PA 645 NON-PROFIT FINANCIAL MANAGEMENT AND BUDGETING FINAL EXAMINATION - SPRING 2014 This examination should represent your own work and not that of others or the product of group work. If you have questions about the exam, you should contact the instructor and not others in the class. This examination consists of three parts: Part I is worth 30 points toward the grade on the examination; Part II is worth 40 points; and Part III is worth 30 points. PART I. -- ESSAY QUESTION (30 points). Answer only one of the following essay questions. The essay question should be able to be answered in 2-3 typed, double-spaced pages. Your response to the question should integrate concepts covered in the course, be well organized, and indicate a logical development of your arguments. Be sure to cite examples from the readings, articles, cases and analyses discussed in the course to support points raised in your response.

1. Discuss the usefulness of management control concepts discussed in the course for financial management

in nonprofit organizations. Be sure to discuss how planning and budgeting fit into the management control process to create a more integrated financial management system. As the nonprofit sector has developed, professionalization within the field has created an

opportunity to capitalize on the momentum driven by increased support from both public and

private donors. In keeping step with this development, the demand on management of nonprofit

organizations and good stewardship of donated funds, has increased. Meeting this demand has

highlighted the importance of healthy, accountable systems within management control

processes, motivated by the organization's mission and guided by both the professionals and

volunteers within the organization.

One of the most important systems extant in management control process is the budget cycle

as outlined by Finkler (2010): budget preparation, budget review and adoption, budget

implementation and evaluation of results/feedback. As was noted in the analysis of Hamilton

Hospital (Case Study 1), the budget cycle can guide the necessary changes in administrative and

communication processes. Taking the necessary time to use the cycle as an organizational

process allows managers to garner relevant financial data from units and departments as well as

anecdotal and qualitative data from employees, clients and community constituents. Each phase

of the cycle allows for an eye toward strategic planning--assessing the efficacy of current

strategies, identifying emergent strategies and relating the information to the current and future

financial state of the organization.

As the budget is implemented, the working capital management cycle, defined in Finkler

(2010) as collecting cash, paying for supplies, paying workers and issuing invoices, begins to

govern daily operations. This increases the necessity for management control processes focused

on accountability and security as mentioned in Gallagher & Radcliffe (2002); such procedures

include background checks, separation of duties and systems of authorizations. These controls

maintain the integrity of the capital management cycle as it serves two purposes: actualizing the

mission and maintaining daily operations.

While there are a plethora of considerations within the budget implementation phase,

including grappling with capital investments as in the Yoland Research Institute (Case Study 5),

operating reserves and liquidity management (McLaughlin, 2009; Calabrese, 2012; Mundy,

1990) and cost allocation as in Harbor City Children's Center (Case Study 4), the primary focus

centers around program administration. The stewardship of funds continues to play a large role,

examining how revenue moves through the organization as a function of operations; this function

relates back to the budget review and feedback phase, which, in a healthy organization, runs

concurrent to operations prior to moving into the planning phase for the upcoming fiscal year.

Utilizing the budget cycle as a framework provides an effective manager and leader with

important checkpoints to maintain organizational health. As the organization circles around to

planning the budget for the upcoming year, Finkler's (2010) variance analysis can be used to

evaluate performance of specific programs, units, departments and even managers. While not

encouraging micromanagement, this focus on what went well and what could be improved can

guide decisions across the entire organization.

This sets the stage for implementing additional processes designed to mediate problems like

ratio analysis or increase outputs and outcomes like breakeven analyses. While a complete focus

on management control processes cannot be the only focus an effective manager and leader

utilizes, an integrated financial management process--one which serves as a guide and

culmination of other important organizational efforts--is pivotal to maintain the health and

viability of organizations driven to provide valued and necessary public services.

2. Based on your experience performing a financial statement analysis of your group’s nonprofit agency and discussing another group’s financial statement analysis, what role can ratio analysis play in assessing the financial situation of a nonprofit organization? Be sure to explain how such reviews are accomplished through the use of ratio analysis and its value in formulating a financial assessment of a nonprofit organization.

PART II. -- SHORT ANSWER QUESTIONS (ANSWER ONLY 4 OUT OF THE FOLLOWING 6 QUESTIONS!!!!) Choose 4 of 6 short answer questions at 10 points each--40 points total on short answer questions. The short answer questions should be able to be answered in one typed, double-spaced page or less. Indicate clearly the question to which you are responding. Be sure to cite readings, articles, cases, and analyses discussed in the course to support points raised in your response.

1. Describe how the process of recording financial transactions and generating financial statements works with respect to the fundamental accounting equation and GAAP requirements for nonprofit organizations.

2. Discuss the purpose and use of required financial statements and how they result from the process of recording financial information for nonprofit organizations.

3. Identify at least two aspects of accounting for nonprofit organizations that are unique and discuss why they are an issue. While it can be argued that nonprofit organizations and for-profit organizations share

many best practices, accounting within the nonprofit sector differs slightly to that of for-profits.

There are unique restrictions and requirements based upon the makeup of nonprofit revenue--a

conglomeration of publicly donated funds, granted funds and so on. This revenue stream requires

nonprofits to account for funds in a more specific manner than that of the for-profit sector. In

doing this, nonprofit organizations generally use fund accounting to track revenue categories,

particularly those which are donor-generated.

In addition to the recording of transactions and fund balances, nonprofits are required to

provide financial statements of financial position, statements of activities, and statements of cash

flows (Finkler, 2010); these are much more specific statements than the for-profit statements of

profits & losses (P&L's). These statements track the relationship of direct and indirect costs, cash

inflows and outflows as well as specific activities performed by the organization. Within these

statements, nonprofit organizations facilitate an understanding of how the organization is

meeting its mission and maintaining solvency.

4. What is the purpose of working capital management and how should it be accomplished in nonprofit

organizations? Working capital management as outlined by Finkler (2010) is the process by which an organization's

current assets and liabilities are used to maximum financial effect. Incorporated into the process is the

acquisition of liquid assets, paying for supplies and inventory, paying employees and invoicing for

services--a cycle of inflows and outflows in an organization. To manage this process effectively,

consideration must be given to investing and collections in both the long-range and short-term health of

the organization.

Mundy (1990) suggests a ladder-step structure to short-term investing; managers should create a

calendar which allows access to short-term resources; comfortable windows of time can be established,

based upon revenue inflows, with short-term investments that release according to a staggered timeline.

An organization might look at CD's that release in 6-month increments with short-term mutual fund

investments occurring between major release times. Working with these marketable securities allows an

organization to make its money work while it waits to be used. As Finkler (2010) points out, an eye

toward legality, risk, yield and liquidity are important factors to consider, but there is a larger push for

organizations to activate working capital beyond daily operations.

While it is important that working capital management include an understanding of operating

reserves (Calabrese, 2012) and necessary cash for daily operations (Finkler, 2010), maximizing the

impact of liquid assets is a matter of understanding when to apply heat to assets (McLaughlin, 2009);

investment can be an action which includes renewing capital assets or even eliminating such assets if the

need is there. In managing this liquidity, accounts receivable plays a large role in keeping cash flowing

into the organization. In this regard, additional control processes are activated; managing both the billing

and collections process are vital to the organization. If these processes are disjointed and inefficient, the

organization risks depleting its working capital and its operating reserves in such a manner that business

can no longer be done. All of these components play an important role in managing the working capital of

an organization.

5. Explain how variance analysis fits into the context of management control to achieve accountability and

control in nonprofit organizations. Variance analysis is used to understand the results of processes within the organization; Finkler

(2010) identifies that variance analysis serves to assist in improving the budgeting process, implementing

appropriate control measures in the current year and evaluating the performance of departments and

managers. With these pieces of information, an executive officer and the board can begin to implement

strategies which contribute to the overall health of the organization, particularly as pertains to the

financial bottom line.

Finkler (2010) and McLuaughlin (2009) identify multiple areas where variance can occur: total

output, departmental, and within a single line-item. Once identified, the reason for the variance can be

connected to the result and rationale can be evaluated. In some cases, variance can be a positive value,

due to effective cost analysis or improved administrative processes. Variance can also intimate

organizational challenges in production or over-spending on particular line-items.

Maintaining an eye toward understanding variance analyses allows for managers to pinpoint

specific problems and highlight opportunities, a powerful theme in the study of financial management;

with an understanding of how to interpret variance, managers can be more effective in managing the

relationship between inputs and outputs. While nonprofits differ from for-profit organizations, the

principle of efficiency still plays a large role in the success of the organization.

6. What cautions should apply to the use of ratio analysis and why?

In utilizing ratio analysis to interpret data from nonprofit organizations, there are several

considerations which must be made: how the organization produced the financial statements

used as the basis for comparison, the scope of the comparison and whether it will include

mimetic organizations or industry standard ratios and, finally, the value of ratios used to assess

the organization.

Though each nonprofit organization is required to supply statements of financial position,

activities and cash flows, these statements may be specific to the organization or industry; it is

important to include financial statement notes in compiling ratios as well as interpreting them.

These attachments to financial statements serve to supplement the information presented in

efforts to clarify the method and rationale for reporting. This is a critical consideration to

facilitate the understanding of the values to be used to compute the initial ratios.

Once ratios have been calculated, an agreement should be made regarding the scope of the

comparison: will the comparison simply focus on industry standard ratio behavior? Will the

comparison sample include organizations with similar size, scope and purpose? Without this in

place, ratio analysis is confined to the historical behaviors of the organization which may not

serve the purpose of the analysis. Additionally, allowing the organization to self-select its sister

organizations may skew results of any analysis.

Though there are commonly used classes of ratios, outlined in Finkler (2010) like common

ratios or leverage ratios, it is important to identify ratios which actually reflect the life and

purpose of the organization being analyzed. While asset turnover ratios might be important for

working capital management in an inventory-driven organization, intangible service providers

like cultural or educational organizations may not find much value in focusing on that class of

ratios. Additionally, there are other ratios from various sources including the Urban Institute

and researchers in various fields which may need to be considered or possibly create more

accurate depictions of organizations.

While ratio analysis can be a valuable internal and external tool when considering the

financial health of an organization, it is important to understand how the organization sees what

it does, the methodology behind the comparison and areas of focus within the analysis itself. As

these areas are addressed, the ratio analysis moves toward being an accurate reflection of the

organization as it is positioned within itself, its industry and the nonprofit sector.

III. -- Problem and Application Questions (15 points each, Total of 30 points). Answer only two of the following three problems. Clearly show all of your calculations. Label your work appropriately.

1. Breakeven Analysis

The Children’s Museum is considering catering birthday parties for members as a way to generate revenue. The costs are as follows: Staff $90 Cake and Food $60 Decorations $30 In addition, party favors have a variable cost of $5 per child. a. Find the break-even price per child assuming that 12 children (the break-even quantity)

attend each party.

b. If the Museum expects to make a profit of $300 on every party (treat profit as an additional

fixed cost), find the price per child to break even and produce the $300 profit on every party (again assume 12 children attend each party).

c. Discuss managerial implications and other considerations of the break-even analysis results. For components 1a & 1b, please see table below:

Expenses

FixedCost Staff $90

CakeandFood $60Decorations $30

$180VariableCost

Favors $5 #ofAttendees 12

$60

Breakeven Cost/child $20

Breakeven+$300profit $45

Cost/child 1c. Narrative Response:

Breakeven analysis as a function provides managers information regarding when or at what

point, an investment will be returned. According to Finkler (2010), organizations utilizing breakeven

analysis gain valuable insight into necessary price point, investment turnover and cost opportunities.

Breakeven analyses can be used to determine an appropriate price for services rendered to reduce

or eliminate risk in service-based programming. Inversely, breakeven analysis can be used to determine

the maximum units of service to be provided while avoiding additional costs to the organization. This

indicates that breakeven analysis can be utilized to establish limits or maximums for price of service to

the consumer, cost of service to the organization and the volume of services rendered, positive or

negative. In the example provided, The Children’s Museum is given an idea of what fixed costs are as a

specific category, what variable costs are and the end results; this information then becomes malleable

as program needs and goals are discussed.

Breakeven analysis can also be tied to investment or asset turnover timelines, providing a longer

view of organizational function; the analysis nominally predicts cash flow as relates to volume.

Understanding when and how a breakeven point exists, allows for managers to make determinations

regarding both volume and price as controllable qualities in organizational work flow (Finkler, 2010).

The example analysis provides insight into budgeted amounts, guiding the event planning process and at

what price point the desired 12 guests will return the initial investment to the Museum.

Utilizing this knowledge, managers can realize cost opportunities: can this program support

itself? Are program goals realistic (e.g. can the necessary volume be achieved?) and is the organization

in a financial position to zero out its obligations? While there are additional considerations in financial

decision-making like contribution margin (Finkler, 2010), breakeven analysis is a starting point for

determining the financial capacity of an organization and its ability to keep its feet on the ground.

2. Cost Accounting Problem

The table below provides the costs associated with running community health clinics by a nonprofit agency. The agency has two mission centers (primary activities) and two general service (supporting) departments. Assume the nonprofit agency is attempting to determine the full costs of providing the services in the two primary activities. The direct expenses charged

to the centers are as indicated in the table. The floor space in square feet occupied by the centers, the number of client visits, and the number of billing and payment documents processed per center are indicated in the table. Centers should be allocated based on data provided in the table. Determine the full costs of the primary mission centers by using the step-down method. Calculate and indicate the full costs and the unit costs for each primary mission center. Show the complete step-down analysis and associated calculations. Required narrative comments: What might the agency do with the information obtained? What price should the agency charge in reimbursement billing for the two services provided based on this analysis. Why? What other considerations might enter into the pricing decision? Show all calculations and clearly mark your work for reference.

Sq. Ft. Facility Space Client Visits Documents Processed

Adult Clinic 35,000 (43.75%) 9,000 75,000 Children’s Clinic 30,000 (37.5%) 6,000 50,000 Doc. Processing 15,000 (18.75%)

80,000 15,000 125,000

Mission Centers Service Centers _______________________________________________________________________________________

Adult Clinic Children’s Clinic Maintenance Document Total Processing

Direct Costs $920,000 $890,000 $700,000 $800,000 $3,310,000

Step-downCostDistributionofHealthcareNonprofitAgency Support Maint Subtotal Processing Total

Maintenance $700,000 -$700,000 $0 $0 $0 Processing $800,000 $131,250 $931,250 -$931,250 $0

Mission AdultClinic $920,000 $306,250 $1,226,250 $558,750 $1,785,000

Children'sClinic $890,000 $262,500 $1,152,500 $372,500 $1,525,000 $3,310,000 $0 $3,310,000 $0 $3,310,000 AllocationRatios Space(sq.ft.) % ClientVisits % Processing %

AdultClinic 35000 43.75% 9000 60.00% 75000 60.00%Children'sClinic 30000 37.50% 6000 40.00% 50000 40.00%

Processing 15000 18.75% 0 0 Maintenance 0 0 0

80000 15000 125000 FeeStructure(inavgcostpervisit)

UtilizingStep-DownCostDistribution UtilizingClientVolumeRatio DirectCost PerVisit

AdultClinic $198.33 AdultClinic $1,986,000 $220.67 Children'sClinic $254.17 Children'sClinic $1,324,000 $220.67

$3,310,000

Narrative Response:

The information obtained from the step-down cost distribution analysis of this healthcare

organization can be used in several ways, alluding to the fluid nature of cost allocation Finkler (2010)

and McLaughlin (2009) use to guide their discussion of financial reporting. The information garnered

helps to determine strategies for enhancing noted opportunities and diminishing demonstrated

deficiencies within the organizational programming; this is particularly important when considering

direct and indirect costs associated with accomplishing the mission of an organization.

In the case of this healthcare agency, step-down distribution is achieved through allocating

maintenance expenses experienced by both mission and support centers, followed by allocating

processing center costs which serve to support the two mission centers—the Adult Clinic and the

Children’s Clinic. In this process, the organization understands what actual costs (in aggregate) the

mission centers are incurring. This process can provide valuable information for financial statements

and Form 990 reporting.

Some of the value of the knowledge ties directly to for-fee services rendered in mission centers;

with the knowledge gained from evaluating the step-down cost distribution, accurate prices for break

even points can be established. Utilizing the step-down method, it has been determined that the Adult

Clinic should charge, on average, $198.33 per visit and the Children’s Clinic should be around $254.17

per visit, based upon current volume and costs within the organization. Using a ratio determined by

client volume, all visits should be priced at an average $220.67. While both numbers are accurate, they

illustrate the power of the lens utilized to analyze financial figures. These prices can then be used for

upcoming budget projections and estimates for grant writing. Depending upon how the information

needs to be used, managers have standing with all three prices. This may impact how pricing is

determined, but may also influence decisions surrounding where to aim program development; if

children’s visits can be justifiably scaled higher than adult visits as exhibited in step-down distribution,

it would be reasonable to aim marketing and outreach efforts toward that targeted population. If the

organization were writing for sponsorship or grants, the higher price could be utilized to justify

increased support to defray client cost and potentially increase liquidity and profit ratios in the

organization.

3. Net Present Value/Cost-Benefit Analysis Problem. The following table contains data prepared for two capital investment projects. (a) Use these data to compute for each project the Net Present Value at discount rates of 10 and 4 percent. Clearly show your calculations and how you arrived at your answers; (b) Describe the facts about the projects that determine which project is preferable under each circumstance and why. What other considerations might enter into a decision?

Project

Year

Capital Costs ($)

Maint. Costs ($)

Benefits ($)

0

2,000,000

0

0

1

1,000,000

10,000

0

2

500,000

70,000

120,000

3

90,000

600,000

A

4

90,000

800,000

5

90,000

800,000

6

90,000

800,000

7

90,000

800,000

8

90,000

800,000

9

100,000

800,000

10

100,000

500,000

0

2,500,000

0

0

1

500,000

50,000

750,000

2

100,000

750,000

3

100,000

750,000

B

4

100,000

750,000

5

100,000

750,000

6

100,000

750,000

7

100,000

750,000

8

100,000

750,000

9

100,000

750,000

10

100,000

300,000