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Regina Herzlinger Managing the Finances of Nonprofit Organizations We are assaulted daily with news of the financial vulnerability of many of the nation’s nonprofit organizations (NPOs). New York City, the Social Security System,

the mind-boggling health cost inflation, the mounting burdens of state and property taxes, the endless gossip about the precarious financial condition of some of the nation’s most venerable educational and cultural organizations all combine to form a bleak picture of a crumbling sector. And the managers of these organizations enhance this feeling.

“New York City’s problems,” said Mayor Beame, “are caused by inflation, increasing demands for services, unions, and the inequitable flow of tax revenues out of the city.” In other words, “don’t blame me.” And Mayor Beame is hardly alone with this message. Every manager of a financially troubled NPO has said the same

—perhaps in a more elegant or oblique way but with substantially the same message: “It’s not my fault—the organization is unmanageable.” But is it? Do major universities and charitable organizations have to be on the brink of banruptcy? Must hospital costs inflate at 12 percent a year? Did the Commonwealth of Massachusetts have to raise its income tax by 50 percent?

Certainly inflation, unions, and increased demands for services have affected the costs of these organizations, but private-sector organizations also have to contend with these factors and seem to be more successful at it.This is graduate school assignment. Please read article and then write This is graduate school assignment. Please read article and then write One page reading summary.One page reading summary. The heart of the problem is internal and largely controllable. It lies in the neglect of proper procedures for fiscal management, a neglect that is apparent in the behavior of the NPO managers and in the absence of the systems of sound fiscal management. The indifference of the top managers of most NPOs to matters of fiscal management is pervasive; many of them are professionals, untrained and unskilled in this area, preferring to delegate it entirely to their technical subordinates (“the accountants”) or…

ManagingtheFinanceso f
NonprofitOrganizations
Weareassaulteddailywithnewsofthefinancial
vulnerabilityofmanyofthenation’snonprofit
organizations(NPOs).NewYorkCity,theSocial
SecuritySystem,themind-bogglinghealthcost
inflation,themountingburdensofstateand
propertytaxes,theendlessgossipabouttheprecariousfinancialconditionofsomeofthe
nation’smostvenerableeducationalandcultural
organizationsallcombinet oformableakpictureofacrumblingsector.
Andth emanagersoftheseorganizationsenhancethisfeeling.”NewYorkCity’sproblems,”
saidMayorBeame,”arecausedbyinflation,
increasingdemandsforservices,unions,andthe
inequitableflowoftaxrevenuesoutofthe
city.”Inotherwords,”don’ tblameme.”And
MayorBeameishardlyalonewiththismessage.
EverymanagerofafinanciallytroubledNPOhas
saidthesame—perhapsinamoreelegantor
obliquewaybutwithsubstantiallythesame
message:”It’ snotmyfault—theorganizationis
unmanageable.”
Butisit?Domajoruniversitiesandcharitable
organizationshavet obeonthebrinkofbanruptcy?Musthospitalcostsinflateat1 2percent
ayear?DidtheCommonwealthofMassachusettshavet oraiseitsincometaxby50
percent?Certainlyinflation,unions,andincreaseddemandsforserviceshaveaffectedth e
costsoftheseorganizations,butprivate-sector
organizationsalsohavet ocontendwiththese
factorsandseemt obemoresuccessfulatit.
Theheartoftheproblemisinternalandlargely
controllable.Itliesinth eneglectofproper
proceduresforfiscalmanagement,aneglecttha t
isapparentinthebehavioroftheNPOmanagers
andintheabsenceofthesystemsofsoundfiscal
management.TheindifferenceofthetopmanagersofmostNPOst omattersoffiscalmanagementispervasive;manyofthemareprofessionals,untrainedandunskilledinthisarea,preferringt odelegateitentirelyt otheirtechnical
subordinates(“theaccountants”)ort odabblein
itonlyt otheextentoffundraising(“ifwehave
aproblem,I’llgooutandraisefundst omeet
it”) .Onatechnicallevel,organized,articulated,
andintegratedsystemsforplanning,resource
allocation,budgeting,andevaluationareusually
absent.
Manynonprofitorganizationsaredeficientin
oneormoreaspectsofthefiscalmanagement
process,andsomeareevenmoredeficientinth e
fundamentalelementofanyfiscalmanagement
system—asoundsystemofaccrualaccounting
60 CaliforniaManagementReview
whichenablesrevenuest obemeasuredandcollectedandexpensesandsourcesproperly
accountedfor.Lapsesinthisfundamentalarea
aret obefounddailyinheadlinestha tdocument
welfareoverpayments,failuresofcitiestocollectlongoverduerevenues,andsimilardeficiencies.
Thatisnottosaythattheentirenonprofit
sectorsuffersfromthisproblem;indeed,some
ofthemostinnovativetechniquesinfiscal
managementhavesprungoutofthesector programbudgeting,benefit-costanalysis,social
accounting,andzero-basebudgeting.Rather,the
pointi sthatwhileisolatedNPOsmayhavedone
wellinsomeparticularaspectoffiscalmanagement,suchaszero-basebudgeting,fe worganizationshavecomplete,integratedfiscalmanagementproceduresofthekindfoundintheprivatesectororthemanagerialclimatetha tfosters
suchprocedures.Andthisabsenceisattheheart
ofthefinancialpressuresofmostNPOs.

Thepurposeofthisarticleistoexaminevarious
componentsofthefiscalmanagementprocessin
NPOsfromatechnicalandmanagerialperspective;t odiscusshowtheymightbeimproved;
andt opresentseveralexamplesofNPOstha t
havesuccessfullyimplementedsomepartofthe
fiscalmanagementprocess.
FiscalManagementDefined
Theprocessoffiscalmanagementshouldensure
tha tanorganizationwillhavethefinancialresourcest ocarryoutitsplans.Theprocess
shouldconsistoffouradministrativelyintegratedactivities:planning,resourceallocation,

budgeting,andevaluation.Suchaprocessshould
restonth ebaseofaccrualaccountingandstatisticalsystems.
Fiscalmanagement:datasystems.Anaccrual
accountingsystemwhichproperlymatchesrevenuesandexpensesandwhichdelineatesall
activitiessoast oenableintelligentmeasurement
ofperformancei sessentialt oanysortofsound
ReginaHerzUnge ri sAssociateProfessorofBusinessAdministrationintheGraduateSchoolofBusinessAdministrationofHarvardUniversity.Herresearchinterestsare
primarilyi nthemanagementcontrolprocess.Shei sthe
co-authorofManagementControlinNonprofitOrganizations.
fiscalmanagement.AccrualaccountingisrequiredbytheAuditGuidesforallprivate
not-for-profitorganizations,andalthoughgovernmentalorganizationsarenotcurrentlyrequiredt ouseaccrualaccounting,recentstudies
byaccountingfirmsanduniversitieshaverecommendedtheadoptionofaccrualaccountingand
theuseofcommercialstatementsforthelocal,
state,andfederallevelsofgovernment.

DespitetherequirementsoftheAuditGuides,
mostnonprofitorganizationsdonothavea
well-functioningaccrualaccountingsystem.For
example,thefederalgovernmentrecentlyrescindeditsrequirementtha tallagenciesuse
accrualaccountingbecause,aftermorethana
decadeofexperience,onlyoneofthehundreds
ofagencieshadcompliedwithit.Someuse
“modifiedaccrualsystems,”whichi saccrual
accountingwithoutsomething,suchasdepreciation ;someusecashaccountingandaccrueonly
forpurposesofstatementpresentation;some
useonlycashaccounting;andallto omanyhave
noaccountingsystematall.TheGuaranteed
StudentLoanProgram,forexample,isa$7
billionprogramwhichhasreceivedadverseopinionsofitsfinancialstatementsbytheGeneral
AccountingOfficeforanumberofyearsbecauseitdoesnotyethaveasystemforcapturing
valid,reliablevaluationsforrevenues,expenses,
andbalancesheetaccounts.
Anadditionalcomponentofthedatabasefora
goodfiscalmanagementsystemisastatistical
systemtha trecordsdatadescribingthevarious
activitiesandoutputsoftheorganization.The
statisticaldatacanbecombinedwiththeaccrual
accountingdatatoproducecost-accounting
systems.TheNationalLeagueofNursing,for
example,hasasystemtha tarticulatesthefull
costsofdifferentprograms,responsibilitycenters,andservices.TheNationalCenter’sEducationalManagementSystemsprovidesimilardata
formanycollegesanduniversities.
Buttheseorganizationsareexceptions;many
nonprofitorganizationshaveagreatdealof
difficultyinrecordingtheeconomicandother
resultsofoperationsintheaccountingand
statisticalsystems.Becausethesedifficultiesrequireadisproportionateamountoftimeand
effortt oresolve,managerstendt oequatefiscal
managementwithattemptst oestablishagood
SPRING/1979/VOL.XXI/NO.3 61
database.Itisnothingofthesort.Rather,itis
theprocessofusingthedatabaset oensuretha t
theorganizationi sfinanciallyandprogrammaticallyviable.
Thatisnott osaytha tto pmanagersshouldnot
getinvolvedwiththedesignandimplementation
ofsuchsystems.Thefe wsuccessfulattemptst o
installthem—asintheexamplescitedabove havecomeaboutbecauseoftheintenseinvolvementoftheorganizations’to pmanagersintheir
designandinstallation.Butalthoughdatasystemsareanecessaryprerequisite,itistheprocessofusingthesedatawhichdeterminesgood
fiscalmanagement.
Fiscalmanagement:process.Theprocessof
fiscalmanagementinNPOsouglitt oconsistof
anintegratedcycleofplanning,resourceallocation ,budgeting,andevaluating.Technicaland
managerialaspectsofeachoftheseactivitiesand
oftheprocessofintegratingthemwillbe’discussedbelow.
Planning
Theactivityofplanningmustbeamongthetop
teninthebusinesstopicshitparade.Asdepicted
inmuchoftheliterature,itconsistsofaprocess
ofscanningtheenvironment,assessingorganizationalstrengthsandweaknesses,anddeveloping
planswhichtakeadvantageofenvironmental
opportunitiesandorganizationalstrengths.
Muchofthemanagementliteratureandcurriculuminthenon-profitsectorisaddressedt o
“th eplanner”;yet,thiscreatureisstrangely
elusiveandrarelyfoundinanorganizationbut
whenfound,almosttotallydevoidofpowerand
influence.
Inorganizations,theplanningprocessismost
successfullycarriedoutinformally—notbya
planningunit—andattheveryto plevelsofthe
NPO—notbyasupportstaff.Itiserraticand
fuzzyinnature.Manymanagersfeelguilty
becausetheycan’tpickupaheftyvolumecalled
“Th ePlan”orpointt oa”PlanningCommittee.”
However,theabsenceofthesetw omaysignal
goodmanagementifaccompaniedbyanorganizationtha thasaclearsenseofitsidentity ,its
goals,andth elong-runchangesneededt o
accomplishthosegoals.SomeNPOsinvertthe
formandsubstance—thinkingtha tthepresence
ofaplanandaplanningunitarethekeyst oa
successfulplanningeffort.Inpractice,they
drainmanagerialresourceswhichshouldbedevotedt ootheractivities.Forexample,the
DepartmentofHealth,EducationandWelfare
employshundredsofpeopleandmillionsofdollarsintheyearlydevelopmentofafive-year
plan.Butthebudgeting,evaluation,andresourceallocationprocesstakesnoaccountof

theplan.Itisatotallywastedeffort.
Onthetechnicalside,therearetw oaspectst o
thisplanningprocess:oneisthedelineationof
activitieswhichwillenabletheorganizationt o
attainitsobjectives;theother,oftenoverlooked,
isthefiscalcomponent—thedelineationofthe
financalresourcesneededt ocarryouttheplan.
Manynonprofitorganizationsdoanexcellent
jo binth eprogrammaticaspectofplanning.
Theirmanagersgenerallyareprofessionalsor
politicalpeoplewhohaveagoodsenseofthe
environment,areresponsivet otheneedsthey
perceive,andcreativeindevelopingplanst o
meetthoseneeds.However,theplanningprocess
rarelyincludescarefulconsiderationofthefiscal
resourcesneededt oexecutetheplans.Most
NPOsbelongt oth e”Godwillprovide”school
offiscalplanning:i ffinancialresourcesfallshort
ofthosereqiired,mannawillfallfromheaven
becauseofthesocialbenefitsoftheiractivities.
AnumberofprivateNPOsareonthevergeof
bankruptcybecauseoftheabsenceoffiscal
planning.Forexample,inthe1960sanumber
ofprivatecollegesanduniversitiesenteredint o
newprogramst omeettheneedsofthenew
socialandeconomicenvironmentofthetime ;
urbanandblackstudiesandexpandedapplied
sciencesprogramsblossomedforth.Theprivate
fundsrequiredt omeetthecostsoftheseprogramswereeatenawaybyarecessionaryeconomicclimate,federalexpendituresforscientificresearchandurbanprogramswerecutback,
andtheendowmentofmanyoftheinstitution s
collapsedwiththeDow-Jonesaverage.Theclosingofanumberofprivatecollegesandth e
precariousfinancialconditionsofmanyofth e
remainingonescanbetraceddirectlybackt o
theinattentio nt ofiscalplanning.
Avenerablecharitableorganizationprovidesa
poignantexampleofthisproblem.In1968it
adoptedanewstrategycallingfortheelimina-62 CaliforniaManagementReview
tionofracism.Thelocalbranchesofthecharity
weresweptupwiththisimportan tandlaudable
goalandgreatlyincreasedtheirparticipationin
programsforvariousminoritygroups.Theprogrammaticresultsaredramaticandnoteworthy.
Thefiscalresults,however,areequallydramatic:
manyofthelocalorganizationshavevirtually
depletedtheirendowmentcapitalt ofinancethe
program.Thehiddencostoftheirnewstrategy
hasbeentheeliminationoftheirabilityt ofund
othercharitableactivities.
Inthepublicsector,evenprogrammaticplanningfrequentlydoesn’tgetdone.Forexample,
in1971theCommonwealthofMassachusetts
decidedthatthereformschoolsfordelinquent
youthshadadetrimentaleffectandembarked
onapolicyof”deinstitutionalization,”which
wast oremovetheyouthsfromthelargeschools
andplacetheminsmall,decentralizedcommunityfacilities.Thereformschoolswereclosed
withinathree-monthperiod.Unfortunately,no
seriouseffortwasmadet ocreatecommunity
facilitiesinsufficientnumber.Thedirectorof
theprogramattha ttimeclaimedhadhehad
takenthetimet oplananddevelopsuchfacilities,theentirepohcywouldhavebeenjeopardized;butonecanquestionthevalueofthe
policyintheabsenceofsuchplans.Mostofthe
youthswentrightbackt othedestructiveenvironmentfromwhichtheyhadoriginallycome.
Giventhehelter-skelternatureofprogrammatic
planning,fiscalplanningcannotbedoneatmost
governmentalunits.TheresultsinNewYork
Cityandothernearlybankruptgovernmental
organizationsstandoutasremindersofthisfact.
Thesolutionst othisprobleminplanningaren’t
easy.Theyrequireachangeinmanagerialattitudesandinorganizationalstructures.Managers
ofpublicorganizationsaregenerallyelectedt o
officeandlimitedt oholdingtheofficefora
shorttime.Theirintereststhereforeareshortrun:theywanttoseeresultsduringtheirown
ownadministrationsandaren’tterriblyconcernedwithtli elong-runconsequencesoftheir
plans.NewYorkCity’sproblemsaren’tthe
resultofthecurrentadministration’splans they’rerootedintheplansoflong-goneadministrators.Achangeinattitudewouldbehelpful
butisimprobable.Therearefe wchecksagainst
thisshort-runorientation.Thepublicandpress
bemoanproblemsratherthananticipatingthem
andthelegislatureisusuallyto ofragmentedin
itscommitteestructuret obeablet ocheck
againsttheexecutivebranchtendenciest oig norelong-runconsequences.
Onesuchorganizationalchangewhichseemst o
workhasbeenthecreationofanofficefor
mappingouttheselong-runconsiderations.The
UnitedStatesCongress,forexample,createdthe
CongressionalBudgetOfficein1974inordert o
obtainanexpert,integratedperspectiveonthe
long-runfinancialconsequencesoftheplans’
presentedbytheExecutiveBranchandbycongressionalcommittees.Thisworthyideahas
beenemulatedbyanumberofstateandlocal
legislativebodies.TheBostonSchoolCommittee,asanotherexample,createdaPlanningand
BudgetOfficein1976whichinitsfirstyearof
existencesavednearly$6rrtillion.Priort othe
creationoftheBudgetOffice,theSchoolCommittee,whichconsistsoffiv eelectedunpaid
members,hadnoresourceswithwhicht oanalyzethelong-runfiscalimplicationsoftheir
plans.Itshouldbestressedtha tthefunctionof
theseunitsi snott odevelopplans,butrathert o
delineatethefinancialconsequencesofto p
management’spolicies.
InprivateNPOstheboardoftrustees,which
usuallyconsistsofbusinesspeople,shouldperformasimilarfunctionandinsisttha tthe
directorsdelineatethelong-runfiscalconsequencesoftheirplans.Butthisisn’tdone,
perhapsforfearofcompromisingthemissionor
reputationoftheorganization.Forexample,the
BoardofTrusteesofTheMetropolitanMuseum
ofArt,whichincludedmanyprominentbusiness
people,hiredanewexecutivedirectort otake
themuseumintonew,venturesomeprograms.
Hisinnovativeplansforspecialexhibits,communityvans,andnewbuildingswereallenthusiasticallyapprovedbytheboarddespitetheabsence
ofanyseriousconsiderationofdollarfiguresin
theplans.Thislapseinjudgmen tbypeoplewho
wereusedt obeinghard-nosedintheirown
spherewentonforyears,duringwhichsizable
deficitsoccurred.
Eightyearsofdeficitslater,themuseum’sBoard
ofTrusteesdecidedt ouseitssubstantialbaseof
financialexperiencet oassistthedirectorin
mappingoutthefinancialconsequencesofhis
SPRING/1979/VOL.XXI/NO.3 63
plans.Afinancesubcommitteewasformedespeciallyforthispurpose.Haditbeenformedeight
yearsearlier,themuseumwouldhavebeenina
sounderposition—bothfinanciallyandprogrammatically—andthedirectorwouldhavehadthe
organizationalresourcesherequired.
ResourceAllocation
Theprocessofresourceallocationconsistsof
evaluatingalternativemethodsofachievingthe
goalsandobjectivesintheplan.Intheprivate’
sector,theprocessconsistsofthreesteps:
gatheringideasforalternativeprograms;evaluatingthecontributionsoftheprogramst othe
firm’sprobabilityonthebasisoftechnical
criteriasuchasthereturnoninvestedcapitalor
discountedcashflow;andsecuringfinancingfor
thoseprojectswhosereturnsaregreaterthan
theircostsofcapital.Inthenonprofitsector,
thereareseriouslimitationsinallthreesteps.
Delineatingalternatives.Manytopexecutivesin
NPOsdonothavetheopportunityt oreviewa
numberofalternativeapproachest oexecutinga
planorsolvingaproblem.GeorgeReedy’saccountofth elateryearsofLyndonJohnson’s
presidencyisillustrativeofthisproblem.Johnsonbecameincreasinglyisolatedbyhiswellintentionedaidesand,ashisalternativesources
forinformationdriedup ,heincreasinglycame
t obepresentedwithresourceallocationdecisionswhichcontainedtw oalternatives—the
statusquoandthegivenprogram.
Theisolationofthechiefexecutiveofficerfrom
thecompleterangeofalternativesisnotunique
t oNPOs;iti sapervasiveprobleminmostlarge
organizations.Itis,however,aparticularly
perniciousproblemi nNPOsbecause,asdescribedbelow,theothertwopartsoftheprogrammingprocessaresomuchmoredifficultt o
executeinNPOsthanintheirprivatesector
counterparts.
Thekeyt osolvingthisprobleminNPOsisfor
chiefexecutiveofficers(CEOs)tostructurea
systemwhichensurestha tseriousalternative
methodsforcarryingoutanobjectiveare
broughtt otheirattentionandintelligentlypresentedfortheirconsideration.TheFranklin
DelanoRooseveltpresidencyisinstructivein
thisregard.Rooseveltlistenedt oeverybody,
seeminglyagreedt oeveryproposal,andthereby
ensuredthathehadavastandcommittedarmy
ofpeoplewhowouldproposealternatives,believingFDRt osympathizewithandagreet o
theirproposals.
Formalizedunitsforprogrammingoranalysis
willnotmeettheneedsoftheCEOforalternativeproposals.Frequently,theybecomeadvocatesratherthananalysts,andcuttheexecutive
offfrominformationandideas.Iti simportan t
fortheCEOsthemselvest odevelopalternative
sourcesofideasandinformation,andonlythen
t ousetheformalsystemforanalysisofideas
alreadypresented.
Evaluatingalternatives.Thesecondpartofthe
processinfor-profitfirms,evaluatingcontributionst oprofitability,isnotusefulforNPOs.In
them,thistechnicalaspectiscomplicatedbythe
absenceofaclearguidelinesuchasprofitfor
evaluatingandrankingalternativeproposals.
Benefit-costanalysis,whichsubstitutessocial
benefitsforprofits,wasdevelopedinthe1960s
asamethodforfacilitatingcapitalbudgeting
andenabhngNPOst orankalternatives.
Atthepresenttime ,veryfewNPOsdoanysort
ofbenefit-costanalysis.Itisextremelydifficult
t oquantifysocialbenefits,andtheconnection
betweencostsandbenefitsformostsocialactivitiesisextremelytenuous .Forexample,despite

yearlyexpendituresinthebillionsonsocial
services,nostudyhaseversystematically
demonstratedtha tsocialservicesprovidesocial
benefits.Further,benefit-costanalysis,unlike
privatesectorcapitalbudgeting,issuitable
mostlyforintraprogramrankingsratherthanfor
interprogrammaticresourceallocations.Soithas
fallenintodisuseinmostNPOs,exceptforthe
CorpsofEngineersandsimilarorganizations
which,becausetheyproduceaproductrather
thanaservice,canmoreeasilymeasurethe
benefit-costrelationshipsintheirprograms.
Inthelate1960sandearly1970sitwasfashionableforNPOst oclaimtha ttheywereusing
benefit-costanalyses,andmanyhavebeencarriedout.However,afterexaminingseveralhundredsuchanalysesitisnotcleartha ttheywere
everusedforanyseriouspurposeanditis
impossiblet otrackanydecisionbackt oa
benefit-costanalysis,becausemanyoftheanalyseswereweakandnosensiblemanager
couldhavebasedanysortofdecisiononthem.
64
CaliforniaManagementReview
Basedontenuou sassumptions,filledwithfuzzy
claimsofbenefitsandpoorestimatesofcosts,
theseanalyseswereofsuchpoortechnicalqualitythattheycouldn’tbeusedfordecision
making.Also,manywerepoliticalinstruments
whichanalyzedonlytw ooptions,thegiven
alternativeversusthestatusquo,ratherthan
analyzinganumberofalternativeapproachest o
accomplishingtheprogram’sobjectives.Their
purposeseemstohavebeent ojustify—nott o
analyze—thealternativepresented.
Thisi snottosaythatbenefit-costanalysisi s
undesirable.Iti snecessaryinNPOstohave
systematicanalysesofresourceallocationalternatives.However,theanalysesshouldbegenuinelyanalyticintheirintent(ratherthanpolitical)andthetechnicallimitationsontheseanalysesshouldbeclearlyarticulated.
Sometimesanorganizationalchangecaneffectivelysubstitutefortheneedtomakesuch
analyses.Acasei npointi stheCorporationfor
PublicBroadcasting(CPB),whichi ntheearly
1970swasunderattackbytheNixonadministrationforfundinganexcessivenumberof
liberalprogramsonpublictelevision.Ineffect,
theCPBwasaccusedofdoingabadjo bof
benefit-costanalysis,buthaditchangedits
fundingphilosophytoamoreconservativemix
ofprograms,anewandequallyvociferousgroup
ofcriticswouldcertainlyhaveemerged.
Insteadoftryingtoimproveitsresourceallocationrules,theCPBchangeditsorganizational
structureand,ratherthanfundingprograms
directly,begant ofundpublictelevisionstations,
whichinturnmadeindividualdecisionst obuy
programs.Themechanismforaccomplishingthis
resource-allocationprocesswascalledtheStation-Program-Cooperative.Itisasyntheticmarketplace,i nwhichindividualstationsbidfor
programsotTeredbyindividualproducers.The
delegationofdecision-

makingnotonlyeffectivelysilencedallcriticsbutalsole dt oefficienciesi nprogramproductionsbecausethe
stations,whosefundsaremorelimitedthan
CPB’s,wouldn’tbuyprogramstheyconsidered
extravagant.
Financingalternatives.Thethirdpartofthe
programmingprocessinfor-profitorganizations
consistsofinvestmentsinthoseprojectswhose
returnsoutweightheircosts.Thesourcesof
financingdonotimpingeonthedecisionof
whetheranalternativei sattractive.InNPOs,on
theotherhand,thesourceoffundingplaysa
verylargeroleindeterminingwhetherornotan
alternativei sattractivebecausemostfundsare
categoricallygivenandavailableonlyforcertain
kindsofactivities.Categoricalfundingleadsto
serioussuboptimization.Managersdon’task,
“Whati sthebestthingtodo? “Insteadtheyask,
“Whati smoneyavailablefor? “andtheactivities
forwhichfundsareavailablearenotnecessarily
thosethatoughttobecarriedout.
Acasei npointi sthecontroversialproposalto
builda$1.2billionhighwayonthewestsideof
NewYorkCityatacostofalmost$300million
amile.Theproposali sbreathtakingi nscope.It
wouldcreateanadditional200acresi nthecity,
addparksandindustrialfacilities,andrequire
15,000man-yearofconstructionwork.Yet
despiteitsmanybenefits,therei snoevidence
thatthisproposali sthebestwayt ospend$1.2
billion.Rather,theproposalhascomeupbecausethecitydesperatelyneedsmoneyandthe
FederalHighwayTrustFundhasmoney availableona90percentfederalfundingbasis —
butonlyforbuildinghighways.
Thecategoricalnatureoffundingi snotrestrictedtopublicfunds;manysourcesofprivate
NPOsfunding,suchasfoundationsandbusinesses,willconsidergivingfundsonlyforprogramstheyconsiderimportan tbutnotforthose
theNPOsconsiderimportant .TherevenuesharingattemptsoftheNixonadministrationare
alaudablefirststepinattemptingtocorrectthis
problem.Similarprogramsbyfoundationsand
businesseswouldalsopresentaboonforthe
resourceallocationprocessforprivateNPOs.
Regardlessoftheseexternalchanges,itisimportantformanagerst orealizethattheirfunctioni s
not”t obringinthemoney”butrathertosecure
financingforonlythoseprojectstheyfee lare
worthwhileandconsistentwiththeirobjectives.
Budgeting
Budgetingi sthesinglemostimportan tpartof
thefiscalmanagementprocess,themosttangible
partoftheprocess,andtheonemostlikelyto
bechanged.Ithasalwaysattractedagreatdeal
ofattention—withwavesofbudgetaryfads
washingovereachother:programbudgetingand
SPRING/1979/VOL.XXI/NO.3 65
performancebudgetingandtheirnumerousantecedentsarenowbeingwashedawaybythe
delugeofzero-basebudgeting(ZBB).
Althoughthesefadsdifferfromeachother
technically,thereisnoreasont obelievethat
ZBBwillsucceedwhereotherbudgetingsystems
havefailed.TheproblemsofbudgetinginNPOs
arenotprimarilythoseoftechniquebutthose
ofmanagement.
Managerialaspectsofbudgeting.Theproblems
arethreefold.First,thebudgeti sperformedina
managerialvacuumwithfe wplanningorevaluationguidelines.Second,therearenoclear
organizationalstructuresformanagingtheprocess,andthird,thereisaschizophrenicmanagerialattitudetowardthebudgetingprocess.
Thesecondandthirdproblemsspringfromthe
samesource:theconfusiontha tmostmanagers
ofNPOshaveinviewingthemselvesasmanagers.
Mostofthemareeitherprofessionalswhohave
theethicofegalitarianismandrespectforone’s
peersorpoliticalfigureswhogravitatetoward
majorityrule.Ineithercase,theirinstinctive
responsetothebudgetingprocessi st ohandleit
inaparticipatoryandconsultativemanner.But
budgetinginvolvestradingoffandlimitingactivities.Majorityruleandpeerreviewareineffectualforthisprocess.YetmanyCEOsaremost
reluctantt oabandontheirprofessionalroleand
t oassumethemantleofleadershipandsolitary
decisionmakingtha tthebudgetingprocess
requires.
Thisreluctanceresultsinafuzzyprocessfor
budgetingandaconfusingclimatewherethe
CEOattemptstheimpossibletaskofbeing
simultaneouslyaleaderandacolleague.
Technicalaspectsofbudgeting.Inaddition,the
budgetingprocessinNPOssuffersfromanumberoftechnicalproblems,themostglaringof
whichisthetendency ,despitethedelugeof
budgetaryadvice,t opulloutlastyear’sbudget:
add5percenthere,8percentthere,addupthe
total ,andlabelitnextyear’sbudget.Thisform
ofbudgetingiscalled”incremental”budgeting.
Andalthoughitisthemostfrequentlypracticed
methodofbudgeting,itisviewedwithdisdain
byprofessionalbudgeteers.
Doesitdeserveit?Onereasonforthedisdainis
thatincrementalbudgetingisfrequentlyperformedonaso-called”line-item”budget,which
66
merelyliststhedifferentclassesofexpensesand
whichdoesn’tinformthemanageraboutthe
functionandoutcomesoftheexpenses.For
example,thetwenty-eight-pageline-itembudget
forthe$170millionUniversityofMassachusetts
hasexquisitedetailonplannedexpendituresfor
clothing,bytypeofuniform,buthasonlyone
lineitemforpermanentsalaries,inth eamount
of$140million.
Itisworthwhilet odevoteasubstantialamount
oftimet osettingupaprogramstructurethat
eithercollectsthecostsandbudgetdataforthe
organization’sprogramsorcollectsthesedata
forparticularorganizationalunits.Programand
organizationalunitsdonotnecessarilycoincide,
andinsomecasesitisusefult ocollectthese
dataforbothentities.Theprogramdataare
usedt oevaluateplans,whiletheresponsibility
centerdataareusedtoholdorganizationalunits
responsibleforcarryingouttheirduties.The
HarvardBusinessSchoolusessuchasystemfor
itsbudgetingprocess.TheMBA,Doctoral,ExecutiveEducation,andResearchProgrambudgets
areusedforplanningandanalyticpurposes,
whilethebudgetsforthe”areas, “thebuilding
blocksfortheorganizationoftheschool,are
usedtoholdthemanagersresponsibleforproper
useoftheschool’sresources.
But”incremental”budgeting,evenifitisperformedonaprogrambudget,merelycontinues
pastactivitiesandthu smaymerelyperpetuate
pastmistakesormediocreperformances.This
year’spreferredalternativeiszero-basebudgetingwhichadvocatesthorouglianalysisofthe
budgetfromthegroundup.
TheonlylargeNPOwhichhashadanyexperiencewithZBBistheStateofGeorgiaunderthe
leadershipofthenGovernorCarter.Asurveyof
itslinemanagersfoundthemlessthanenchantedwiththeprocess—claimingthatthe
costsweregreaterthanthebenefits.Onthe
otherhand,thebudgetofthestateunderwent
substantialtransformationduringtheperiod
thatZBBwasineffect—notinmagnitudebutin
distribution.AndthenewgovernorofGeorgia
hascontinuedt ouseamodifiedversionofthe
process,whilethenewPresidentoftheUnited
Stateshasinstalleditinallfederalagencies.
Theexperienceofthefederalgovernmentwith
onecycleofZBBhasbeenpoor.Therewasvery
littletimeforpreparationandtrainingofmanaCaliforniaManagementReview
gersinhowt odoazero-baseanalysisandeven
lesstimet ostudythevoluminoussubmissions
whichresultedfromtheprocess(thePublic
HealthServicealonehadover400decision
packagest obeanalyzed).Manymanagersfelt
notonlytha ttheirworkwasfornaughtbutalso
thattheprocessactuallydiminishedthecaliber
oftheirbudget.”I tdrivesoutanalysisand
substitutespaperwork,”saidonehigh-level
official.
Thus,ZBBseemst obeaneffectivecommunicationvehiclewhichenablesnewCEOstoensure
tha tresourcesarebeingallocatedinaccordance
withtheirpriorities.However,iti sto oonerous
anddetailedfornormalbudgetingpurposesand
forCEOswhoarewellacquaintedwiththe
programsintheirorganizations.Forthem,itcan
beusefulasaresourceallocationdevicethrough
whichprogramstha thavebeenidentifiedas
needingparticularlycloseattentioncanbecarefullyandsystematicallyanalyzed.Ithasbeen
used,withapparentsuccess,intheprivatesector,forjustsuchpurposes—withparticularly
greatrewardsaccruingt oZBBoftraditionally
difficult-to-budgetprograms—suchasadministrativeactivities.
Theremainingactivitiescanbebudgetedforon
anincrementalfashion,orasisdoneinthe
ProvinceofOntarioinCanadacanbebudgeted
throughtheuseofthefollowingformat:
Last-Year’s
Budget
ChangesCausedby
Changei n
Quantity QualityInflation
ThisYear’s
Budget
Changesi nexistingprogramswhicharenot
causedbythesethreereasonsarechangesthat
can’tbejustified.Thisformatisalsoveryuseful
forcontrolpurposes.

Forexample,whenthe
TranslationServicesintheProvincefoundthe
quantityofwordst obetranslatedfarlower
thanthatbudgeted,thisformat,whichclearly
highlightedtherelationshipbetweenvolumeand
cost,enabledarapidandinformedbudgetcutt o
bemadeinresponset othedecreasedvolume.
Twomoreaspectsofthebudgetingprocess
shouldbenoted.First,itisimportan tt ostart
theprocesswithanestimateofrevenuesand
thent omatchexpensest otherevenues.Most
organizationsreversethisprocess:budgeting
expensesfirstandthenmatchingrevenues,wishfully,t oexpenses.Inprivateandnon-federal
serviceorganizations,thecalculationsofservice
revenuesandexpensesareinterdependen tand
careshouldbetakent oensurethatallallowable
avenuesformaximizingreimbursementareexplored.Forhospitals,whicharefrequentlyreimbursedona”costorcharges,whicheveris
lower”basisandwhosefullcostsarecalculated
viaacomplexdouble-distribution-of-overhead
procedure(thefamousorinfamous”step-down”
methodology),itisparticularlyimportan tt o
devoteasubstantialamountofeffortt obudgetingrevenues.Manyfinancialadvisoryservices
providesimulationpackageswhichareinvaluableforthispurpose.SomeNPOsviewthis
processassomewhat”immoral.”Itisnomore
“immoral “thanknowingthetaxcodewell
enoughtoavailoneselfofeverylegitimatededuction.
Inadditiont ofe erevenues,allothersourcesof
revenuesshouldbeexploredandbudgetedfor.
Amongthesearerevenuesfromendowments(in
thoseorganizationswhichhavesuchsourcesof
capital);giftsforoperations;grantsforvarious
programs;andpricesforancillaryactivities.The
latterhasprovedt obeanunexpectedbonanza
inmanyNPOs.Inarecentconferencefor
museumdirectors,forexample,thebulkofthe
timewasspentdiscussingrestaurantandgift
shopmanagementandmarketingofreproductionsofthemuseums’collections.Forendowed
institutions ,theprosandconsofa”totalreturn “approacht odeclaringrevenuesfromthe
endowmentshouldbecarefullyconsidered.
Itisimportan tthatthelifetimeoftherevenues
bematchedwiththelifetimeoftheexpenses.
Notdoingsomayleadt othelarge-scaledismissalofpersonnelfinancedwithshort-term
funds.Manyinstitutionsofhighereducationare
nowsufferingfromthisproblemintheformof
tenuredfacultywhosetenurewasfinanced-b y
long-gonegrantsandcontracts.Themostpermanentformoflong-termcapitali sendowment
capitalanditisworthwhilet oallocateagreat
dealofeffortt ofindingsuchcapital—rather
thangrantsorgifts.
Inaddition,thebudgetshouldalsoincludethe
positivedifferencebetweenrevenuesandexpenseswhichanNPOrequiresinordert ocontinueitsoperations.Thisdifferenceisnota
profitbecauseiti snotintendedasareturnt o
theownersoftheorganization.Rather,iti san
SPRING/1979/VOL.XXI/NO.3 67
allowanceforcontingenciesandforadditional
costsofreplacingcurrentfixedassets—acost
which,underhistoricalcostaccounting,i susuallyunderstated.TheVermont-NewHampshire
BlueCrossandBlueShield,nonprofithealth
insurancefirms,werealmostdriventobankruptcybecauseofthereluctanceoftheirstates’
RateSettingCommissiontorecognizetheircontingencyandreplacement-of-capitalallowances
asbeingdifferentfromprofit.
Evaluation
Thelastpartofthefiscalmanagementprocessis
theonetha tcontrolstheorganizationbyevaluatingactualresultsrelativetothosebudgeted.
Thisstepcompletesthefiscalmanagementcycle
bymeasuringtheextenttowhichtheplans(as
articulatedbythebudgetandotherdocuments)
areactuallybeingcarriedout.
UntilrecentlytheCityofNewYork,a$9
billionenterprise,wasunabletocarryoutthis
step.UntiltheinstallationofitsIntegrated
FinancialManagementSystems,itlackedthe
informationsystemwhichwouldenableitt o
compareactualt obudgetedactivities.Theabilitytomatchexpensesagainstbudgeti stheonly
foiTna lwaytomeasurewhetherthefinancial
plansarebeingcarriedout.And,i fiti snot
done,thereisnowayt oknowtheextentto
whichthebudgeti sbeingproperlyexecuted.
Designingsuchanaccountingsystemessentially
involvesgoingbackt othechartofaccountsand
developingaprogrammaticaccountingsystem
whichusesthebasicrevenueandexpenseaccounts.Sometimes,newrevenuesandexpense
accountsmustbesetup.Manyorganizations
findthisprocesscomplicatedbythefactthat
theymusthaveyetanothersystemforreimbursementpurposes.Revampingtheaccountingsystemforinternalmanagerialpurposesi sa
difficultandexpensivejob ,butonewellworth
theeffort.

Inaddition,itisusefultosetupsystemswhich
measuretheextentt owhichplannedresults
wereachievedandwhich,totheextentpossible,
measurethequalityofthoseresults.Thetechnicalabilityt oproducemeaningfuloutputdata
ofthissorti slimited,particularlywhencomparedwiththeabilityt omeasureinputsviathe
accrualaccountingprocess.Nevertheless,iti s
importan tthati nlargeorganizationssystematic
effortst omeasureoutputbemade.
Iti salsodesirabletha tsubunitswithinthe
organizationbeheldformallyaccountablefor
certainmeasuresofperformance.WNET,New
YorkCity’spublictelevisionstation,solvedits
productionproblemsbyadoptingthismethod
ofresponsibilitycentering.Ithadhadlargeand
embarrassingoverrunsi nthecostsofproducing
“TheAdamsChronciles”programsbecausethe
productionmanagerworkeddirectlyforthe
station’svicepresidentforproductionandwhile
hewas,i ntheory ,heldresponsibleforcosts,in
practicehewasmuchmoreconcernedwith
quality.Sincehewasaccountablet othevice
presidentforproduction(alsoheldresponsible
primarilyforprogrammingquality),hehadno
incentivet oworryaboutcostcontainment.The
problemwassolvedbycreatinganewtypeof
position,aproductioncoordinator,jointlyresponsiblet othevicepresidentsforfinanceand
production.Thiscoordinatoractsasanintegratorbetweenthedemandsoffinanceforcost
reviewanddemandsofproductionforhigh
qualityandi sheldresponsibleforbothaspects.
And,becauseofthisnewtypeofresponsibility
center,thestationnowcontinuestoproduce
highqualityprogramsbutitdoessowithout
incurringbudgetoverruns.
Somenonprofitorganizationsholdtheirmanagersresponsibleonlyformeetingbudgeting
expenses.Anotherformofresponsibilitycenter
i sonewherethemanagerisheldresponsiblefor
revenueaswellasexpenses—aprofitcenter.A
numberofNPOshavefruitfullyusedtheprofit
centerconcept.Alargeteachinghospital,for
example,convertedthechnicsofitslargeoutpatientdepartmentint ogrouppracticeswhich
areheldresponsibleforprofitsandwhoseprovidersandmanagersreceive,inadditiont otheir
salaries,abonuswhichisbasedontheirproductivity.Thegrouppracticeshavenotraisedthe
feesinthefouryearssincethey’vebeenformed
andhavemaintained,andevenenhanced,the
hospital’smedicalreputation.Yettheproviders
havesubstantiallyincreasedtheirincomes.The
profitcentermotivatedthemt obecomenot
onlymoreproductivebutalsomuchmoreaware
ofsupportingexpenses—whichhavebeendramaticallyreducedoverthefour-yearperiod.
GeorgetownUniversity,whoseschoolsare
organizedasprofitcenters,separatelyrespon-68 CaliforniaManagementReview
sibleformeetingtheirexpenseswithrevenues,
providesanotherexampleoftheuseofprofit
centers.Thisi snocross-subsidizationamong
schools.Forexample,i ftheCollegeofArtsand
Sciencesfindsitselfinadeficitposition,it
cannotrelyonthewealthierprofessionalschools
ofLaw,Medicine,orBusinesstobailitout.This
systemofprofitcentershasenabledtheuniversityt omaintainitselfasafineacademic
institutionwithanunusuallystrongfinancial
position.
Somenonprofitorganizationshaveevengoneso
farast oinstituteaseriesofrulesfortransfer
pricingtheinternalsaleandpurchaseofservices.
TheDepartmentofDefensehasaseriesofprofit
centersforinternalunitslikethemotorpool
whoseservicesarepurchasedbyotherdepartments.TheEDPunitinmostlargeNPOsi srun
asaprofitcenterwhoseservicesaresold.And
theProvincialGovernmentofOntario,aftera
comprehensivestudyoftheissue,instituteda
seriesofprofitcentersforthegovernmentwhich
use,totlieextentpossible,market-basedprices
tovaluethetransferofservicesamongtheprofit
centers.
Theuseofmarket-basedtransferpricescan
haveverybeneficialresults.Alargehospital,
forexample,usedatransferpriceof$10per
squarefoottochargeitsgrouppracticesforthe
costofthespacetheywereusing.Thiswasthe
marketpricefornew,well-maintainedspaceata
nearbyphysicians’officebuilding.Thecostof
thedepartmentsprovidingthespace,however,
was$15asquarefoot—50percentover
marketvalue.Thecontinueduseofthetransfer
pricingmechanismnotonlyidentifiedtheinefficiencyofthesedepartments—afactthathad
beenpreviouslydisguisedi nthehospital’s
jumbleofcostdata—butalsoprovidedanincentiveforthesedepartmentst oreorganizethemselvest obecomemoreefficientproducers.
Eveni ncaseswheremarketpricesarenot
available,becausecomparableservicesaren’t
availablei ntheoutsideworld,theuseoftransfer
pricesi sdesirable.Intheabsenceofmarket
data,theycanbebasedonstandardcostsor
negotiatedbetweenthebuyerandtheseller.The
existenceandconsequentarticulationofcostsof
serviceswhichthebuyerhadpreviouslythought
tobefreecan’thelpbutleadt omoreeffective
fiscalmanagement.
Integration
SomeNPOshaveanumberofthepiecesofthe
fiscalmanagementpuzzlesolvedbutarestill
missingthebenefitsoftheprocessbecausethey
haven’tintegratedthepieces.TheDepartment
ofHEWprovidesagoodexample;itdevelopsa
plan,hasaresourceallocationprocess,goes
throughawell-delineatedbudgetingcycle,and
hasanelaborateevaluationsystemwhichuses1
percentofthebudgetofanyprogramforevaluationpurposes.YetHEWi sthemostwidely
criticizedgovernmentagencyforthepoorqualityofitsfiscalmanagement.Why?Becauseit
hasneverintegratedthesefourpartsofthe
cycle.Allofthemoperateseparatelyandtono
purpose.
Thelackofintegrationi sreinforcedinpartby
HEW’sorganizationalstaicture.Eachpartofthe
fiscalmanagementprocessi sundertheaegisofa
differentAssistantSecretary,nooneofwhomi s
terriblyeagert ocooperatewiththeother.Iti s
alsocausedbythefacttha ti nthepasttenyears,
HEWSecretarieshavecomeexclusivelyfromthe
pubhcsectorand,despitetheirexcellencei n
programmaticandideologicalissues,notoneof
themliashadtheexperienceofparticipatingina
well-functioningfiscalmanagementprocess.
TheycopedwithHEW’sproblemsbyinstalling
theirownsmallsystemst omonitortheirpet
projectsratlierthanbyattemptingtoinstitutionalizemajorreformsi nallofHEW’sfiscal
managementprocess.
SomeNPOshaverecognizedthisproblemand
haveattemptedtochangetheirorganization’s
entirefiscalmanagementprocess.Oneofthe
necessaryprerequisitestothischangei st o
centralizeresponsibilityforitunderoneunit.
Anotherist ocarefullyplanandcostoutthe
process.Andthethird ,andmostimportant ,i s
fortheCEOst ostayseriouslyinvolvedi nthe
processoffiscalmanagement.Theyshouldalso
ensurethatthedataunderlyingthisprocessare
ofgoodquality-produced