Nonprofits and Public Sector: The Latest Hot Market

Public and Nonprofit Sector Markets

Public sector or government agencies and nonprofit organizations have similarities in the fact that both require fund accounting and management capabilities, and have complex financial reporting requirements that are quite different from the commercial, for-profit financial accounting. For instance, over dozens of separate government agencies in one state will logically use dozens of different formats to prepare their separate financial reports, but some standardization of the fiscal procedures and reporting structures may be needed when all these reports are sent to the US Department of Labor (DoL).

Still, the not-for-profit and government sectors differ at least in the fact that government agencies, ranging from local police, school or transportation authorities, via water or any other utility, to an expansive federal division, are funded by tax revenue, grants, and service revenues (where occasionally applicable), as opposed to individual or corporate donors in the case of nonprofit businesses. Also, the public sector logically reports to regulatory authorities and taxpayers, instead of to the major donors, as is the case of profit organizations.

Even so, many recent circumstances have rendered the nonprofit and public sector accounting markets a land of both opportunity and challenges.

On one hand, a depressed economy is making it ever more difficult for nonprofit organizations to entice tightfisted would-be donors to untie their purse strings, while the public sector has been expected to justify every tax dollar spent during these days of reduced tax collections owing to both the tax decrease recently passed by the Congress, but particularly to subdued corporate financial performances. When times are good and funding and collections flow more freely due to more optimistic and generous donors and tax payers, there are naturally fewer demands for accountability and at length stipulated reporting of where and how the grants, endowments, and so on are being spent. Thus, as the recurring stream of funds available to nonprofit organizations begins to dwindle, the importance of donor tracking, more effective and focused group mailings, and accounting for expenditures has become crucial, as well as restrictions on expenditures and more stringent accountability for surpluses or deficits.

On the other hand, in addition to all the brouhaha about the immense fraud scandals of publicly held for-profit companies la Enron, Tyco, or WorldCom, which has prompted the passing of the Sarbanes-Oxley Act, the government has increased its scrutiny of not-for-profit financial statements in the wake of September 11, 2001, which has resulted in the extraordinary spate of subsequent charitable donations, but unfortunately also in the questions about where exactly parts of the money have gone (or even sadly been misappropriated in some instances). Also, given the lack of economic exuberance, in return for essentially giving away money, the donors increasingly expect more accountability and justification for how those funds have been used. Given that accurate reporting is critical for nonprofit organizations to continue to win grants and pledges, fundraising software packages are also highlighting their enhanced reporting capabilities to ensure compliance with Financial Accounting Standards Board (FASB) 116 and 117 rules covering financial statements and revenue recognition for not-for-profit entities.

Also, it is needless to say that this is a presidential election year in the US, whereby not only the two major election camps are in full swing of fundraising, but so are a number of interest groups and lobbying forces, each trying to impress their beliefs upon and thus influence the voters. Last but not least, a number of tribal organizations, college foundations, religious societies, charitable institutions, etc., have been enlarging the potential not-for-profit client base for many vendors. Due to an expected increase in defense and national security spending, federal government contract spending and activity are also expected to increase in the next several years. With the new emphasis on improving homeland security and expanding antiterrorism operations around the world, many public sector agencies will likely experience a significantly greater demand for their services over the next several years, but also the increased scrutiny and skeptical eyes from grant award decision makers.

Vendors Respond

The above combination of favorable circumstances has been a blessing for fundraising, grant management, and nonprofit accounting software providers, owing to the consequently higher demand, which has been consistently accelerating within the last few years. Accordingly, a slew of not-for-profit software vendors ranging from unavoidable Best Software, via the likes of Accufund, Executive Data Systems, Fund E-Z Development, Intuit Fundware, Serenic Software, to stalwart Blackbaud, as well as their value-added resellers (VAR), have been penetrating the nonprofit and government markets, while so far, Microsoft Corporation's (NASDAQ: MSFT) Microsoft Business Solutions (MBS) division has not exactly been the forerunner in that segment.

Moreover, often many smaller nonprofit organizations will have first attempted to leverage a smaller, off-the-shelf or retail sold commercial accounting package like QuickBooks, Peachtree, or ACCPAC Simply Accounting, given that by modifying the chart of accounts' number structures, some sort of fund accounting suitable structure could be produced. Also these shrink-wrap systems that are sold at retail outlets have more end users and therefore may have fewer bugs, more features, and may be updated more frequently, while each of these systems has dozens of experienced consultants within each major local region.

However, sooner or later, these organizations will likely hit the wall due to their inability to control the mushrooming new funding opportunities, new donors, and consequently more transactions in the system down the track. Best Software has been positioned well even in that regard, given that nearly 20 per cent of new MIP Fund Accounting Pro customers have migrated from Peachtree in 2003. Best acquired a former renowned not-for-profit accounting provider Micro Information Products (MIP) in 2001, while in 2002 it acquired JSI Fundraising, adding the Paradigm (for smaller nonprofit entities) and web-based, upper-end Millennium fundraising packages to its portfolio that now encompasses both the accounting and fundraising needs of the nonprofit target market. Moreover, for the government sector, it offers MIP Government Series Advantage fund accounting product and FAS Gov Suite, a government-specific fixed asset management package, while the 2003 acquisition of KTS Group brought into the fold GT Pro and Rainbow, the respective nonprofit and campaign management packages.

Encore Acquisition is MBS's Response

On April 27, MBS announced the acquisition of accounting products from a Winnipeg, Manitoba, Canada-based vendor, Encore Business Solutions, Inc., that could be critical to the success of the customers and partners in the public sector. The acquisition includes Encore's not-for-profit accounting products and the inter-company payables management and requisition management modules currently sold by MBS under an original equipment manufacturer (OEM) agreement with Encore.

As a result, MBS Great Plains 8.0, scheduled for release this summer, will also include functionality essential for MBS and its partners to conduct business in the public sector, such as grant management, fund accounting, and encumbrance management. According to both companies, in North America alone, there are an estimated 2.3 million public sector entities, which include government, not-for-profit, education, and healthcare organizations. Since Encore and MBS have identical support policies, they insist customer support will be provided for the current and previous versions of all modules. Also, Encore's code has been developed with the same developer toolset as MBS Great Plains, which should make it an attractive opportunity to enhance existing horizontal financial management applications.

The Encore acquisition should bring even closer the two former partners' complementary product offerings and should enlarge the opportunities within the public and nonprofit sectors under the Microsoft umbrella, while the products' technologies are quite compatible so that product integration will not be terribly complex, if at all.

Not-For-Profit Accounting Systems are Different

A major difference between a for-profit and a not-for-profit accounting system would be how a surplus (i.e., retained earnings and owners' equity balance or fund balance, for a for-profit or a nonprofit entity, respectively) is tracked. Also, for-profit firms (e.g., corporations, partnerships, and sole proprietors) usually have one surplus account, while a nonprofit entity can have several, depending on the extent of its funding sources and donor restrictions placed upon what they can and cannot do with surplus funds. For that reason, the featured capabilities of public sector and nonprofit accounting packages should typically include fund accounting; projects, grants and encumbrance management; fundraising; and special reporting for strict fiscal accountability.

Said in a somewhat simplified manner, fund accounting requires that every individual fund has its own self-balancing chart of accounts structure, whereby any entries between diverse funds (e.g., from a restricted fund for a research project to a fund that is allocated to the acquisition of a property, plant, and equipment) must be offset automatically by the software to a due-to or due-from balance sheet account, by way of automatic due-to and due-from journal entries. But, because new grants can be issued as often as yearly, it might be impractical to create an entirely new chart of accounts or a new series of general ledger account codes to track their activity. To avoid creation of such bulky structures, most accounting software has the ability to use special project and grant codes, which are often entered along with a general ledger account, and which allows for more detailed financial reporting without having to make use of a larger and ever-expanding chart of accounts.

These organizations are looking for systems to support the project manager, who is responsible for sharing and tracking the revenue or donations, expenses or reimbursements, and profitability of a project or grant. One should note that most enterprise-wide business systems sold by software vendors are general purpose in design and, without significant tweaking they do not address many of the unique requirements of businesses engaged primarily in providing products and services under project- or grant-specific contracts and engagements. Namely, traditional generic GL-oriented accounting systems have not been designed with project phases, work breakdowns, or detailed time capturing in mind, and thus, they merely can report how much has been spent and collected, but not why certain project or grant is losing or winning money.

One should also add to the above a strict adherence to Governmental Accounting Standards Board (GASB), FASB, and Generally Accepted Accounting Principles (GAAP), including creating detailed reports that adhere to the various pronouncements. These relevant organizations have many project-specific business and accounting requirements including the need to track costs and profitability on a project-by-project basis, to provide timely project information to managers and customers, and to submit accurate and detailed bills and invoices, often in compliance with complex industry-specific and regulatory requirements. Further, given that funding sources may often operate on different fiscal years than the beneficiary nonprofit organizations, financial reporting has to be flexible enough so that reports can be produced with varying reporting periods for various grants, which often cross over the nonprofit organization's normal fiscal year.

This market segment is obsessed with budgets and expenditures, as well as with a laser-sharp focus on the bottom line. Extensive budgeting is also required and, while most accounting packages accommodate the budgeting process, the nonprofit organizations may require far more budget revisions and the inclusion of encumbrances (explained further on) and other more advanced computations, such as future forecasting to streamline the responsibility centers.

Grant and fund management helps organizations track receipt and revenue and reimbursement and expenses of the assigned grant money. Should a city get a federal grant for homeland security, for example, it will need to document how that grant is consumed. But there are many different types of contracts the government is using and within each of those there are dozens or more variations, whereby each variation will drive its own type of billings, revenue recognition, and requirements for reporting back to the federal government customer.

On the other hand, large non-profit organizations that create a significant amount of funding through donated funds often require nonprofit accounting software that has strong fundraising and donor management capabilities that track donors, donation campaigns and pledge drives, and automate many of the direct mailings so that the entity can maximize the ability to solicit funds. Even fledgling nonprofit organizations without current needs or plans for fundraising, will likely at a later stage consider resorting to the use of external donors. To that end, some leading nonprofit accounting systems have either a native fundraising module or interfaces to an external fundraising system.

Encumbrance management on its hand brings more budgeting and financial reporting capabilities to purchasing applications for the public sector. In other words, it is a budgetary tool that enables government agencies to ensure they are within their approved budget with earmarked expenditures. When an agency issues a purchase order for a product or service (e.g., a municipality has to assign budget dollars to an upcoming event or for an equipment purchase), it becomes legally bound to pay the vendor the agreed upon price when the service or products are delivered (i.e., the money has been committed but not yet spent). In turn, because it is legally bound, it needs to "encumber" the funds beforehand to pay for these services or products so that the funds are available when the invoice is received.

When funds are encumbered, the remaining amount of budget available to spend is reduced and this lets the government know what is "spent" before the money actually leaves the account to prevent overspending. But when the goods or services are received and the invoice is approved, the actual amount of the invoice is expensed in the general ledger and the amount that was not needed is relieved of the encumbrance, and so the budget has now a somewhat increased amount available for further encumbrances.

Therefore, it was only natural to expect MBS's next move to address the nonprofit segment inferiority, which solution turned out to be Encore, and look for more chess-like moves from the top small-to-medium enterprise (SME) application providers.

User Recommendations

While the value proposition of integrated ERP, accounting and fundraising, fund & grant accounting, and management systems cannot be debated, companies should always identify the trade-offs they are willing or not willing to make in order to achieve a specific level of integration. For example, not many, if any systems will feature equally strong fund accounting and fundraising capabilities at the same time. It is unlikely that different groups within the organization will require the same capabilities from the system (e.g., while the accounting department mainly wants the summary of transaction data, the fund-raising stuff needs details to analyze the purpose and effect of grants).

Thus, it is important to identify the laundry list of items that might or should be integrated between these systems, such as campaigns, appeals, funds, events, purchase orders, budgets, budget revisions, costs, accounts payable invoices and checks, forecasts, and so on. Also, the companies should vigorously clarify the meaning of integration that the vendors tout—will the integrated solution contain a centralized database, for example? Also, does the integration accommodate the creation of new entries and synchronization of changes to existing records occurs in real-time or via batch-file transfers?

Often, buying completely integrated solutions is not an option when the companies have an accounting or fund, grant, or project-management system in place, which they will not simply rip-and-replace. Thus, prospects should assess the contesting vendors' flexibility to integrate to legacy and other third-party applications, and to keep up with new versions or upgrades to both solutions. Built in interfaces to commonly used third-party products like MS Project, MS Office, Crystal Reports, etc., should be questioned, possibly during software demonstrations. Particularly nonprofit organizations need the ability to merge data with Microsoft Word to produce thank-you notes, renewed pledge forms and year-end contribution statements for tax reduction purposes of donors.