Bachelor of Accounting Financial Management Report on WACC and NPOs

This report is divided into two parts. Part A focuses on the calculation of the time value of money, specifically the cost of debt, equity, and preference shares, and the Weighted Average Cost of Capital (WACC). It analyzes the WACC on both a pre-tax and after-tax basis, considering the impact of a new major investment on the cost of capital. Part B delves into the role of financial management in not-for-profit organizations (NPOs), emphasizing the importance of financial management, cash management, budgeting, asset management, and the use of fund accounting. The report highlights the similarities and differences between financial management in for-profit and not-for-profit entities, addressing the unique challenges and requirements of NPOs. The report concludes by emphasizing the importance of financial management systems, including budgeting, cash management, and fund accounting, for NPOs to ensure efficient resource allocation and achieve their societal missions. It also provides relevant bibliography.

Bachelor of Accounting

Contents
Part A: Calculation of time value of money...............................................................................1
Part B – Role of Financial Management for ‘not for profit organizations’...............................3
Introduction............................................................................................................................3
Need for Financial Management in Not-for-profit Organisations..........................................3
Role of financial management................................................................................................4
Conclusion..............................................................................................................................5
Bibliography...............................................................................................................................5
Part A: Calculation of time value of money
a) Cost of debt, equity and preference shares
i) Cost of debt
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Yield to maturity = 8.3%, tax rate = 40%
Cost of debt = yield to maturity * (1-tax rate)
= 8.3% * (1-0.4)
= 4.98%
ii) Cost of preference capital
Dividend = 8%*$70 = $5.6, current market price = $76
Cost of preferred stock = annual dividend on preferred stock / current market price of
preferred stock
= 5.6 / 76
= 7.36%
iii) Cost of Equity
Beta = 1.05, risk free rate = 4%, Market return = 11.4%
Cost of equity = risk free rate + beta (expected market return – risk free rate)
= 4% + 1.05(0.114 – 0.04)
= 11.77%
b) WACC of SVI on pre-tax and after tax basis.
After tax WACC = wdrd + wprp + were
= 0.4 * 0.0498 + 0.1 * 0.0736 + 0.5 * 0.1177
= 0.01992 + 0.00736 + 0.05885
= 8.61%
Pre-tax WACC = WACCAT / (1-t)
= 0.0861 / (1-0.4)
= 14.35%
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SVI should use the after tax WACC when making investment decisions. This is because the
interest expense payable on debt is tax deductible and hence it is important to consider that
factor while calculating the WACC (Tijdhof 2007)
c) As a result of the new major investment which is expected to increase both the
operating and the financial leverage, the cost of capital will change. The new costs of
debt, preference and equity are as follows:
i) Cost of debt
Yield to maturity = 9%, tax rate = 40%
Cost of debt = 0.09* (1-0.4)
= 5.4%
ii) Cost of preferred stock
Dividend = 8%*$70 = $5.6, current market price = $70
Cost of preferred stock = $5.6 / $70
= 8%
iii) Cost of equity
Beta = 1.15, risk free rate = 4%, Market return = 11.4%
Cost of Equity = 4% + 1.15(0.114 – 0.04)
= 12.51%
New WACC = 0.5 * 0.054 + 0.1 * 0.08 + 0.4* 0.125
= 8.5%
Old WACC = 8.61%
Hence, we see that as a result of the new investment, the WACC has decreased by 0.11%.
This is because the weight of equity in the capital structure has gone down. Equity is the most
expensive source of capital, and debt the least, so when the weight of debt increases and that
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of equity decreases, the WACC will decrease. Even though the cost of both debt and equity
has increased as a result of the new investment, however the change in weights has greater
impact on the WACC (Titman 2016)
Part B – Role of Financial Management for ‘not for profit
organizations’
Introduction
Not for profit organisations exist for the society where they provide benefits to the members
of the society. The operations are based on the receipts which are from grants, fundraising,
donations (Australia 2012). The expenses are in the form of providing services to its clientele.
These organisations are generally judged on the basis of their effectiveness in providing
quality services and fulfilling their mission. However, a good financial management will
ensure that there are adequate resources available from time to time, the company remains
solvent and continue to provide social services to the community
Financial management for not for profit organisation is similar to the financial management
system for profit organisations in many aspects. However, a major difference is that for profit
enterprises maximizing profits and shareholder value is the main goal whereas for not for
profit organisation the primary objective is to provide socially desirable services (CPA 2012)
There is lack of flexibility for a not for profit organisation because there is restriction to the
use of funds as the resources have to be applied as per the instructions of the resource
providers or as per the company’s stated mission. These resource providers are not engaged
in the exchange transaction (Balckbaud 2011). It is important for the not-for-profit company
to provide financial reports to demonstrate that the dollars were used for the specified
purpose only. Hence, fund accounting systems become crucial.
Need for Financial Management in Not-for-profit Organisations
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These organisations function on the financial resources provided by external donors. In order
to maximize the resource utilization for servicing clients, the funders set a very low limit for
expenses related to administration and management (Abraham 2006) Hence, without a proper
management system, it becomes very difficult and time consuming for the organisation to
comply with the reporting requirements of the funders especially for government funders. As
a result, the organisations become vulnerable and are more focused on meeting the day to day
demands of the funders. This leads to crisis management and the company is not able to
focus on the long term planning and development or to improve the quality of the program
(Lauren Kotloff 2012) Thus financial management has become imperative for these
organisations.
Role of financial management
Cash management and budgeting are two important areas of financial management for such
organisations. Cash management is important because the company needs to ensure there are
adequate funds to service the client. Cash flow can be very challenging because the cash is
provided by resource providers who are not beneficiaries of the services. Hence, there is no
guarantee of cash flow. It is impossible to predict the revenue forecasts and hence budgeting
becomes important.
a) Budgets
Budget is an operational plan for the year. In the budget, the company should specify the
various programs it is planning to undertake and the resources required to fulfil the program
requirements. The resources are then allocated to the various programs. Through budgets, it is
ensured that there is maximum utilization of the resources (Strydom 2014) The budgets states
goals for the staff and the steps to achieve those goals. Potential problems that may arise in
the future is also indicated in the budgets. Continuous review of the budgets and the
measurement of actual results with the budgeted helps in making the management more
effective. Any unforeseen event if happens, should be accounted for in the budget.
b) Asset Management
Management of a not for profit organisation must ensure that there are enough liquid assets to
finance the current operations. There should be a fine balance between the available assets
and the growing assets. The company should be able to meet its financial obligations which
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may be in the form of debt and other financial responsibilities. Once a budget is prepared, the
company should look at making most efficient use of the available assets for financing
current operations and also maximize the resources which are available or are to be obtained
in the future. The resources can be maximized by an analysis of the costs and benefits of
sources of revenue.
c) Use of Fund Accounting
Not for profit organisations use fund accounting where they record the resources whose use
may be specified or restricted by the donors or the governing bodies or the law. Each fund
may be said to be a balance sheet in itself as it will comprise of fund specific assets,
liabilities, revenues, expenses account. The fund balances or the net assets should be properly
categorized in the balance sheet as non-restricted, temporary restricted or restricted based on
the restrictions imposed by the donor (Zietlow, Hankin & Seinder 2006). A fund accounting
helps to make a distinction between funds available immediately for current operations and
funds to be used for donor specified use. It also serves as audit tools for ensuring resources
are spent as per the restrictions (Herzlinger & Sherman 1980)
Conclusion
In order to be effective and efficient, it is important for not for profit organisations to
financial management systems in place. Budgeting and cash management are the two most
important areas to be focused by the financial managers. This is because the organisation
receives money from the public to fulfil a societal need and hence, it should ensure the need
is met within the granted financial resources and also the daily working of the organisation is
not hampered due to cash problems. Fund accounting is important because it helps in
differentiating the various funds based on time and purpose. Such differentiation helps in
ensuring maximum utilization of the granted funds for the specific purpose. It is also essential
for the not for profit organisation to periodically review themselves for continuous growth
and development.
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Bibliography
Abraham, A 2006, 'Financial Management in the Nonprofit Sector: A Mission based Approach to
Ratio Analysis in Membership Organisation', The Journal of American Academy of Business, vol 9, no.
2, pp. 212-217.
Australia, C 2012, 'Financial Management for not-for-profit organisations', CPA Australia, Australia.
Balckbaud 2011, 'Financial Management of Not - For- Profit Organsations', Charleston.
CPA 2012, 'A Guide to Financial Statements of Not-For-Profit Organizations', Charetered Professional
Accountants of Canada, Canadian Institute of Chartered Accountants, Canaada.
Herzlinger, R & Sherman, D 1980, 'Advantages of Fund Accounting in Nonprofits', Harvard Business
Review, July 1980.
Lauren Kotloff, NB 2012, Building Stronger Nonprofits Through Better Financial Management, New
York, viewed 2 September 2017,
<http://www.wallacefoundation.org/knowledge-center/Documents/Building-Stronger-Nonprofits-
Through-Better-Financial-Management.pdf>.
Strydom, B 2014, 'Financial Management in Non-Profit Organisations: An Exploratory Study',
Mediterranean Journal of Social Sciences , vol 5, no. 15.
Tijdhof, L 2007, WACC: Practical Guide for Strategic Decision- Making , viewed 2 September 2017,
<http://zanders.eu/en/latest-insights/wacc-practical-guide-for-strategic-decision-making-part-8/>.
Titman, S 2016, Financial Management: Principles and Applications, 7th edn, Pearson Australia,
Australia.
Zietlow, J, Hankin, J & Seinder, A 2006, Financial Management for Nonprofit Organizations: Policies
and Practices, Wiley.
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