faith-based organizations by providing grant money to Indiana StateUniversity. The individuals responsible for evaluating and guiding the grant process wereFred Hofheinz and Jim Hudnut-Beumler. Members of the advisory panel assembled aspart of that grant project were invaluable in shaping the research project that under-lies some of the significant findings presented in this book. They believed, as we do,that proficient financial management can greatly aid in the accomplishment of charitablemissions. A particular thanks goes to the 288 financial managers who took part in theexhaustive survey covering financial management practices employed by their organiza-tions. Thanks also for research input and critiques provided by Dr. Raj Aggarwal andDr. Kathleen Eisenhardt.

We are particularly grateful to Susan McDermott, senior editor at John Wiley, whowas instrumental in directing the project from inception to publication.

Graduate students at Indiana University-Purdue University at Indianapolis (IUPUI)have enriched and helped shaped this book as they learned from and commented oncontent in the previous edition of this guide as part of the graduate nonprofit financialmanagement class taught each summer there since 1999.

Finally, we thank our families for bearing with us in the arduous process of putting thisguide together. My contribution is dedicated to my parents, Harold and Miriam Zietlow,for their continual encouragement, support, and prayers.

Jo Ann Hankin thanks Clariza Mullins, currently Treasurer, Pepperdine University,for her important contribution to Chapter 11 on Cash Management and Banking Rela-tions. Clarizas technical expertise, hands-on experience, and communication style arepart of what make this chapter an extremely useful one.

Alan Seidner wishes to thank former professional staff members of Seidner & Com-pany, Investment Management, for their help in researching and completing some of thematerial in this publication. Specifically, special thanks go to Joan West, Leah Romero,Sandee Glickman, Joe Flores, and Lina Macias.

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CHAPTER 1UNDERSTANDING NONPROFITORGANIZATION FINANCES

1.1 DEFINITION OF NONPROFITORGANIZATIONS 2

(a) 501 (c)(3) Corporations 3(b) Bylaws and Articles of Incorporation 4

1.2 CHARACTERISTICS OF NONPROFITORGANIZATIONS 6

(a) Organizational Mission 6(b) Organizational Structure 7

1.3 UNDERSTANDING THE LANGUAGE OFTHE NONPROFIT ORGANIZATION 7

1.4 FINANCIAL POLICIES 8

1.5 FINANCIAL PRACTICES 9

1.6 PRIMARY FINANCIAL OBJECTIVE 10

(a) Differences between Businesses andDonative Nonprofits 11

(b) Survey Evidence on the PrimaryFinancial Objective 12

(c) Financial Objective for Purely FinancialDecisions 13

(d) Recommended Primary FinancialObjective: Approximate LiquidityTarget 13

1.7 CONCLUSION 14

APPENDIX 1A: THE LILLY STUDYFINDINGS 16

Almost 1.7 million nonprofits are registered in the United States today, not includingchurches and small nonprofit organizations that are not required to register with theInternal Revenue Service (IRS). The number of registered charitable organizations hasexploded from roughly 300,000 in 1970 to 1,680,000 today. One-half of the nonprofitsectors revenue goes to the largest 15 percent of these organizations, some of which arelarge hospitals and universities. Faced with growing missions and shrinking resources,many organizations have turned to for-profit activities, such as issuing credit cards withtheir logos and selling their mailing lists to advertising firms, in order to augment theirrevenues. Most of these same organizations have overlooked the potential of better finan-cial management to enhance revenues (from better investment management and fastercash collections) or reduce costs (from better negotiations with banks and process reengi-neering).

Our framework is intended to be of immediate value to nonprofit financial profession-als. This handbook caters to the treasurer with little or no formal training, business-onlytraining, or too little time (perhaps due to a multitude of responsibilities) or supportstaff to do the job the way he or she knows it can be done. Our other target audiencesare the chief executive officer (or executive director) and board members. This hand-book specifically includes material for small and resource-constrained organizations, as

1

2 Ch. 1 Understanding Nonprofit Organization Finances

well as large ones. Material is presented in an easy-to-use format, including forms orchecklists where helpful. The discussion goes beyond the buzzwords to provide reason-able steps toward more proficient treasury management. We incorporate a number ofconcepts:

Donor accountability and stewardship Learning organization, reengineering, and benchmarking Balanced scorecard Program selection and cost-benefit evaluation Social entrepreneurship Strategic alliances and collaborations Financial statements and ratio analysis Budgeting techniques, including cash budgeting Financial forecasting Liquidity measurement and analysis Fundraising evaluation Fraud prevention and detection Advanced cash flow management Investment and other financial policies E-business Executive performance incentives

1.1 DEFINITION OF NONPROFIT ORGANIZATIONS

In the broadest terms, nonprofit is a designation given by the IRS to describe organizationsthat are allowed to make a profit but that are prohibited from distributing their profitsor earnings to those in control of the organizations. If these organizations apply for andreceive tax-exempt status from the IRS, they are not required to pay federal incometaxes or state business income taxes except in specific cases, which are discussed later inthis book. This classification makes them distinctly different from for-profit corporations,which distribute profits to their owners or shareholders and must pay corporate incometaxes on their earnings. Furthermore, tax-exempt organizations may also be exempt frompaying property tax, sales tax, and use taxnot all states exempt nonprofits from all ofthese taxes. As a Section 501(c)(3) organization, the entity does not have to pay federalunemployment taxes. In addition, contributions to some nonprofit organizations are taxdeductible for donors. After receiving federal tax exemption, refer to the Web site of theNational Association of State Charity Officials (www.nasconet.org) to see whether yourorganization is required to register with a state to solicit for contributions or be exemptfrom state taxes in that state. Further details regarding nonprofit organizations can befound in Sections 501 through 521 of the IRS code.

The approximately 2 million nonprofit organizations in the United States includealmost 1.7 million tax-exempt organizations registered with the IRS as well as the400,000 churches that are not registered with the IRS. The number of nonprofit orga-nizations in the United States must be estimated because many churches and very