Carlos E.

Tovar
December 6, 2010

The Strategic Approach in Non-Profit and For-Profit

Financial Management
Purpose

The intent of this paper is to analyze the financial management

strategies of non-profits in comparison to for-profits.

Abstract

Non-profits and for profits are types of entities that overall are major key

contributors to the United States economy. Considering this impact, one looks at

the foundation of their general governance, goals to be accomplished, and

subsequently the implication their goals have on specific areas of the financial

management. Specifically, strategic approaches and dilemmas encountered in

decision making in regards to equity capital.

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The Strategic Approach in Non-Profit and For-Profit Financial Management

Despite of overall differences in strategic approaches between non-profit

and for profit financial management, both profit and non-profit entities have

managed to position themselves as significant role players in the economy of the

United States. This is why it is important to better understand their general

strategic approach towards financial management and aim to possibly synergize

certain areas in regards to structure and practices. Somehow finding alternatives

to synergize certain areas of financial management methods would potentially

serve to enhance their current economic impact while benefiting both of the

major key players in our economy.

As mentioned both non-profit and for-profit entities are responsible for

many aspects of the economy at large. Per an article on the Journal of American

Academy of Business, the non-profit sector was valued at over $1.6 trillion. This

particular figure is notable as it represents 5 percent of the gross domestic

product of the U.S. economy, 8 percent of wages and salaries, and 10 percent of

employment. In comparison to large industries in the United States, the impact is

such, that its contributions to the economy are considered substantial. Similarly,

for profit entities, which are part of the private sector, also play a key role in the

existence and acceleration of economic performance in the U.S. This is not a

surprise, as it is known that the size of all industrialized or advanced economies

are proportionate to the size of their private sector. Hence, the private sector is a

dominant sector in the U.S. economy, but nevertheless the non-profit sector is as

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important.

From this perspective, one would wonder how each of these type of

entities strategically approach their financial management in order to succeed,

but specifically what makes them different, similar, and what are the areas of

opportunity for eventual synergy. In this regard, a blog posted by management

help.org indicates that, “the misperception that for-profit and non-profit are totally

different continues to hamper that synergy from happening”. Such comment

suggests a notion that if one looks close enough, there might be availability of

certain factors that can be considered towards the benefits in support of

conjunctive financial management alternatives.

In order to properly analyze and understand the strategic issues that deem

for-profit and non-profits different, one must understand the basic principles

associated with each type of entity. In this sense, the goal of the entity is the root

of how for-profit and non-profit financial managers develop their strategy to

promote an economically healthy entity. Referencing to a previous comment on

an existing misperception of difference among for-profit and non-profit, one can

coincide that there are definitely overall similarities. Sometimes this may not be

realized, but both types of entities must have effective governance structure,

cost-effective operations, and more importantly robust planning practices, all of

which are driven by the ultimate goal of the entity.

For instance, governing boards in for-profit and non-profit are similar in

that they must carry out establishment of overall plans and policies, ensuring

financial resources for the organization and ensuring compliance to rules and

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regulations. However, there are differences in the governing models that are

configured to enact the nature of their specific responsibilities. In this respect,

non-profit board members are expected to actively participate in fundraisings

through solicitation of funds, whether it is from individuals, foundations, or

government agencies. Although, for-profits may attend similar events, the

motivation for their participation is more in nature of support rather than soliciting

funds. In addition, for-profit governing boards typically attend to decisions in

regards to distributing profits to stockholders and how to maximize profits, but

non-profit governing boards attend decisions that focus on how to move towards

the mission of the entity without regard of seeking profit.

Evidently, a for-profit entity’s goal is concerned with profitability and finding

ways to maximize shareholder value. In this sense, financial managers tend to

lean towards those decisions that can potentially lead the entity toward that goal.

Nevertheless, the ability of for-profits to maximize shareholder value is

determined by how well they can do to boost the market value of its stock. In

doing so, they strategize plans that will maximize growth of the entity’s future

cash flows, and that way maximize shareholder value and meet their goal. Non-

profits do not share the same goal. In contrast, the general goal of a non-profit

entity implies providing a service that satisfies a socially desirable need. In

essence, their goals are different in that non-profits are purely mission oriented,

and for-profits are market oriented. However, one can possibly argue that the

objective of each of these types of entities could involve more flexible objectives

that perhaps could incorporate both, profit maximization and mission oriented

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objectives.

Now despite that both, for-profit and non-profit entities, generally have

different goals denoted they both share a need to raise equity capital. What this

means for for-profit entities is that they are in a position where raising equity

capital is contingent upon their ability to continuously maximize shareholder

value. If they are able to do so, then the for-profit entity may use acquired equity

capital to make further investment decisions that will once again maximize future

cash flows and ultimately maximize shareholder value. In the case of non-profits

there are more restrictions as to how they decide on investing their equity capital

because their investment decisions must take into consideration the mission

impact aside from the monetary implications. In this regard, the investment

decisions that drive equity capital are an essential aspect to financial

management in for-profit and non-profit entities as both face the pressures for

raising capital regardless of their distinct goals.

As part of the framework entities applies to make a wise investment

decision, the manager must identify the investment opportunities where the

present value of future cash flows are greater than the cost to acquire. In order

to measure that investments follow this pattern, both for-profit and non-profit

entities consider investment selection methods such as the discounted cash flow,

the net present value (NPV) and the Internal Rate of Return (IRR). For instance,

when utilizing the (IRR) method, the proposed investment decision is measured

in comparison to the set (IRR) to decide whether a particular project is deemed

acceptable or not. The risk of the project is also measured and factored into the

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(IRR), so if the project is riskier then the rate is set higher to compensate for the

risk. For for-profit entities this means that in case it is determined that the cost of

capital for an investment is higher than the calculated (IRR) for a particular

investment, then this investment would result in a negative Net Present Value.

Typically, the entity evaluating the investment opportunity would also complete

the discounted cash flow and net present value calculation before reaching a

decision. Under the circumstances where the rate of return across all of the

measurements is negative, then a for-profit entity would more than likely seek

other options that would pose as lucrative investment opportunities.

Although both for-profit and non-profit financial managers may apply the

methods previously discussed, non-profits do not raise their equity capital in the

investment markets in the manner for-profits do. Instead, non-profits heavily rely

in financial support from sources such as contributions, grants, endowments, and

certain government support. In order to obtain these funding, non-profits have to

constantly focus resources on fundraising and meanwhile carry the burden of the

costs associated to executing such activities. Most nonprofits engage in

requests via mass mailings, telephone calls, and emails to their current

contributors and potential supporters to make donations to cover the expenses

that are incurred to keep the organization running. Also, special fundraising

events are held with the goal of raising awareness of the nonprofit’s social

mission and of course raising money. Aside from this typical fundraising

techniques used by non-profits, they also advocate issuance of memberships

and planned giving as a source of unrestricted funds. Some non-profits have the

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ability to easily provide basic membership benefits associated to the mission in

order to generate stable income over time. Such benefits could range from

monthly newsletters, to lowered fees for events, and even preferred treatment of

some kind. In the same manner, other fundraising methods involve encouraging

inclusion of the non-profit in wills or compromising private businesses to provide

a service for the good of the non-profit mission. These techniques are more

likely treated as unrestricted funds by non-profits and are not a significant portion

of their equity capital as restricted funds, which are comprised of endowments,

charitable foundations, and grant money.

From this perspective both, for-profit and non-profit entities depend on

cash flows to maintain their entities afloat. However, in the case of non-profits the

circumstances are specifically due to the lack of unrestricted funds. Although

restricted funding represents a substantial portion of non-profits equity capital, it

is often difficult to use a significant amount for managing the entities operating

costs and thus non-profits are positioned under circumstances where they can

only dip into already minimum un-restricted funding and perhaps loan acquisition.

For instance, a non-profit institution depends on the nature of the funds and

assuming they may have risen more than enough funds to cover a deficit in

operation expenses, the non-profit could only use a portion to pay for operating

activities and then the majority would be restricted to specific uses. This is an

issue for financial managers of non-profits because it can be complex to make

sure that the total expenses on a restricted program do not exceed the amount of

money provided by a grant even though there may be a an allowance for

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overhead costs. In this regard non-profits have to thoroughly analyze long-term

initiatives and funding terms because of the fear that once a grant expires and

the funder is no longer willing to provide further cash flows then it’s the non-

profits to come up with the remaining sources to complete the initiative.

Consequently, it is obvious that acquiring the necessary resources to maintain a

non-profit proves to be far more challenging that it could be in the case of a for-

profit.

Having said that, in a non-profit environment the framework followed for

investment decision making as discussed must take into consideration the

additional criteria of social return in regards to their mission. When compared to

for-profits, the decision making process can turn more complex than just the

monetary aspect of a rate of return. As opposed to for-profits, non-profits

contemplate decision-making based in the implications of how their

contributions/donations are expensed relative to the direct investment in the

mission of the entity. The theory basically dictates that depending on how much

of the available funding is directly utilized towards the mission will weight the

most when making a decision as to what’s more beneficial for the entity. From

the non-profit perspective, those decisions that signify minimal administrative

costs and at the same time provides greater return of service for the mission at

hand will be the most optimal decision as ultimately this will be the basis to

attract further contributions and donations. In measuring the capacity of the

return of service for the mission, social return must be quantified. This is a

difficult task for the financial manager as not only is the task to efficiently manage

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investments to meet its financial obligations, but also maintaining a moderate

threshold of administrative cost to primarily achieve funding for the social goal.

Referencing to the negative net present value evaluation above, one can further

describe the effect of the additional criteria to measure the social return factor in

decision-making. The equation as applied to for-profit entities focuses only on

the cash flows values, but does not take any consideration to intangible value of

fulfilling the purpose of the entity’s mission. As perceived by non-profits, fulfilling

the purpose of the entity’s mission possesses a non-monetary value which is to

be included in the total net present value when making an investing decision. So

if the net present value plus the net present social value is higher than the cost of

capital, then the choice would be to invest in this opportunity.

In an extension of this analysis, one can suggest that it could be beneficial

if contributors provided more flexibility with the use of restricted funds. This

alternative could drastically benefit non-profits when evaluating decision-making

and open opportunities to explore investing options. It could even be considered

to possibly use restricted contributions with the purpose of seeking long-term

sustainability of the non-profit carrying out the mission and implementation of

measures that would also support the non-profits’ development as opposed to

solely focusing on direct pursuit of the social goal. Otherwise, while there may

be funds available to pursue the mission, it will be the availability of funds to pay

for the basic costs of the non-profit that will dictate whether the entity’s doors

remain open.

Undoubtedly, non-profit and for-profit entities are a profound basis of the

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economy in the United States, but seldom are seen as the type of entities that

while different would also share similar challenges in certain areas of financial

management strategy. Despite the strategic approaches and planning for for-

profits and non-profits are particularly determined by their respective profit

maximization and mission oriented goals, certain broad aspects of financial

management can be mutually identified. In this regard formulating capital equity

is a main concern for both, but addressed differently in the process of decision-

making and investments within the context and definition of their respective

entities’ goals. After evaluating their approaches, one could point out that for-

profits’ handling of its equity capital is more flexible as it permits the facility to

explore a wide variety of investment opportunities as long as profit maximization

is attained. On the other hand, non-profits find themselves in a seemingly more

complex situation struggling to accurately allocate funds as designated by

contributors while managing increasing operating costs not sustained by the

more affluent portion of funds available. Considering their structural differences,

synergizing both for-profit and non-profit financial management techniques to

produce a strategy that will implement the pros of both types of entities is difficult.

However, there is potential to adjust certain areas of non-profit strategies to

somewhat resemble that of for-profits in the sense of having more flexibility in

capital equity management to efficiently meet their mission goals and at the

same time achieve long term sustainability of the entity.

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