Accounts Receivable Management in Nonprofit Organizations

Abstract

This paper contributes to the discussion about nonprofit organizations’ (NPO) model of financial management in the accounts receivable area. In fact, when it is judged from a technical point of view, the opinion that nonprofit financial management do not differ from a for-profit business could be justified, and is known in nonprofit financial management discussion (Jegers 2011; Hansmann, 1987). But that point of view is only partially right. Sloan et al. and Wedig et al. implemented with modifications a financial management portfolio theory to NPO financial management (Sloan et al., 1988; Wedig 1994, Wedig et al. 1996, Jegers, Verschueren, 2006). In the paper, the model of financial liquidity management in NPOs is presented from the perspective that claims the basic financial aim of an NPO is the most financially effective realization of the mission, resulting in the donors’ support for the organization (Leone, Van Horn, 2005; Eldenburg et al., 2011). It is close in many points to the maximization of for-profit firms’ values, but in fact it has many differences, and non-profit entrepreneurship could attract entrepreneurs more than for-profit organizations (Michalski, 2012; Chapelle, 2010). The net working capital requirements and the elements shaping it, such as the level of cash tied up in accounts receivable, inventories, the early settlement of accounts payable, and operational cash balances, is one of the fields where a difference could be seen. Not many NPOs have to deal with all aspects of liquidity decisions or current assets management. Like for-profit organizations, some of them use only cash from current assets, redistributing it from donors to beneficiaries. Other NPOs collect free-of-charge goods for resale, using this income to realize their mission. Many NPOs are almost identical in operating processes with for-profit businesses, but are nonprofit because of their main mission.

An NPO’s management team’s decision about the accounts receivables policy is a balance between gaining new customers by way of a more liberal organization’s trade credit policy and limiting the risk of allowing for delayed payment from unreliable purchasers. That kind of decision shapes the level and quality of accounts receivables (Michalski, 2012). Paraphrasing Keith Smith and James A. Gentry’s observations, it is possible to observe that Robichek et al. (Gentry, 1988; Robichek et al., 1965; Smith, 1973) talk about the risk involved to accounts receivable decisions which must be accepted by financial institutions’ pledging of accounts receivable of the firm. Keith Smith (Smith, 1973; Gentry, 1988) predicted and Michalski (Michalski, 2008) showed how a portfolio theory may be used to decrease the accounts receivable risk. Current assets, and among them accounts receivables, could be viewed in the portfolio context as presented by Friedland (1966; Gentry, 1988). Pringle and Cohn (1974; Gentry, 1988) tried to adapt the CAPM theory to working capital elements. Bierman and Hausman (1970; Gentry, 1988) discuss the granting policy of an organization and shows that trade credit policy requires balancing the future sales gains against possible losses. Lewellen, Johnson and Edmister (Lewellen, Johnson, 1972; Lewellen, Edmister, 1973) explain how and why traditional devices used for monitoring accounts receivable should be changed by new and better ones. Freitas (Freitas, 1973) shows the relationship between liquidity and risk during accounts receivable management. The question discussed in that paper concerns the making of decisions by NPOs in the accounts receivables area.

Keywords: efficiency of nonprofit decisions, accounts receivable management, incremental analysis, nonprofit organizations

JEL Classification: L31, L32, A13, C25, C31, C51, G31, L30