MGMT_640_Final Paper

Similarities and Differences: Financial Management in Non-profit vs. For-profit Organizations 1
Similarities and Differences: Financial Management in Non-profit
vs. For-profit Organizations
Amer Nazar
University of Maryland University College

Executive Summary
Financial Management in non-profit organizations is similar to financial
management practices seen in corporations and other for-profit organizations in
our society. Both types of organizations are operationally similar with the only
difference being the way that they manage their fiancés. The two biggest differences
between the two are that a non-profit is allowed relief from taxes, depending on the
type and purpose of the organization, and the second is that a for-profit
organization functions with the purpose of maximizing the amount of profit it
makes relative to the amount of money invested, while a non-profit organization
functions with objective of providing the maximum amount of services it can for the
amount of money that it takes in.
The financial management structures of both can vary. A non-profit
organization has a leader(s) who is responsible for making a financial decision and a
treasurer who is responsible for making sure those decisions are carried out. The
financial management system of a for-profit organization however, can be much
more complicated with decision making processes that involve multiple parties.
Financial documentation however, is relatively similar for both types of
organizations. The record keeping and systems are equivalent, with the biggest
differences being that a non-profit can qualify for tax-exemption and the fact that a
non-profit does not have to deal with shareholders’ equity. Budgeting and financial
planning is an area where a non-profit organization is at a disadvantage however.
Lack of consistency in incoming finances can make this difficult. The necessity of

using conservative techniques to ensure a stable operations budget is very
apparent. In the case of a for-profit organization, performance is relatively simple to
measure given that performance is based on profit and loss. In the case of a non-
profit, it is more complex. A non-profit does not gauge performance on a financial
platform. Instead, success depends on the amount of services that the organization
provided given the amount of resources it used.
While non-profit and for-profit organizations are different, it is very evident
that proper financial management through very similar methods is crucial to the
successful function of both types of organizations.
Keywords: non-profit, for-profit, financial management

Non-Profit vs. For-Profit Organizations
Financial Management in non-profit organizations is similar to financial
management practices seen in corporations and other for-profit organizations in
our society. Both types of organizations are operationally similar with the only
difference being the way that they manage their fiancés.
The biggest difference between a non-profit (NPO) and a for-profit (FPO)
organization is the methods and techniques that they use to handle finances. Unlike
an FPO, an NPO is not required to pay income tax on any monies that are brought in
through philanthropic means (Averkamp, 2014). NPOs fall into the categories of
education philanthropic groups, volunteer and public interest groups. FPOs are
usually the opposite. FPOs consist largely of businesses and corporations with sole
objective of generating the highest profit possible. An FPO can offer some of the
activities mentioned, but normally those are claimed as a tax deduction because the
rest of the organization’s activities are purposed with generating profit for the
organization and it’s shareholders.
As mentioned above, the bulk of an NPO’s income is generated through
philanthropic methods (i.e. donations, fundraisers, pledges, etc). This type of
income falls under the category of surplus revenue or consumer surplus. The
textbook definition of consumer surplus is when a consumer is willing to pay more
than the current standard for a particular product or service (Averkamp, 2014).
While in the case of an NPO, they may not receive personal gain from this expense;
they are paying for a service to be offered.

Depending on the purpose of the organization in particular, they can be
classified, among others, as a charity, a trust and a cooperative. A trust is
established when a benefactor(s) appoints a trustor or a board of trustors to
distribute monies or other assets to a trustee(s) for a predetermined cause which
the trust was established for. A Charity is simply an NPO established with the
purpose of providing money and support to people in need (Averkamp, 2014).
Lastly, a cooperative is a type of NPO established by a group of similar people or
businesses with objective of cooperating to further their cultural, financial or social
cause. These usually have a mutual benefit for all parties involved. Cooperatives
however, can fall under both NPO and FPO (SBA, 2010).
The Financial Management Structure of a non-profit vs. a for-profit
The financial management structure of most NPOs is relatively simple. Either
there is a permanently established board with a fixed mode of operations, or there is
a democratic system, which allows the membership of the organization to vote and
establish executives and bylaws (Fensler, 2013). Normally a leader is responsible
for approving financial decisions and a treasurer carries them out. In the case of a
trust, this responsibility falls on the trustor(s).
In an FPO however, the system can be quite different. Depending on the size
and nature of the FPO, the financial decision making process more complex. When
applicable, the management, stockholders, bondholders, financial markets and
society all play a role in this process. They all have interests to protect. Management,
stockholders and bondholders have a financial stake and need to protect their

investments, whereas the financial markets and society are interested in making
sure that the services offered are acceptable given what is being paid for them
(Damodaran, 2013).
Financial Documentation
Both FPOs and NPOs need to keep extensive records of incoming and
outgoing finances. The main documentation required by the regulating authorities is
similar for both of the organization types. The main financial documents required (if
applicable) of an FPO are a balance sheet, an Income statement/statement of
revenue and expense, a Statement of cash flows, and a Statement of Stockholders’
Equity along with any supplementary notes.
The documents required of an NPO are similar. Where an FPO requires a
balance sheet, an NPO is required to produce a Statement of Financial position. A
balance sheet for an FPO shows the formula: Assets = Liabilities + Shareholders, the
Statement of Financial position shows the formula: Assets = Liabilities + Net Assets
(Averkamp, 2014). The difference being that, with an NPO, there is no equity to be
distributed among partners or shareholders.
The next document required of an NPO is the Statement of Activities. The
FPO equivalent of this is the Income Statement, also known as the Statement of
Revenue and Expense. While and income statement will go into the intricacies of the
FPO’s profit and losses for that financial period, the objective of the statement of
activities is to provide records of revenue/expenses and to account for the change in
net assets (Averkamp, 2014). Along with this, some NPOs may be required to

provide what is called the Statement of Functional Expenses. The contents of this
statement are divided into three categories: Management/General, Program and
Fundraising (Jones, 2014). This document does not declare funds that were
generated by these activities, but instead provides a break down of the costs
associated with them.
The last main financial document required of an NPO is the Statement of Cash
Flows. This is equivalent to the Statement of Cash Flows required of an FPO. The
difference being that along with the Statement of Cash Flows, and FPO is required to
produce a Statement of Stockholders Equity (Averkamp, 2014).
Most NPOs apply for tax-exempt status. This means that the members of the
organization, for the purpose of the organization only, can claim relief from certain
taxes. Depending on the status of the organization, this can mean a partial or even a
full reduction on those taxes (Averkamp, 2014). Tax-exempt status is not decided by
the organization and must be applied for, a process that is regulated by the Internal
Revenue Service (IRS).
Budgeting and Financial Planning
Unlike an FPO which has strictly enforced parameters that govern it, and
NPO is often susceptible to change. An FPO for example, has paid employees and
administrators that ensure consistency and productivity. An FPO has investors and
generates income through the sales of a product/service. There is system of
accountability in place. An NPO does not have the same consistency. Time and

resource availability is often limited for an NPO. Executive and membership
turnover rates are high and it is often difficult to find an immediate replacement.
The bulk of income for an NPO is generated through means that are often
unpredictable (Calabrese, 2013). Means such as donations/collections, fundraising,
grants and attendance fees can be lucrative but aren’t often guaranteed. A lot of
NPOs also invest a portion of their money with hopes of a successful return, but this
is not always guaranteed.
An NPO’s income consists largely of surplus revenue and is directly
correlated with the current economic state of the society in which the NPO
functions. The one factor to remember is that the demand for an NPO’s services
often increases when there is an economic crisis. Therefore an NPO needs to
financially be prepared for the possibility that any moment resources can decrease
significantly while the demand for services increases (Calabrese, 2013).
The solution to this dilemma is conservative budgeting. This process begins
with strategic planning. The NPO needs to identify what its purpose is and come up
with a goal. Once the goal has been established a plan needs to be developed. This
plan is a step-by-step map of the NPO’s progression towards its goal. The final step
is to establish a check and balance system through which accountability is
enforced. At this point, the NPO is now prepared to start establishing a budget.
The first step in this budgeting process is the establishment of an Operating
Reserve. “An operating reserve is an unrestricted fund balance set aside to stabilize
an non-profit’s ﬁnances by providing a cushion against unexpected events, losses of

income, and large unbudgeted expenses.” (Non Profits Assistance Fund, 2011). This
cushion is absolutely necessary due to the unstable nature of an NPO’s income.
Along with an operating reserve, an NPO needs to become financially disciplined.
This means eliminating as much waste in its budget as possible and to develop
avenues by which it can increase revenue.
Techniques for Conservative Budgeting
In the world of FPOs, a technique was developed called Lean Enterprise.
“Lean enterprise or lean thinking — often shortened to "lean" — encompasses
practices that create value for customers with the least waste. "Value" is determined
by the customer and is defined as "any action or process that a customer would be
willing to pay for." Through the lean philosophy, you can eliminate waste and create
better workflows that ultimately enhance the quality of your products and services”
(Lachel, 2014)
More than just an administrative process, Lean Enterprise involves changing
not only a company’s processes, but also its culture (Lachel, 2014). The idea being
that if policies are established, then people will follow them, but if the culture is
established, then it becomes part of the nature of those involved. This makes it an
ideal technique to apply to an NPO. Lean Enterprise enforces three basic concepts:
1) Being smart when it comes to the consumption of financial resources. 2) To use
smart and creative thinking to provide an optimum experience for those being
served. 3) To create an engaging environment for those involved in the function of
the organization (Lachel, 2014).

Unlike an FPO, one of the primary objectives of an NPO is to provide a service
to a community at limited or no cost to those being served. This already encourages
the development of an organizational culture that promotes positive qualities.
Leadership, critical and creative thinking, positive environments, and community
engagement are all concepts that are already being applied in the functioning of an
NPO. This makes Lean Enterprise an ideal technique to use when developing a
conservative budget and financial plan for an NPO.
Accountability, Performance & Standards in the Non-profit World
In an FPO, performance is measured by how much profit is coming in and
how much loss the organization took. Pre-established roles and job descriptions
determine who is held accountable for any decreases or increases in performance.
In an NPO however, this system can’t always be applied because an NPO does not
measure performance in terms of profit versus loss. Unlike an FPO where the
success of the organization is measured by profit or loss, an NPOs success is
measured using its mission statement and whether or not it achieved its mission
using the resources that it was provided. A NPOs performance is gauged by
measuring five factors. These factors are: input, output, activities, outcomes and
impacts (Epstein, 2011).
The first of these, inputs, is very important (Epstein, 2011). An NPO does not
only require financial input. For an NPO, input consists of contributions that include,
financial, time, people, insight/expertise and others. A decrease or absence of any of
these parameters will reduce the performance of an NPO.

Next is output. Output consists of the services/products being offered by the
NPO (Epstein, 2011). This parameter is gauged by measuring the amount of
services/products the NPO produces give the input that it was provided.
Inconsistent output normally means that the NPO is not managing resources as
conservatively or efficiently as it should.
The third parameter is Activities. Similar to output, if an NPO is taking in
resources, but failing to provide suitable and consistent activities is an accurate
metric with which to see the performance of an NPO.
Lastly outcomes and impacts actually go hand in hand because they
demonstrate what specific effect the NPO had on an individual or a community
(Epstein, 2011). An NPO that has little to show in the way of impact on a
community/individual is either not performing up to standard, or that it was the
service for that situation.
The importance of Financial Management to the success of both Non-profit
and For-profit Organizations
FPOs and NPOs exist to serve different purposes in our society. Despite being
different, they are in fact comparable in the way that they function. They have
different methods by which they do business, but ultimately there are performance
and accountability standards that are based on their financial management. The
difference is that, while an FPO measures its performance on the amount of profit it
makes relative to the amount of money it invested, and NPO measures its
performance based on the amount of service it was able to provide based on the

resources that it was provided. While they are different, it is very evident that
proper financial management is crucial to the successful function of both types of
organizations.

References:
Averkamp, H. (2014). Nonprofit accounting (explanation). Retrieved from
http://www.accountingcoach.com/nonprofit-accounting/explanation/1
Fernsler, T. (2013). A master plan for your organization.Nonprofit World, 31(4), 24-
27. Retrieved from
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b9f7-414c-ad67-
a9a32737cf4e@sessionmgr4003&hid=4105&bdata=JnNpdGU9ZWRzLWxpdmUmc2
NvcGU9c2l0ZQ==
Calabrese, T. (2013). Running on empty: The operating reserves of u.s. nonprofit
organizations. Nonprofit Management & Leadership, 23(3), 281-302. doi:
10.1002/nml.21064
Michalski, G. (2012). Operating cycle and nonprofit organizations
efficiency. Economics, Management & Financial Markets, 7(4), 360-376.
LaChel, H. (2014). Implementing lean for nonprofits.Nonprofit World, 32(1), 4-6.
Retrieved from
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4b5b-a0cd-
4f3a37de95f9@sessionmgr4002&vid=1&hid=4105&bdata=JnNpdGU9ZWRzLWxpd
mUmc2NvcGU9c2l0ZQ==

Epstein, M. J. (2011). Measuring the efficiency and effectiveness of a nonprofit's
performance. (cover story). Strategic Finance, 93(4), 27-34. Retrieved from
http://eds.a.ebscohost.com.ezproxy.umuc.edu/eds/detail?sid=e0197047-fe27-
4d83-905d-
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mUmc2NvcGU9c2l0ZQ==
Jones, S. (2014). functional expense allocation - a summary. Retrieved from
http://www.millercooper.com/mainpage.php?page=resources&subpage=allocation
Damodaran, A. (2013). Corporate finance: Capital structure and financing decisions.
Informally published manuscript, Stern School of Business, New York University,
New York City, NY, . Retrieved from
http://people.stern.nyu.edu/adamodar/pdfiles/country/Brcapstr.pdf
Nonprofitassistancefund. (Unknown). Nonprofit operating reserves and policy
examples. Retrieved from
https://nonprofitsassistancefund.org/sites/default/files/publications/operating_re
serves_and_policy_example.pdf

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