Financial management is a process that involves activities carried out in different fiscal years. Public and non-profit organizations carry out their financial management processes over a period of three years after which an audit is done. These organizations come up with a budget to be executed over this period. It acts as a benchmark and a control when the originations are checked for the proper usage of funds in terms of the amounts budgeted, the number of transactions aimed to be carried out , the amount of funds aimed to be invested, the cost of purchasing goods and services to be used by the organizations.
Financial management also involves management of inventories, capital budgeting which is making of decisions of the types of projects to undertake i.e. either short term or long term, depending on the financing options available. Risk management is a part of financial management in these organizations; it involves reduction of the probability of risks occurring through management and insurance.
Public and non-profit organizations use different financial management systems and different methods in approaching financial management. The areas in which these differences occur are:
Accounting: the Financial Accounting Standards Board (FASB) sets accounting standards for nonprofit organizations while the Government Accounting Standards Board (GASB) sets the standards for public organizations. The differences occur where public organizations use fund accounting where there is use of specific accounts; non- profit organizations do not use this form of accounting. Other differences occur in calculation of administrative and indirect costs, non-profit organizations try to reduce their costs as much as possible so as to justify themselves to the funding agencies, however public organizations do not justify the costs to any authority.
Budgeting: Public organizations use annual year budgets while others prefer performance reports. Nonprofit organizations prefer more detailed systems to account for the money they receive from funding agencies.
Purchasing: The major differences occur in that public organizations purchasing procedure is longer due to the regulatory issues. It involves biding, acceptance of bids and issuance of contracts. Nonprofit organizations don’t subject to such process.
Cash management: Public organizations invest in less risky assets whose returns are almost certain while nonprofit organizations can invest in risky assets with uncertain high returns.
Debt management: Public organizations have the ability to issue bonds, while nonprofit ones usually borrow in case they have a need in funds.
Risk management: Public organizations are more exposed to public liability than nonprofit ones. They, therefore, lay more emphasis on risk management.
Public organizations almost certainly have their accounts audited; however nonprofit organizations may avoid the audit by involving the use of an internal auditor or us of an auditor who has some interest with the organization.
In the discussion of these organizations we will look at General Motors, New York City Public Transit System and San Diego’s municipal workers.
General Motors was a successful company in the automobile industry especially after the World war II. It had around 40% of the market and in the year 1955 this rate raised 51% of the market. General Motors was a great success in this industry. In 1955 it earned more than $1billion which was a record breaking earning because no other American organization had made such amount of earnings. In 1960, contributions to the pension fund were $95 million and payments of benefits of around $25 million, it was, therefore, operating at a surplus.GM prospects were over the roof with everything showing that it would continue to make such profits in future, as a result GM gave the labor unions almost everything they asked for not knowing it would result to its failure in the near future. The pension benefits and health care benefits soared with time, this added up the growing fixed costs, GM was at an disadvantage compared to companies like Toyota from Japan who did not pay pensions and health benefits because the cars were shipped to suppliers.
In early 1990, the company experienced huge loses, to an extent huge pension costs had used up significant amount of resources that would have been used in designing better cars. Moreover GM was left behind in the investments of hybrid cars. This was an opportunity cost to the manufacturer.
In the late 1990-s, the company made some gains from sales in SUVs , however it had only 180,000 hourly employees in comparison to 400,000 retirees, whatever gains the company made were cleared away by the this imbalance.
General Motors market share continued to fall to around 30%, it was almost the imminent fall of this giant in the automobile market. GM sales continued to fall, it resulted in the company offering cheaper vehicles, and it also had a zero financing policy.
In the first quarter results projection, it was expected that GM would have more losses of around $1 billion (controversial to 1955, when it had made earning of the same). It was at this time facing the risk of liquidation. GM froze the pension of salaried employees in 2006; however this hardly helped the company because most employees were members of the union. The announcement of 2005 end year results was worrying because the company had made a loss of $10.6 billion.
NEW YORKS CITY PUBLIC TRANSIT SYSTEM
Metropolitan transportation authority controls the New York public transit system, it is a state agency. The transit system was also facing similar pension problems as GM. The pension costs were very high, by 2000 they were estimated at $16 million, hover by the year 2005 the costs had increased to $165 million. Demographic trends and increased benefits were the major cause of this increase in costs. Employees retired after working for 25 years after which they would enjoy pension for more than 25 years.
New York was facing a problem similar to other states. The other states were in even worse situation because every negotiation with the labor unions aimed at an increase in benefits, insofar as these unions could organize themselves politically and would have a say at the elections in which they could vote the bosses out of the office. With the help of Kalikow, New York transit system opted to reduce its expansion projects and limiting bus routine, it also reduced night operations and increased the fair, all this was done with the aim of reducing the rising costs. A proposal by Kalikow for pension cuts did not go through.
In 1970, the transit system was in financial trouble after it rose its fairs while the services it was providing were poor, it lost more than 300 million passengers. Within the same time the retirement costs were escalating with the employees opting for early retirement because of the benefits.
The subway was facing more problems with its cars breaking down and causing delays. The trains were also malfunctioning. There was an $8.5 billion proposal to improve the subway by investment in new cars and refurbishing stations. This was an increase in costs similar to pensions.
From 1995 to 2000, pension assets increased significantly from $59 billion to $106 billion this was a result of a bullish stock market. The funds were overfunded. In July 2000, Patalki signed a law that had the largest pension increase since Lindsay era. It reduced contributions for transit state and city employees and fixed the benefits to inflation. Its cost was estimated around $3.5 billion in a decade time.
In 2001, Kalikow took charge of MTA, the books of account of the agency had huge amounts of debt; the levels were higher than those of majority of other states. He increased taxes, however, all the revenue gained was eaten up by the huge pension costs. The pension obligation was over the roof by 2009, it stood at $620 billion four times increase a decade ago.
In the previous years the political and civic leaders had warned of the growing danger of pensions. The New York pensions were more generous than they should have been, However even with markets falling, the legislature continued to improve the benefits with better packages. New York managed to deal with increased cost pensions by raising taxes to pay for them. This was done at the knowledge of the public and it solved this problem.
San Diego was also facing the same problem similar to New York; however the state was far much worse. In 2005, the pension fund was $1.7 billion, the employees in the public sector were discharged and all investment plans were halted. Its accounts statements were not audited while there was no bond rating and no Wall Street access.
The residents of San Diego despised the payment of taxes. The town was closely managed, with businessmen running the city hall and seeking tax breaks. The unions were becoming stronger and contributed more to the politics of the town. Salaries began to increase and the spending of the town began to rise. The government, however, did not use taxes to fund these costs, but balanced its budget by means such as selling of land.
After September 11, 2001, the investments by the town started falling. In 2002, the town would not manage to fund the benefits. Pension expenses were expected to increase to 141 of payroll. The pension crisis was fueled by scandals and litigations that were in the pension benefits. Aguirre wrote that the saga of greed, conspiracy and political cowardice was the major cause of the financial crises of in the tow.
Common Themes in the Cases Discussed Above
(a) Decision making strategies
In the case of GM, New York transit system as well as San Diego, suffered from the fact that the pension benefits to their employees increased over time and the number of persons to be compensated also were rising over the years.
General Motors, a giant in the automobile market was brought to its knees due to high costs of pension benefits. The policy makers at GM did not discount future costs that would have been incurred from awarding unions almost anything they wanted. On the other hand, New York subway faced the same problems of escalating pension benefits and the appetite of legislatures increasing these benefits to protect their elective positions. The problem was that these solutions were short term with costly implications in the future.
San Diego town had still the same problems, however, because the residents were conservative, the increase in taxes to fund the rising pension benefits was not the solution. The town had to abandon its investment plans because of the deficit in its budget. These three situations show some form of self interest by the responsible for making decisions parties that were short term ones; therefore, these parties fell to consider implications in the future. In the case of New York subway the right decision was made to increase taxes to fund the tax benefits.
(b) Slow Accretion to Power by the Labor Unions
The labor unions have been significant in the rise of pension benefits. They agitated for the rise in benefits for GM employees including health care issues. The unions led its employees to strike in case their demands were not met. An example is when the employees went on a 9 weeks standoff strike which resulted to GM agreement on conditions of the employees.
The unions were gaining political power in due time and would, therefore, vote bosses who did not agree with their demands. This was the case in New York and San Diego where the legislature continued to increase benefits to gain currency with the labor unions.
In relation to financial management the two common trends can be discussed including the following aspects: cash management, debt management and risk management.
General Motors used to have super normal profits. In the 1970s, most of the company’s investment was allocated into expansion of the company through building of plants and buying of subsidiaries. However, the increase in pensions reduced the amount of investment funds; which could have been used in the production of new hybrid cars, therefore, GM ended up lagging behind in the manufacture of the hybrid vehicles.
New York subways system would not be able to maintain its buses and trains; this was the effect of most of the cash being used in pension benefits for the employees. However, the subway reduced its expenses through reducing the routine of the buses and limiting night operations. San Diego cash problems were solved through selling land and other unconventional ways. The town had no access to bonds and the stock markets; it, therefore, was limited in terms of cash options.
GM had to manage debt properly with the company having issued bonds as a way of borrowing funds. New York subway opted to raise taxes rather than borrow to finance the payment of pension benefits. On the other hand, San Diego had to borrow, due to the fact the authorities of the town rejected rises in taxes. The town had almost filed for bankruptcy.
GM did not mitigate against several risks it was facing, these include the increase of pension costs in the future and the risk of stiff competition in the automobile market. The company signed risky and costly agreements with union workers. San Diego faced a lot of risks with it not being able to meet costs. The risks of the public service failure were among the most evident ones. The fact that San Diego took a loan, also increased its risks, New York subway significantly reduced its risk though not boring but using taxes.
The use of taxes to finance pension savings was tested by New York subway as a means to stabilize the situation. The method proved that taxes can meet pension costs. However, this would be in the short term, because the costs will increase with time and the level of taxation will also reach the optimal rate. Taxation is a risk free way of raising funds, it can be manipulated by various income groups. It can be direct or indirect. The taxes are in most cases able to raise the necessary funds in the states.
The problem of retirement benefits is an issue that should be solved by all the stakeholders, namely: the government, the labor unions, and the employers. Discussions between the three parties should make a difference in solving the issues at hand. The unions seek to have a raise in the benefits while the government and corporations incur the burden of the benefits.
There can be a scheme in which the employees contribute to the pension benefit to reduce the pressure on the employers to provide for better resource of pension benefits.
The provision of the retirements should be universal and all the employees should have access to it. This will, therefore, require the government to subsidize the cost of basic coverage. Subsides by the government would mean that the costs to the corporations and the state agencies would significantly reduce and the problems as those faced by GM would not occur.