Governmental and Nonprofit Financial Management

By Charles K. Coe PhD

The first book to comprehensively discuss both governmental and nonprofit financial management!
Governmental and Nonprofit Financial Management makes it easy for both nonprofit and governmental managers to understand essential governmental and nonprofit financial management topics and their various subfields.
• Understand the similarities and differences between governmental and nonprofit financial management standards and procedures
• Learn multiple cost-saving techniques
• Explore highly technical financial management subfields, from auditing and financial analysis to capital budgeting and risk management
• Use over 40 applications to calculate everything from T-bill yield to lost cash discounts
• Benefit from the in-depth coverage — an excellent primer for the non-accountant
Bonus! Apply what you have learned by completing problems, cases, and report writing exercises at the end of each chapter.

• Language: English
• Publisher: Berrett-Koehler Publishers, Inc.
• Release date: Jan 1, 2007
• ISBN: 9781567263916

Charles K. Coe PhD

Charles K. Coe is professor in the Department of Public Administration in the School of Public and International Affairs, North Carolina State University. With a doctorate in Public Administration, Dr. Coe is the author of Public Financial Management and The Purchasing and Materials Management Handbook. His research on public budgeting, financial management, and productivity has appeared in Public Administration Review, State and Local Government Review, Public Performance and Management Review, and Public Budgeting & Finance.

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Preface

This book is a general overview of the major subdisciplines of financial management. The intended audience is the governmental and nonprofit generalist, not the specialist. Financial management is comprised of highly technical subfields, including accounting, auditing, purchasing, budgeting, cash management, and risk management. In large organizations, the chief executive officer (CEO) and staff usually rely heavily on specialists in each of these areas. Still, the generalist needs a good working knowledge of each subfield. In small local governments and nonprofits, the finance director is usually responsible for all of these functions. Typically, however, the finance director has accounting knowledge but is not an expert in the other areas. The finance director learns more over time through experience, but is always principally occupied with accounting, financial reporting, and budgeting. In this organizational setting, the CEO has an inviting opportunity to be actively involved in financial management, especially investing cash, issuing debt, financial analysis, contracting, and managing risk. Best financial management practices result in considerable savings and efficiencies.

The book is aimed at both nonprofit and governmental managers. The last decade has witnessed unparalleled growth in nonprofit organizations. Governments, at all levels, have devolved a myriad of programs to nonprofits. Government contracting with nonprofits continues unabated. Yet government and nonprofit managers do not always understand each others’ financial management standards and procedures. While similar or the same in many respects, they dramatically differ in others. For instance, governments and nonprofits are subject to different accounting standards and use different metrics to measure financial performance. Government and nonprofit managers who do business with each other should understand these similarities and differences. The book makes these distinctions clear to the reader.

The book is the first to discuss comprehensively both governmental and nonprofit financial management. Several financial management books, many of which are outdated, exclusively discuss governmental financial management. However, there is no nonprofit financial management book that discusses the various subfields. Instead, separate books have been written on budgeting, accounting, financial analysis, and cash management.

Financial management begins with the preparation of a budget for the ensuing fiscal year. After the fiscal year begins, the budget is executed and the other functions—purchasing, cash management, debt management, risk management—take place. After the fiscal year ends, an independent Certified Public Accountant (CPA) conducts an audit of financial transactions. The organization of the book does not follow that flow. Instead, accounting precedes budgeting. The order is reversed because to understand budgeting, a firm grounding in accounting principles and practices is necessary.

Many, but not all, nonprofit and governmental financial management books provide an excellent discussion of subject matter but do not ask the reader to apply the information through problems, cases, or simulations. This is a major shortcoming. As any teacher knows, students learn best by doing. Consequently, problems are included at the end of each chapter. Some of the problems ask the reader to replicate computations found in the task. Others require critical thinking, analysis, and report writing. The problems have been tested on students in my classes.

Please note that an instructor’s manual is available for text adopters. Call 703-270-4170 for more information or email [e-mail]

Chapter 1

Introduction to Public and Nonprofit Financial Management

This chapter examines the differences and similarities between governmental financial management and nonprofit financial management.

Financial management occurs over three fiscal years. In fiscal year 20X0 organizations budget for the upcoming fiscal year, 20X1. After the fiscal year begins, the budget is executed. Management carries out the governing board’s policy directives. Financial managers ensure that funds are well spent in the amounts and accounts budgeted, account for transactions, invest cash, purchase goods and services, manage inventories, borrow monies for short-term financing and long-term capital projects, and manage risks to persons and properties by means of safety management and insurance coverage. Finally, after the fiscal year ends, local governments and nonprofits engage the services of an independent certified public accountant (CPA) to conduct a financial audit.

NONPROFIT AND LOCAL GOVERNMENT PROFESSIONALISM

Large state, local, and nonprofit organizations typically have sound financial management systems staffed by professionals. However, small governments and nonprofits have small and relatively unsophisticated financial management systems. In 2002, according to the U.S. Census, there were 87,849 local governments, composed of 3,034 counties, 19,431 municipalities, 16,506 townships, 13,522 school districts, and 35,356 special districts. Most of the local governments were small: 53 percent of the counties and 94 percent of the municipalities had populations of fewer than 25,000. Indeed, 49 percent of the municipalities had populations of fewer than 1,000.

Similarly, nonprofits are mostly small. For instance, of 1.3 million public charities, 73 percent have budgets of less than $500,000 and only 4 percent have budgets of over $10 million. Small local units of government are usually more professional than their similarly sized nonprofit counterparts for five reasons. First, state laws regulate the financial management practices of local governments, specifying eligible investment instruments, conditions under which debt can be issued, and accounting and budgeting practices and requiring an annual post audit by an independent CPA. Nonprofits are not subject to statewide regulations.

Second, city and county managers typically have more professional preparation than nonprofit directors in like-sized organizations. Such managers commonly have master of public administration (MPA) degrees. In contrast, few universities offer either a master’s degree or undergraduate education expressly in nonprofit management.

Third, local government officials belong to statewide professional associations that provide training, technical assistance, and peer support. City and county managers belong to such associations, as do virtually all municipal and county department heads. No such affiliations are available to nonprofit managers.

Fourth, cities and counties belong to associations that lobby both state and federal governments, provide technical assistance, gather and disseminate useful information, and issue useful technical publications. Though statewide associations of nonprofits exist in most states, they do not offer the same range of services and support.

Fifth, cities and counties often belong to regional councils of government (COGs). COGs are especially important to small local units that have few, or no, planning staff. The staff of COGs develop master plans for both local units and the region.

FINANCIAL MANAGEMENT IN LOCAL GOVERNMENTS AND NONPROFITS

Both local governments and nonprofits perform all the financial management functions, but to different degrees and in different ways. This section discusses these distinctions with respect to each function. The remaining chapters of the book examine each of these areas in more detail.

Accounting

The accounting practices of both governments and nonprofits are regulated by national accounting standards, but the standards differ. The Financial Accounting Standards Board (FASB) prescribes the accounting standards for nonprofits. The Governmental Accounting Standards Board (GASB) sets the standards for state and local governments. A fundamental difference in the standards is fund accounting. GASB requires that the governmental accounting system be organized around the basic accounting concept of a fund—a self-balancing set of accounts segregated to carry out specific activities. FASB, in contrast, does not require fund accounting.

A second fundamental difference is how local governments and nonprofits account for indirect, administrative costs. Nonprofits typically receive funding from different agencies, such as state and local governments, the federal government, foundations, private donations, and community organizations. These organizations, understandably, prefer that as much of the funds as possible be directly spent on client services, not general administration. Thus, nonprofits must justify to funding agencies the amount spent on indirect costs. Typically, a nonprofit’s external independent auditor must approve in writing the method used to allocate indirect costs. Governments, in contrast, are under no such obligation.

Finally, some states specify the chart of accounts that local units must use to account for transactions, but nonprofits are not subject to requirements regarding statewide accounts or procedures.

Budgeting

As stated earlier, many states require that their local units adopt an annual budget and set the date by which the budget must be adopted by the governing board. Few local governments, however, have a program-performance budgeting (PPB) system that reports expenditures by program and performance metrics. In contrast, a higher percentage of nonprofits have the more professional PPB system. Most nonprofits typically operate multiple programs, funded by multiple sources. As with indirect costs, funding agencies want reassurance that their grants or donations will be spent on the intended program. Moreover, they want to see what they are getting for their money; that is, how much service is being provided and how well.

Purchasing

Governments and nonprofits follow virtually the same purchasing practices. The principal difference is that states heavily regulate some local government purchasing procedures. Among the practices that states regulate are the preparation of specifications, minority goals, advertising of the letting of contracts, withdrawal of bids, acceptance of bids and proposals, project scheduling, and contract execution. By comparison, nonprofits are not subject to such regulation. Another distinction is that governments statutorily set bid limits, which are limits on purchases over which competitive bids must be sought. Nonprofits less frequently set such limits for themselves.

Cash Management

The fundamental difference between governments and nonprofits is that nonprofits may invest in any instrument, no matter how risky. States limit local governments to investment instruments that have little or no risk of loss of principal. For instance, local units cannot typically invest in equities (stocks). Most nonprofits typically have limited funds to invest and likewise avoid more risky investment options. However, nonprofits with larger reserves can and do invest in stocks, in which case they usually engage the services of an investment adviser.

Debt Management

Governments are legally able to issue tax-exempt bonds. Usually, only large local units issue bonds; smaller units, needing smaller amounts or not having a credit rating, borrow from banks. Nonprofits, of course, may not issue bonds. If they need funds to build or improve facilities, they borrow from banks, as would a private company or individual.

Risk Management

Local governments, regardless of size, have considerable public and employee liability risk exposure. For instance, they all have police, fire, public works, and recreation departments and jails. Moreover, counties, and some cities, have social service departments that provide services with considerable risk exposure, such as foster care and care to the disabled and to senior citizens. Some nonprofits likewise have considerable exposure, especially those that provide human services and services to youth. Other nonprofits have little public liability risk; for them, risk management is of little concern.

Auditing

Most states require that local units, regardless of size, engage a CPA to conduct an independent financial audit of their accounting transactions at the end of the fiscal year. Not subjected to such a mandate, small nonprofits often avoid an audit, by either having a board member examine the books or engaging an auditor to undertake an examination less expensive and less detailed than a full audit.

Thus, governmental and nonprofit financial management are very similar with respect to some functions but very different regarding others. Where the differences are major, such as in accounting, this book discusses nonprofit and governmental practices separately. Where they are the same, or very similar, the book blends the discussion but highlights minor differences in practice.

Chapter 2

Accounting

Accounting is the process of recording, classifying, and summarizing financial transactions. The receipt and disbursement of funds are accounted for and reported to the governing board, internal management, the public, bond-rating agencies, investors, potential investors, other governments, nonprofit agencies, and the media. Accounting has early beginnings. For instance, cities throughout the Byzantine Empire had to account for a fixed portion of their receipts being spent to repair their walls to protect against barbarians. The constitutional history of England is essentially the story of the struggle for authority to raise and spend public funds.

A well-designed and well-managed accounting system ensures proper stewardship over public funds. Accounting policies and procedures must comply with legal requirements to minimize mishandling or misappropriation of funds. In addition to providing financial control, accounting serves management by linking service outcomes to costs. The accounting system is the foundation for all financial management functions, including:

•  Preparing and administering operating and capital budgets

•  Purchasing goods and services

•  Preparing a cash budget and investing idle funds

•  Issuing and administering short- and long-term debt

•  Evaluating and operating the risk management program

•  Preparing the annual financial report

Moreover, timely expenditure and revenue reports are the basis for evaluating performance, structuring service delivery mechanisms, and developing strategic plans.

Regardless of the size of a government or nonprofit, accounting activities should be centralized in a single office. State, local, and nonprofit accounting systems are centralized in various offices, including:

•  State: Office of comptroller or director of accounts

•  Local: Finance director, accountant, or comptroller

•  Nonprofit: Treasurer or finance director

In addition to centralization, accounting departments should have well-trained staff. Despite accounting’s somewhat staid image, accounting standards are continually changing and accounting software and hardware technology are becoming more sophisticated.

ACCOUNTING STANDARDS

The federal government, state and local governments, and nonprofits have different accounting standards set by different standard-setting bodies.

Federal Standards

The Federal Accounting Standards Advisory Board (FASAB), established in 1990, sets federal accounting standards subject to the approval of the Office of Management and Budget, Department of the Treasury, and General Accountability Office. The FASAB initially passed two Statements of Federal Financial Accounting Concepts (SFFACs). SFFAC 1, Outlines of Federal Financial Reporting, established the reporting principles of budgetary integrity, operating performance, stewardship, and systems control. SFFAC 2 established the financial reports that agencies must provide. In 1998, the U.S. Government issued the first audited government-wide financial statements. As of 2005, the FASAB had established 30 accounting standards, which are available at www.fasab.gov.

State and Local Government Standards

The National Committee on Municipal Accounting (NCMA), sponsored by the Municipal Finance Officers Association (later Government Finance Officers Association [GFOA]), first established generally accepted accounting principles (GAAP), published in what is called, for obvious reasons, the Blue Book. In 1968 the GFOA issued the third Blue Book, titled Governmental Accounting, Auditing, and Financial Reporting (GAAFR), since regularly updated. The most recent edition was published in 2005.

In the private sector, auditors established the Committee on Accounting Procedure (CAP), which issued Accounting Research Bulletins (ARBs). Eventually, the Accounting Principles Board (APB), closely tied to the auditing profession, replaced the CAP. Both private and public sector professionals and policymakers eventually agreed that independent standard-setting agencies should be formed. In the 1970s the Financial Accounting Standards Board (FASB) replaced the APB. FASB is a private organization controlled and supported by a nonprofit, the Financial Accounting Foundation (FAF). FASB’s jurisdiction extends to private sector businesses and certain nonprofits.

In 1984 the FAF, which had established FASB, created a sister body to set standards for state and local governments, the Governmental Accounting Standards Board (GASB). GASB, like FASB, has a full-time chair, six other part-time members, and professional staff. To date, GASB has issued 47 standards, found at www.gasb.org under Publications. One of the most significant standards is GASB Statement 34 (Basic Financial Statements—and Management’s Discussion and Analysis—for State and Local Governments), issued in 1999. Statement 34 made seven major changes:

•  The financial statements must have a management’s discussion and analysis explaining the current financial condition.

•  The government-wide financial statements—The Statement of Net Assets and Statement of Activities—must be prepared on the full accrual accounting basis.

•  The fund financial statements must follow major fund reporting, with major funds being reported separately and minor funds aggregated.

•  Capital assets must be depreciated upon acquisition, and accumulated depreciation must be reported on the Statement of Net Assets.

•  Major infrastructure assets acquired after 1980 must be reported and capitalized.

•  The financial statements must report the original and final budget compared to actual results for the general and major special revenue funds.

•  A summary reconciliation, showing the interaction between the government-wide and fund financial statements, must be made.

Nonprofit Standards

In 1993 FASB issued Statement 116 (Accounting for Contributions Received and Contributions Made) and Statement 117 (Financial Statements of Not-for-Profit Organizations), creating a uniform set of accounting principles in four audit guides. Previously, nonprofit accounting had separate principles for (1) colleges and universities, (2) hospitals and health-care entities, (3) voluntary health and welfare organizations, and (4) other nonprofit organizations.

GAAP Hierarchy

The standard-setting bodies establish generally accepted accounting principles (GAAP). There are four levels of GAAP, ranging from level 1 (most important) to level 4 (least important), as shown in Exhibit 2-1.

Exhibit 2-1. Levels of GAAP

GOVERNMENT ACCOUNTING PRINCIPLES

GASB Concepts Statement No. 1, Objectives of Financial Reporting, the cornerstone of government financial reporting, has 13 principles.

Accounting and Reporting

Principle 1 requires accounting systems to comply with both GAAP and finance-related legal and contractual provisions. These may conflict, however. For instance, a government’s budget might be on a cash basis, or the federal government might require accounting records on a non-GAAP basis. GAAP does not require two accounting systems, but it does require additional information to convert non-GAAP accounts to GAAP at year-end.

Fund Accounting

Principles 2–4 deal with fund accounting. A governmental accounting system is organized around the basic accounting concept of a fund, which is a self-balancing set of accounts segregated to carry out specific activities. The use of fund accounting is the biggest single difference between governmental and business accounting. Funds date back to the 1870s, when governments kept myriad pockets (funds) to segregate public monies for particular purposes. Funds are established by legislative action, executive order, or legal requirements. GAAP do not prescribe a set number of funds, stipulating only that governments should establish those funds required by law and needed for sound financial administration. There are 11 funds, grouped into 3 classifications: governmental funds, proprietary funds, and fiduciary funds.

Governmental Funds

Governmental funds account for tax-supported activities. The five governmental funds are the general fund, special revenue funds, debt service funds, capital projects funds, and permanent funds. The general fund is the chief operating fund of a state or local government. GAAP state that the general fund should account for all financial resources not accounted for in other funds. GAAP also require there be only one general fund.

Special revenue funds account for resources restricted for specific purposes, such as:

•  Gas taxes restricted for road maintenance and repair

•  Property taxes restricted for downtown development

•  Property taxes restricted for fire tax districts

•  State tobacco settlement funds restricted for smoking reduction and economic development

Debt service funds pay the principal and interest on general long-term debt. A debt service fund is not required unless it has been legally mandated or financial resources are being accumulated to make principal and interest payments due in future years.

Capital projects funds are also optional unless legally required. They account for major capital acquisition and construction projects, commonly bond-financed. GAAP caution against using the fund to accumulate a capital reserve.

Permanent funds are perpetual care endowments for such purposes as a municipal cemetery, library, or museum. The only beneficiary of permanent fund monies is the government itself; and only their interest earnings, not the principal, may be spent.

Proprietary Funds

Enterprise funds and internal service funds are the two types of proprietary funds. Enterprise funds may be used to report any activity for which a fee is charged