Strategic Financial Management

This article focuses on how organizations such as nonprofits may create a financial system that allows them to manage their operations and maintain financial stability. The article provides recommendations on how to create and implement policies that will support a strong financial system as well as a process that auditors may use in order to audit the records.

Keywords 501(c) ; Audit; Board of Directors; Dollar Unit Sampling; Financial Statements; Frame; Population; Reserves; Sampling Unit; Statistical Sampling

Finance > Strategic Financial Management

Overview

In order for organization's to be successful, they must create a strategic plan that will position the firm for growth and competitiveness. The senior management team will need to analyze all data, including the financial records, to ensure that the organization can make a profit, remain competitive and be positioned for continued growth.

A social service organization (Making Ends Meet, n.d.) identified four important stages in the financial planning process. These stages are reviewing the past, forecasting the future, setting strategies and plans, and setting annual budgets. Each of these phases is of equal importance and some of the tasks at each phase include:

Reviewing the Past:

• Monitor recent trends in demand and expenditure
• Monitor trends in funding streams
• Monitor and report on actual performance and outcomes, including end-of-year position and performance against specific performance indicators for similar organizations
• Collect comparative information about actual costs and cost drivers
• Review the results and evaluate the recommendations from any external inspection reports and management letters from external auditors (Strategic financial planning, n.d., “Stages of financial planning”).

Forecasting the Future:

• Evaluate the impact of national policies and strategies
• Identify and estimate levels of the various funding streams
• Review the impact of local policy initiatives and priorities
• Determine the future impact of known trends on demand and expenditure
• Identify the financial implications of demographic trends and other "drivers" of demand which are outside the control of the organization (Strategic financial planning, n.d., “Stages of financial planning”).

Setting Strategies & Plans:

• Take into account the corporate context for strategic planning
• Link financial planning with service, human resource and asset management planning
• Collect information on the knowledge and skill base required for effective budget management at all organizational levels
• Engage all key stakeholders in the strategic financial planning (Strategic financial planning, n.d., “Stages of financial planning”).

Set Annual Budgets:

• Come to consensus on what the budget process should be
• Ensure budgets are informed by financial plans
• Involve budget managers in budget setting
• Match commitments and expected changes in demand with resources available
• Respond to unexpected changes
• Review budget structures
• Engage with key stakeholders
• Ensure short term decisions in budget setting do not undermine longer-term priorities and strategies.

As the organization goes through the financial planning process, key decision makers should determine the types of policies that need to be in effect in order to be successful at each of the individual phases.

Application

Financial Policies

The board of directors is very important in the governance of non-profit — 501(c) organizations. Individuals who accept these positions are committed to organizational oversight. Part of this responsibility includes making sure that the organization is fiscally sound. Loyalty, care and obedience are considered to be three basic functions of trustees and these three functions are the benchmark for financial policies created by the board of directors (National Center for Nonprofit Boards, 1996).

What does each of these functions symbolize?

• Loyalty implies that the board members will act in the best interest of the organization and avoid any actions or decisions that will appear to be a conflict of interest with the mission of the organization.
• Care refers to the promise that board members will review, critique, and respond to any reports that are related to the organization, especially as it relates to management, programs and financial matters.
• Obedience ensures that the organization will adhere to all laws and regulations that affect the operation of the organization.

In order to successfully fulfill these obligations, the board of directors should ensure that they are able to:

• Make decisions that are in the best interest of the organization;
• Enforce guidelines that prohibit the use of assets to benefit professional staff or the board members;
• Assist in preventing conflicts of interest;
• Make sure there is a quorum at each meeting so that important decisions can be made; especially at meetings that will allow the organization to operate smoothly (National Center for Nonprofit Boards, 1996, p. 5).

Finances & Daily Activities

One of the most important decisions that a board can make concerns the daily operation of the organization. The board should have a clear understanding of the organization's financial status. Financial decisions and transactions are critical to the daily activities of the organization. Therefore, it is imperative that there are policies in place that will assist the staff members with performing daily activities. In order to achieve financial stability, the board must develop and implement a "system of financial accountability, a financial plan that reflects the organization's mission, a sound investment strategy, and adequate reserves" (National Center for Nonprofit Boards, 1996, p. 6).

Creating a Successful Financial Plan

Once the board has an understanding of the organization's financial position, it can create strategic policies to manage the organization's financial structure. The National Center for Nonprofit Boards (1996) recommended a five step process to creating a successful financial plan for 501(c) organizations.

• Step 1 — Establish the Structure Since the magnitude of work would be too much for a single person, the responsibilities of an effective financial planning and oversight should be divided among all of the board members. The professional staff and other resources should be used as necessary. Although the full board is ultimately held responsible for decision making, there are laws that support delegating the task of financial evaluation and assessment to committees. When establishing the financial structure, the board is responsible for:
• Making sure that the responsibilities for financial oversight are covered through the committee structure;
• Scrutinizing all financial considerations before they come to the floor for board vote; and
• Overseeing everything that the board does.
• Step 2 — Define Responsibilities and Set Limits The designation and clarification of financial responsibilities and limits are necessary so that an organization can avoid confusion and minimize conflict. By adhering to this rule, an organization should be able to successfully complete and submit Form 990 to the Internal Revenue Service. When the board defines responsibilities and sets limits, it should:
• Make clear assignments of financial responsibility;
• Be responsible for carefully reviewing financial reports submitted to governmental agencies, such as the Internal Revenue Service, to ensure that there are no problems; and
• Create guidelines that prohibit expenditures for certain purposes and outline limits in other areas. This information should be detailed in financial policy statements.
• Step 3 — Understand and Use Available Tools Since most board members are not seasoned financial experts, it is important for each board member to have access to the tools that will assist them with understanding the financial ramifications of an organization's actions. As a result, the board should:
• Structure financial policies that compliment and strengthen the strategic plan;
• Use the budget as a tool for setting financial policy;
• Review the organization's revenue sources to determine whether they are sustainable;
• Build and monitor the organization's reserve funds to safeguard against unexpected events;
• Use financial statements to evaluate whether actual expenditures match the goals of the budget and strategic plan; and
• Write a policy specifying acceptable uses for reserve funds; and
• Use the audit to check internal systems, and carefully review the audit before accepting it.
• Step 4 — Use Internal Resources Strategically When creating financial policies, the board should identify and appoint the key players as well as monitor the authority that is given to each person. Three of the key players tend to be the chief executive; the staff finance officer; and the treasurer. Board members are responsible for:
• Appointing and monitoring the chief executive and key staff;
• Ensuring that the staff members receive adequate training to upgrade their skills;
• Regulating the power given to each individual who has financial responsibilities;
• Implementing a policy that requires two signature authorizations for checks that exceed a predetermined amount;
• Regulating the chief executive's capability of accepting gifts or committing to investments without first gaining board authorization;
• Creating a "check and balance" with functions in order to prevent fraudulent activities; and
• Investigating how to get bonding insurance for the treasurer and key staff.
• Step 5 — Effectively Use External Resources The board may need the assistance of external resources, such as consultants, in order to operate efficiently. The board should:
• Choose a bank that is federally insured and not connected to the organization;
• Review insurance policies to determine if the organization provides adequate coverage;
• Develop an investment policy that clearly conveys the board's investment goals and their link to the organization's mission;
• Avoid unnecessary investment risks;
• Ensure that investments are structured to allow for immediate availability of cash; and
• Hire a qualified investment consultant and monitor results on a regular basis.

Viewpoint

Statistical Sampling

The previous section described how 501(c) organizations can set up their financial system in order to monitor key personnel and the processes that they have in place. A five step process was presented, and the third step indicated that there should be an audit to check internal systems. An organization may suggest that an internal or external auditor check their books. Auditors are continually seeking new tools to assist with the auditing function so that they do not have to rely on their judgment. "To meet their clients' needs in environment of heightened competition and runaway inflation, many auditors are turning to scientifically supported methods of planning, executing and evaluating audit procedures to obtain evidential matter. Statistical sampling is one such method" (Akresh & Zuber, 1981, p. 50). There are many ways that an accountant can set up a statistical sampling. Hitzig (2004) provided a model that worked on the premise that one could set up a statistical sampling by defining the population, frame and sampling unit.

• The Population The population is the combination of every account or transaction that the auditor desires to use in order to arrive at the conclusion. The first step in the process is to define the test objective. Once the test objective has been determined, the auditor should define the population. The steps are in this order so that the auditor can draw a sample based on the specific test objective.
• The Frame Once the testing has been completed, the auditor must attribute the results to the items versus the population since auditors tend not to choose a sample straight from the population itself. This representation is referred to as the frame. The frame allows the auditor to establish a foundation for further identification of items that should be incorporated into a sample.

In most cases, the accounting population is presented in a list format (i.e. payroll file, accounts receivable detail). This list (or frame) tends to streamline and simplify the sample selection process. However, the population's sample frame is not required to be a list. Sometimes, the geographical locations that floor plans or other population identifiers can reveal are used as frames. Also, there may be an occasion where the auditor has to create an appropriate frame when one is not available. Regardless of whether or not a list is used, the selection of a frame is usually centered on availability and usefulness. The frames that prove to be the most accessible are computer data files. If these files are used, there is an opportunity to integrate them by applying computer-assisted auditing methods and data retrieval techniques.

There are some circumstances where the auditor has to be on alert to make sure that they do not encounter any problems with their samplings. Hitzig (2004) provided some examples such as:

• Over Specified Frames

In the event that there are frame units that fail to include population membership, the units are not applied to the end result that the auditor might be looking for.

• Underspecified or Incomplete Frames

As the auditor makes plans to collect a sample, he/she must ensure that each item seen in the population is simultaneously included in the frame. If the frame is not completed, then there is a probability of some significant members of the population not being accounted for in the sample. If this type of action were to occur, “there is a violation of AU 350's requirement for representativeness, which requires that every item in the population under examination must have a chance of being selected. If a frame is incomplete, there is an opportunity for biased estimates of the population value that is under examination. This statement is true especially if the auditor is not careful to distinguish between the size of the population and the size of the frame on which the selection of the sample was performed” (Hitzig, 2004, “Overspecified Frames”).

• The Sampling Unit A population is comprised of basic units that are assembled to form the sampling unit. The sampling unit is determined by the auditor's choice of frame. The item that the auditor conducts the examination upon is referred to as the sampling unit, and the sampling unit is vouched or traced. The examination can be conducted by inspection, observation or confirmation.

Auditors tend to make the statistical sampling procedures flexible. If the collection and assessment processes are performed adequately, there is a high probability that there will not be any questions regarding validity due to technical issues. For example, if the total documented amount of the sampling units is equivalent to the total documented amount of the population being scrutinized, then the technical information is validated and accepted. Therefore, it is considered genuine.

How are sampling units selected? Auditors have different preferences. However, listed below are some common trends in the field.

• Accounts. Accounts are the preferred method of sampling unit, especially if dealing with consumer accounts (i.e. credit cards). Using this approach will allow the auditor to precisely confirm the net balance in any designated account. However, there may be problems if an auditor attempts to confirm account balances on commercial accounts. Therefore, commercial accounts tend to be controlled through vouchers payable systems.
• Open invoices. If an organization has a collection of open invoices that are ready to be accessed right away, then open invoices would be the preferred method. Since the open invoices only consist of debits to the accounts receivable, the auditor will need to administer a different test technique for crediting the accounts.

Since many organizations document their purchases in a vouchers payable method, they have found that it is simpler to validate separate invoices versus account balances. This selection of sampling units can also be associated with equal probability (i.e. basic random sampling) or with probability in relation to size (i.e. dollar-unit sampling).

• Invoice line items. Dollar-unit sampling allows an auditor to select a particular invoice line product as the indicated sampling unit. Such an approach is referred to as subsampling (Leslie, Teitlebaum, & Anderson, 1980). In this scenario, “a computer program identifies the invoice and the dollar within the invoice in which the selected line item is located. The auditor is responsible for manually identifying the line item by footing the invoice until the selected item is found. The auditor only has to vouch for that item, and every other selected line item in the sample. In dollar-unit sampling, the auditor projects the results associated with the selected line items by using the total book value of the frame as the representation of the frame size” (Hitzig, 2004, “Invoice line items”).

Conclusion

In order for organization's to be successful, they must create a strategic plan that will position the firm for growth and competitiveness. The senior management team will need to analyze all data, including the financial records, to ensure that the organization can make a profit, remain competitive and be positioned for continued growth. As the organization goes through the process, key decision makers should determine the types of policies that need to be in effect in order to be successful at each of the individual phases.

The board of directors is very important in the governance of non-profit — 501(c) organizations. Individuals who accept these positions are committed to organizational oversight. Part of this responsibility includes making sure that the organization is fiscally sound. Loyalty, care and obedience are considered to be three basic functions of trustees and these three functions are the benchmark for financial policies created by the board of directors (National Center for Nonprofit Boards, 1996).

An organization may suggest that an internal or external auditor check their books. Auditors are continually seeking new tools to assist with the auditing function so that they do not have to rely on their judgment. "To meet their clients' needs in environment of heightened competition and runaway inflation, many auditors are turning to scientifically supported methods of planning, executing and evaluating audit procedures to obtain evidential matter. Statistical sampling is one such method" (Akresh & Zuber, 1981, p. 50). There are many ways that an accountant can set up a statistical sampling.

Terms & Concepts

501(c): The section of the Internal Revenue Code that grants tax exemption to nonprofit institutions such as religious, educational, charitable, and scientific organizations.

Audit: A formal assessment of an organization's accounting records. Audits are traditionally performed by independent public accounting firms.

Board of Directors: Qualified individuals who are chosen by a company’s shareholders to supervise and manage the company.

Dollar Unit Sampling: A method that incorporates a combined-attributes-and-variables method of inferring through the use of statistics. The technique is useful in sampling variables and attributes at the same time, but it is unique due to its establishment of sampling units as separate and solitary dollars instead of physical units like inventory items. The dollar unit sampling methods are usually carried out on the inventory items that contain the dollars chosen.

Financial Statements: Reports prepared at the end of an accounting period that include statements of economic standing, statements of activity, and statements of cash flow status.

Frame: When the auditor attributes the results of a testing to the items versus the population, he or she will come up with a list. This list allows that the auditor have a strong foundation with which to identify items that will then be part of a larger sample.

Population: The assortment of all files and accounts that the auditor wants to use in order to arrive at the conclusion.

Reserves: Resources accumulated above the amount necessary to cover operating expenses.

Sampling Unit: A unit that an aggregate is divided into in order for further sampling to commence. Each individual unit is selected separately, distinctively, and indivisibly.

Statistical Sampling: A technique of choosing a part of a population through calculating the mathematical probabilities involved. Such sampling helps to make more sound and scientific inferences having to do with the traits of the whole population.

Bibliography

Akresh, A., & Zuber, G. (1981). Exploring statistical sampling. Journal of Accountancy, 151, 50-56. Retrieved August 25, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=4585670&site=ehost-live

Bryce, H. (1996). The nonprofit board's role in establishing financial policies. Washington, DC: National Center for Nonprofit Boards.

Hitzig, N. (2004). Elements of sampling: The population, the frame, and the sampling unit. CPA Journal, 74, 30-33. Retrieved August 26, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=15023175&site=ehost-live

Leslie, D., Teitlebaum, A., & Anderson, R. (1980). Dollar unit sampling: A practical guide for auditors. London: Pitman.

Mf Saltaji, I. (2013). Corporate governance relationship with strategic management. Internal Auditing & Risk Management, 8, 293-300. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=90542685&site=ehost-live

Robertson, C., Blevins, D., & Duffy, T. (2013). A five-year review, update, and assessment of ethics and governance in strategic management journal. Journal of Business Ethics, 117, 85-91. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=90521145&site=ehost-live

Strategic financial planning. (n.d.). Making ends meet: A website for managing the money in social services. Retrieved September 3, 2007, from http://www.joint-reviews.gov.uk/money/Financialmgt/1-22.html

Wang, T., & Bansal, P. (2012). Social responsibility in new ventures: profiting from a long-term orientation. Strategic Management Journal, 33, 1135-1153.Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=78388200&site=ehost-live

Suggested Reading

Agundu, P. (2005). Strategic management dynamics: Training imperatives for up-moving accounting and financial professionals in the banking industry. Finance India, 19, 525-533. Retrieved August 26, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=18775463&site=ehost-live

Bromiley, P., & James-Wade, S. (2003). Putting rational blinders behind us: Behavioural understandings of finance and strategic management. Long Range Planning, 36, 37-49. Retrieved August 26, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=9340554&site=ehost-live

Hyperion financial management, strategic finance, reports & analyzer. (2004). DM Review, 14, 75. Retrieved August 25, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=12432153&site=ehost-live