Chapter 30 provides knowledge of financial management in not-for-profit businesses. This chapter presents the following content: For-profit (investor-owned) vs. not-for-profit businesses, goals of the firm.
Chapter 30 Financial Management in NotforProfit Businesses Topics in Chapter Forprofit (investorowned) vs. notfor profit businesses Goals of the firm What are the key features of investorowned firms? Owners (shareholders) are well defined, and they exercise control by voting for the firm’s board of directors Firm’s residual earnings belong to the owners, so management is responsible to the owners for the firm’s profitability Firm is subject to taxation at the federal, state, and local levels What is a notforprofit corporation? One that is organized and operated solely for religious, charitable, scientific, public safety, literary, or educational purposes Generally, qualify for taxexempt status InvestorOwned vs. Notfor Profit Businesses Notforprofit corporations have no shareholders, so all residual earnings are retained within the firm Control of notforprofit firms rests with a board of trustees composed mainly of community leaders who have no economic interests in the firm Goals for InvestorOwned and NotforProfit Businesses Because notforprofit firms have no shareholders, they are not concerned with the goal of maximizing shareholder wealth Goals of notforprofit firms are outlined in the firm’s mission statement. They generally relate to providing some socially valuable service in a financially sound manner Is the WACC relevant to not forprofit businesses? Yes. The WACC estimation for notfor profit firms parallels that for investor owned firms WACC for InvestorOwned and NotforProfit Businesses Because notforprofit firms pay no taxes, there are no tax effects associated with debt financing A notforprofit firm’s cost of equity, or cost of fund capital, is much more controversial than for an investorowned firm What is fund capital? Notforprofit firms raise the equivalent of equity capital, called fund capital, by retaining profits, receiving government grants, and receiving private contributions The firm’s opportunity cost of fund capital should rise as more and more debt is used, and the firm should be subject to the same financial distress and agency costs from using debt as encountered by investorowned firms Implementation Problems with the Tradeoff Theory The major problem is their lack of flexibility in raising equity capital Notforprofit firms do not have access to the typical equity markets. It’s harder for them to raise fund capital It is often necessary for notforprofit firms to delay worthy projects because of insufficient funding, or to use more than the theoretically optimal amount of debt Capital Budgeting for Notfor Profits The financial impact of each capital investment should be fully understood in order to ensure the firm’s longterm financial health Substantial investment in unprofitable projects could lead to bankruptcy and closure, which obviously would eliminate the social value provided by the firm to the community What is social value? Social value are those benefits realized from capital investment in addition to cash flow returns, such as charity care and other community services What are municipal bonds? Bonds issued by state and local governments Municipal bonds are exempt from federal income taxes and state income taxes in the state of issue “Roll overs” NotforProfit Health Care and Municipal Bonds Notforprofit firms cannot issue municipal bonds directly to investors. The bonds are issued through some municipal health facilities authority The authority acts only as a conduit for the issuing corporation Sources of Fund Capital Excess of revenues over expenses Charitable contributions Government grants Impact of Nonaccess to Equity Markets The lack of access to equity capital effectively imposes capital rationing, so the firm may not be able to undertake all projects deemed worthwhile In order to invest in projects considered necessary, the firm may have to take on more than the optimal amount of debt capital ...Topics in Chapter Forprofit (investorowned) vs. notfor profit businesses Goals of the firm What are the key features of investorowned firms? Owners (shareholders) are well defined, ... goal of maximizing shareholder wealth Goals of notforprofit firms are outlined in the firm’s mission statement. They generally relate to providing some socially valuable service in a financially sound manner... Control of notforprofit firms rests with a board of trustees composed mainly of community leaders who have no economic interests in the firm Goals for InvestorOwned and NotforProfit Businesses Because notforprofit firms have no