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Running Head: Contrast of non-profit and for profit financial statements and how legislators can make better decisions in their capacity by use of either of the two-take either side
Title: Contrast of non-profit and for profit financial statements and how legislators can make better decisions in their capacity by use of either of the two-take either side
This paper will elaborate the elements of financial statement that are used by the nonprofit and for profit organizations. The paper will dwell on the contrast of the entries and interpretations and how legislators that are not keen on the distinctions are capable of making vulnerable mistakes in their decision making from either side of the statements when they have good faith of increasing the budgetary allocations to strengthen the organizations.
This paper will also elaborate how either sides of net worth can be interpreted in the field of accounts. The paper will discuss how nonprofit organizations fund accounts are split into unrestricted, permanent restricted and temporary restricted net assets.
The evaluation on the income statement will review the ratios of expenses over financial period or budgets allocated in a period as they contrast between the nonprofit and for profit balance sheets. Thereafter the paper will elaborate how legislators can evaluate the net income and assets that are held by just reviewing the cash flows. Hence a future budget can be drawn by consideration of any pending expenses payments.
Table of contents:
Contrast of non-profit and for profit financial statements. 5
Cash Flow statements. 8
Balance Sheet 9
Income Statement 11
How legislators can make better decisions in their capacity by use of either of the two-take either side 15
The main goal of nonprofit organisations are, first to steer of profits as they strive to meet their mission and vision; second to minimize benefits to the subscribers while striving to satisfy the people welfare. (Bryce, 1992, p. 3) These goals therefore put the people first in services from the nonprofit organizations. However because the nonprofit organization handle a lot of funds from government, grants and aid, the are obliged to conform to Financial Accounting Standards Board (FASB) practices and regulations. The nonprofit organizations are further required to conform to the Internal Revenue Services (IRS). (Wolf 1999).
In all these requirements, the nonprofit organizations are expected to show operating statements, balance sheets and cash flow statements. All these financial status reports have a standard procedure of recording before they are forwarded to the heads of the organizations. However there are fundamental differences that exist in procedures of recording these financial statements between the non-profit and for profit organizations. (Wolf 1999).
The balance sheet will show the status of the either organizations; non profit and for profit. It reflects the amount of assets that the organization holds compared to the liabilities it owes. Therefore the net outcome is the organizations true value. The balance sheet is also used for outline the assets that the organization holds into three; temporary assets, permanent assets and restricted assets. (Wolf 1999).
The income statement on the other hand is used to comprehend the financial activities during the financial period. It also tracks down how the three categories of assets have changed over the same period. If the process of recording the income statement is efficiently done, one should be able to have a preliminary glimpse of the non profit organization’s net worth, their wells their expenditure practices and revenue flows. (Wolf, 1999, p. 215). The cash flow statement shows whether the organization is liquid or not. This is achieved by assessment of the incoming cash versus the disbursements. (Hummel, 1996, p. 78)
When all these three major financial statements are combined, one can be able to assess the true value and worth of either nonprofit or for profit organizations. Thus, many legislators or aid, grant or welfare contributors will normally ask for these statements for a quick audit purpose. These statements can be compiled either internally of by attachment of expert audit firms that comply by the FASB standards. (Wolf 1999). One of the most distinct differences between a nonprofit and for profit financial statement is the tax element. The nonprofit statements are not taxed whereas the for-profit financial statements are subjected to tax as a legislative requirement.
Contrast of non-profit and for profit financial statements
The biggest contrast that exists between a nonprofit and for profit balance sheet is how the equity is recorded. This equity refers to the income that the nonprofit organizations receive vis-à-vis what is owed. (Thomas, 1994, p. 405). In the nonprofit balance sheet the incoming equities are recorded as the net assets or fund/aid/grant balance. Therefore any nonprofit organization that has more net equities is considered high in net worth. (Cumfer & Sohl, 2001, p.519).
The nonprofit organizations have three accounting options to adopt. These are based on cash, funds accrual and modified methods. (Dreezen & Korza, 1998, p.246). The process of deciding which option to adopt relies on time of recording the revenues and expenses so that there is less flaw. But most nonprofit organizations prefer the cash method since it is flexible in evaluation of the financial position. Thus according to Wolf (1990, p. 170), cash entries will only be made at the exact time of transactions. In the for profit case cash entries are made any time. This delay of recording the receivables and payables in for profit accounting system often masks the true financial position. (Wolf, 1990, p. 170). This is particularly true as what the for profit organizations holds as assets or liabilities are not immediately known. For this reason the nonprofit organizations cash positions are instantly accountable and simpler to infer. (Olenick & Olenick, 1991, p.217).
The next different accounting method that is feasible in the nonprofit organization is the accrual type. This approach is complex but never the less gives guidance of the financial status of the organizations. The complexity of this accounting method is on how pledges and expenditures are recorded in books irrespective of whether they have actually been executed. (Dreezen & Korza, 1998, p.246) The most pragmatic way of understanding the accrual approach is how the credit card functions.
Therefore the nonprofit accounting that adopts accrual method will make entries for grants just by the mere word that they will be released to the non-profit organization. This is treated as income entry even if the actual grant will be received months later. The same trend is used on some expenditure irrespective of whether these are cash or non cash based. On the other hand this method bears in mind the accounting period and the exact time when the accruals took place. (Olenick & Olenick, 1991, p.219) Thereafter, some revenues and expenses are treated as accrued, current or deferred.
The dichotomy of the current accrual is declared if earnings and expenditures are within the current financial period including the full settlement. Example is early bookings. Revenue and expenses are declared accrued in the current period is they were utilised in the current period but settlement is done by the end of the financial period. Example is subscriptions. In the case of deferments, revenues and expenses have been prepaid for in the prevailing accounting period but they will be utilised in the next accounting period. Example is a grant pledge or promise. (Olenick & Olenick, 1991, p.219).
The third accounting approach is the modified cash. In this case some cash entries will be promptly made while others will be done in future or at a specific time frame like weekly, monthly or quarterly. The later entries are typical of what the organization is owed in pledges or debts and the process is primarily done to tidy up the bookkeeping. (Wolf, 1991, p.171).
It is important to note that the above three nonprofit accounting methods do not suit all organizations uniformly as there are different missions and objectives. (Wolf, 1991, p.171). Therefore most nonprofit organizations design accounting methods that address their staff duties, pool of resources, accounting regulations and accounting insurance. (Olenick & Olenick 1991, p. 236-39). Additionally it was noted that the organizational staff accounting competency must be considered so that the system takes them along the accounting period in as much as goals are defined. (Olenick & Olenick 1991, p. 216).
Unlike the case for profit accounting organizations, the nonprofit organizations that adopt either the cash or modified approach must be ready to re-modify to the accrual approach sometimes annually. This process is needed to determine the solvency position. (Wolf, 1991, p.171- 172). In the case of the for profit organizations, the processes of solvency tests takes place at least quarterly. It is prudent to check an organizations solvency status other than just knowing its financial balances. Either way, nonprofit organizations in contrast to the for profit organizations have the flexibility of choosing which financial examination approach to use as long as it works best at the time of the audit. ( Dreeszen & Korza, 1998, p. 247)
The other major difference between the nonprofit and for-profit financial statements is the goals of the nonprofit. In most cases the nonprofit organizations are led by socially responsibility as a key driver while for profit organizations are guided by a profit motive with social responsibility coming secondary. Therefore the nonprofit organizations are only successful if they are well funded. In order to get their funds streaming in, they are obliged to maintain high accounting standards. Part of this accountability process means that the nonprofit organizations must classify their assets in three tiers as earlier elaborated. ( Dreeszen & Korza, 1998, p. 247)
In contrast the for profit organizations are required to show owner equity while the nonprofit organisation is required to show tax exempt following a funding on their current balance sheet. (Dreeszen & Korza, 1998, p. 245). The next contrast is the entries made for the fixed assets, which is done in for profits financial statements and omitted in the nonprofit organization financial statements. Instead the nonprofit organizations consider and record pledge aids, grants and funds as their assets and are legally in order to press for their deposit with the organization. This has implications that the nonprofit organizations can decide whether to record these as cash or accruals. (Connors, 1993, p.789). This flexibility of financial statement entries has implications that the nonprofit methods is more accurate than the for profit organizations.
Cash Flow statements
Cash Flow statements help both nonprofits and for profit organizations evaluate their liquidity status over a given financial period. There, the cash flow statement will ordinarily operate two entries; cash received and spent. If the cash flow records are well maintained, the organizations will be able to gauge if they have enough cash in the short or long term or whether they face cash difficulties. Cash flow statements can also be used for by nonprofit organizations to ascertain the specific months that they will be short of cash. This is easily done by projecting the total cash that is or will be available versus the respective monthly or periodical expenditures. (Olenick, & Olenick, 1991), p. 372).
The fundamental difference between the cash flow statement in nonprofit organization and for profit organization is the precision of knowing income verses disbursement per income. For profit organization will normally pool the income resources then spend as per the budget. Thus the nonprofit organizations are able to breakdown the net incoming cash in the operations with the impact it has on their processes; breakdown loans and grants that are different from the operational revenues; breakdown the liabilities that are not normal expenses and ; monitor the income funds and their respective utilities and balances. (Olenick& Olenick, 1991, p. 372).
Nonprofit organizations often receive gifts which are well separated from the unrestricted and temporary restricted assets. It is this indirect entry approach that is embraced by many nonprofit organizations. Thus the approach of longer term investment and asset classification is a distinction from the for profit organizations whose entries are guided by specific financial periods, often in annual quarters. When it comes to cash received from financial operations, the nonprofit organizations are required to first indicate how they intend to utilize restricted permanent funds ahead of the actual disbursement. In the case of for profit organizations, the entries are made on the expenditure as the budgeted project or programs go along. (Olenick & Olenick, 1991, p. 372).
According to Keating (1991, p. 21), the non profit organizations balance sheet is denoted by Assets = Liabilities + Net Assets. This formula is used to express the financial status from the grants, loans, pledges and cash vis-à-vis the payables. In the case of for profit organizations, the balance sheet is express as Assets = Liabilities at the break even point, with preference for a solvency ratio of 2:1 for assets to liability in order to be declared financially healthy.(Olenick & Olenick 1991, p.352). However the for profit .This ratio underscore the importance of profits in the for profit organizations.
There are other salient distinctions between the nonprofit organizations balance sheets and for profit organization case. These differences surround the grants, loans and pledged funds that normally assume short term or long term liabilities. (Keating, 1991, p.30-31). In terms of the balance sheet assets for the nonprofit organizations, any donor related funds are normally registered as temporary or permanent restricted. In the case of for profits, there are rarely donor entries, maybe long term loans or short term loans. Additionally the grants and donor pledges in the non-profit organizations are recorded as the net values. This is due to the past realizations that the grants and pledges could be exaggerated. In the case of for profit organizations, the accounts receivables must be stated at the gross value in contrast to the nonprofit organizations. (Keating, 2001, p.32)
In non-profit organizations, prepaid expenses are depreciated with the consumption of the assets. In the case of for profit organizations depreciation is deem by time factors irrespective of whether the asset is fixed or current. The depreciation of assets in profit organizations is not concerned with the idleness of the asset, value will go down anyway. The non-profit organizations have a distinct way of recording the investment values, because the fair values consider tax exemptions therefore the entries will be reflected by the lower investment costs. For profit organizations must factor in the tax thus the fair value will always be high when considering the cost of investment. (Keating, 2001, p.32)
When it comes to fixed assets, the nonprofit organizations do not normally reflect this entry because they are not for sale. In fact the depreciation of assets in the nonprofit organizations is strictly along the straight line approach over an annual spread. (Keating, 2001, p.32) But as mentioned, the most fixed assets are not consumed so the balance sheet entries will not include them. (Olenick & Olenick, 1991, p. 352-56).
The nonprofit organizations can choose to record the accounts payable such as grants, bills owed and credits owed in segments or in integration. For profit organizations will normally lump all these together. The nonprofit organizations’ balance sheets have provision for refundable advances. These arise when some grants pledges do not mature on technicalities. (Keating, 2001, p.32). For profit organizations consider these as bad debts after a certain period of time elapses. (Olenick & Olenick, 1991, p. 352-56).
The nonprofit organizations will normally record dues that are held on behalf of other organizations as liabilities up to the time they hand them over then the receipts can be transferred. For profit organizations that are in the clearing and forwarding sector will record this as assets then once transfer is done the net worth will remain in the balance sheets. In the donor funds entries, the nonprofit consider them as an endowment by the perpetual method. For profit organizations do not have provisions for donations. They raise and record these as loans if from third parties, either short or long term. (Keating, 2001, p.32). For profit organizations have an endowment to pay back these loans after a certain period of time.
This is also commonly referred to as operating statement or statement of activity. This is depicted with formula: Revenues – Expenses = Change in Net Assets. (Keating, 2001, p.34) The interpretation of this model will be either a deficit or surplus. The nonprofit income statement is normally bound by expenditure restrictions by the donors who have interest of how the funds are to be spent. Therefore the cross restriction entries movement is heavily dependant on the nod and must be reflected appropriately.
Due to the three categories of funds restrictions, a liability is deemed on when the conditions set by the donors have been met. This happens because until the conditions for the donors are met, a pledge can be rescinded on that ground and be enforceable by law. Thus the nonprofit organizations are prohibited from moving permanently restricted donations unless authorised. If the reverse happens, it will be considered an irregularity in the nonprofit financial accounting. (Keating, 2001, p.34). For profit organizations expenditure follow strict budgets allocations as the authorisation for funds expenditure. Once funds are available , there are no other extraneous requirements for approval.
The nonprofit income statements have additional entries as compared to the for profit income statements. They entries give provision for cancelled pledges from volunteer donors that were unconditional. If the nonprofit organizations receive gifts the asset are recorded from a fair value. But before the gift is delivered, if the nonprofit organization fears that there might be default, they are at liberty of recording a fraction of the fair value. (Keating, 2001, p.34) In the case of for profit organizations, there are no provisions for gifts. The income assets are recorded at delivery and the fair value is recorded after tax consideration. Anyway, nonprofit organizations are only keen to record in kind services when they are expecting it to generate revenue to the organization.
The nonprofit income statements have provisions for earning revenue following a programmed service. This entry is further flexible to accept either money or an asset as a medium of exchange. For profit organizations will normally deal for cash or value of cash to be payable in the short or long term. Non profit organizations earn revenue from member ship while for profit organizations earn revenue predominantly from sales, share capital or earned interest rates. (Keating, 2001, p.34)
When the nonprofit organizations hold fundraising, they are required to record the income realized separately from the rest such as donors and grants. This is done to monitor restriction caps and the funds will be recorded at the gross value. For profit organizations will normally record the capital or owner’s equity gross value and the other applicable aspects like tax and exchange rates levels where applicable. (Keating, 2001, p.32)
The nonprofit income statement has provision for income or fundraising expenses that they incur when setting up for the organization goals. The non profit organizations have also got a fundraising cost. For profit organizations have fixed and current costs entries in contrast that have been predetermined to a fair degree. Therefore, for profit organizations will have current costs covering administrative, support, management, communications and daily operations while salaries, personnel insurance, property insurance, social security and rental costs are considered fixed costs. The fixed costs are normally spread over a long period of time due to their enormous values in for profit expense statements. (Keating, 2001, p.34-35).
There are fundamental differences of how the nonprofit and for profit organizations. Ordinarily a budget is supposed to show how both side of divide will spend within available resources. Second, there are various budgets approaches that are normally applied in both for profit and nonprofit organizations. These are cost benefit analysis budgets, zero budgets, flexible budgets, performance budgets and forecasting budgets. (Olenick & Olenick, 1991, p. 83-84). This estimation process will bear in mind factors like inflation and deflation, which normally impact on true values over a period of time.
For that matter, the nonprofit organizations will always be cautious in their budgets because loans, grants and other pledges can be varied instantly with a sharp change in business climate or economic factors. (Olenick & Olenick, 1991, p. 83). Nonprofit organizations use flexible budgeting to adjust their operations according to the inflow of funds. ( Finkler, 2002, p.67). This practice is however minimal in for profit organizations as the operation are normally very tight and could cause considerable negative impact on the business.
The performance budgets are the most familiar with for profit organizations as they use these to reorganize the organizations achievements along the available resources. The performance budgets are also very helpful to the for profit organizations because the association between the profits and the expenditures are elastic. Non profit organizations do not have to worry about profits. They care more for the value of services. (Finkler, 2001, p.68). Therefore, the for profit organizations operations will mostly be budgeted along cost centres while the nonprofit organizations are organized along program centres. In this case the performance of the budgets in the nonprofit organizations will be along the value and impact of the target groups. For profit organizations will typical discontinue cost centres that are not reciprocating with good value returns for the investments.
The most familiar budgeting type with the nonprofit organizations is the cost-benefit analysis. As the name suggests there is more emphasis of how the value goals are impacting on the target group. So whenever the costs overweigh the benefits, the projects will need a re-evaluation and or renegotiation for assistance. For profit organizations will normally not use this budget approach in isolation but will integrate it with the other type so that their budgets are more practice. (Finkler, 2001, p.70-73)
The zero budgets are normally adapted by the nonprofit and for profit organizations especially when they are setting up the business from scratch. For profit organizations will normally revert to this approach in the course of their operations when they would like to review their operations to highlight what is not valuable after very few years. (Finkler, 2001, p.75) Most nonprofit are capable of doing this continuous process with the flexible budget approach.
Forecasting budgets are used for estimating the future resources and expenditures from historical information. This approach is used by the for profit organizations by assessing their past financial records to see where they were able to receive income, revenues and loans and interest vis-à-vis how they were spent. The nonprofit organizations on the other hand are able to use forecasting budgets to see where their grants, pledges, loans and gifts will be coming from along the restricted expenditure framework that most donations come with. (Finkler, 2001, p.75-76)
How legislators can make better decisions in their capacity by use of either of the two-take either side
According to Herzlinger and Nitterhouse (1994, p.1) the legislator needs to understand the difference between the non-profit and for profit financial statements so that they van be able to efficiently allocate the scarce funds. The legislators are interested in this distinction because there is budgetary constrain that has gone as far as limiting the number of non-profit organizations and the workforce.
According to Thomas (1994, p. 406) the legislators of nonprofit organizations should be able to see if the projects or programs that are in place have outrun their budgeted expenditures as well as be informed on the net worth. The accuracy of the net worth can be counter checked by the cash flow statements for any pending paid expenses and likelihood of future revenues. (Olenick & Olenick, 1991, p.136).
Ordinarily, many legislator need to be certain that the nonprofit organization are conforming to the accounting methods in the wake of recent financial scandals and crisis. (Hummel, 1996, p. 76.). The fact that the nonprofit organizations are heavily dependant on the funds from both government and non-government organizations calls for this high standard of accountability and verifications ahead of funding the next period. (Grobman, 2002, p.113).
The legislators are the representatives of the people in the funds committees that are channelled to the nonprofit organizations. Therefore any forms of misappropriation that arise are typically questioned from the organization to the legislators. An evaluation of the financial statement can enable the legislator to determine if the services costs or the nonprofit organization are worth the goals. The legislators will be able to see the amount of funds that have been allocated to the organization and press for better services to the people. In the same way they can influence policy by proposing a cut back whenever the services overrun costs. This has implications that a nonprofit organization that keeps proper accounting records will benefit from good leadership decision process from all the stakeholders. (Hummel, 1996, p. 76.)
In the recent past, the capability of many legislators to input their development ideas in the nonprofit organizations has been derailed by poor publicity of the financial status of the organizations. This observation was based on the fact that many nonprofit organizations do not keep good records of accounting, especially for the three categories elaborated in the introduction of above. (Salamon, p. 174)
The legislators must should be able to comprehend the financial statement alongside the side notes in the nonprofit organizations for the sake of the accountability of the donation and in the for profit organizations for the sake of the stakeholders interests. (Finkler, 2001, p.443) As a public watchdog, the legislator should ensure that the financial statements are going towards the attainment of the organizations mission and vision. Additionally the legislator is interested in the financial statements to see if the organizations are stable in continuity. The legislator is equally interested in the financial statements to see if the oversight bodies like accounting firms are capable of executing their mandate.
This paper has elaborated on the different entities of financial statements. The paper has reviewed the components of each of the three main financial statements with an in-depth analysis of the differences between nonprofit and for profit organizations. The paper has also outlined how the legislators can be able to analyze the financial information’s therein and how this impact on the projects and programs that is in place.
This paper was on the clear mission of enabling the financial management of the nonprofit and for profit organizations to infer the required financial documentation standards. This is on the backdrop that the stability and prosperity of the organizations depend on sound financial management. This paper has identified that the income statement, cash flow statement and the balance sheet are the main financial statements that are of interest to both the nonprofit and for profit organizations. This paper has underscored the importance of the three financial statements to enable the management and the legislators to evaluate various positions such as income net assets, expenses and debts.
This paper has touched on the importance of accountability of grants, aid and other government funds to the nonprofit organizations in order to secure next allocations in the following financial period. This paper will enable the legislators to have a first hand knowledge is interpreting the contrast in financial statements instead of using other secondary professional, an exercise that is both costly and prone to errors. The nonprofit and for profit organizations will need to have good financial management practices that will drive the organization towards the mission, vision and objectives. Failure to know the contrast in nonprofit and for profit financial statements is a potential ethical hazards and a breach of accounting regulations. Olenick & Olenick, 1991)
This paper has elaborated the theoretical and real world practices between nonprofit and for profit organizations. The paper has emphasized that for profit organizations are profit drive while the nonprofit organizations are drive by value for public investment from donations, grants and sometimes gifts. The bigger emphasis of this paper was on the preference of reporting styles and convenience or reporting guide by the overall organization mission and goals. Therefore it was not strange to see even the budgeting preference taking a similar trend differences in entities. (Finkler, 2001)
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