Unlike public companies, nonprofit organizations aren’t legally required to complete an annual financial audit. They don’t need to demonstrate to shareholders and government entities that their finances are in order. There are a few reasons, however, that nonprofits should conduct audits of their financial operations.
Large nonprofits which receive more than one million in outside grants and donations often elect to have regular audits conducted. Doing so provides proof to current and potential donors that funds are being used correctly and as designated according to the grant and/or mission of the organization. In today’s world, transparency is everything.
While the audit process between for-profit and nonprofit organizations is quite similar, nonprofits must focus on accountability, not profitability. If your nonprofit organization decides to get an audit, be prepared to make changes to processes and/or systems.
Let’s say auditors find something awry in your books. The firm will provide guidance to your management team on how to fix the issues, in order to get a clean audit. The audit document can help immensely when you hit up large donors, who often ask to see a nonprofit’s financials before giving.
Clean audits will help secure a bank loan; poor audits may cost you that critical cash infusion. Understanding what worries auditors is the first step in preparing for an audit.
Red flags for auditors
Experienced auditors categorize risk into three buckets:
1. Inherent risk. This is the type of risk that is built into your organization, and depends upon your size, complexity, and even your market. For instance, a nonprofit with a large staff is automatically more at risk for financial errors, incomplete data, and even fraud, simply because there are more humans involved. The good news is, many inherent risks can be countered by instituting a strong internal control system.
2. Control risk. Regardless of the level of inherent risk, an organization that doesn’t have proper controls and systems for managing money is probably going to suffer in an audit – and otherwise. For example, the same person who collects donations should not be the same person who records, deposits and/or tracks the money.
3. Detection risk. The risk that an auditor will miss a critical piece of information goes up if there is high inherent and/or control risks.
For nonprofits, the most important guiding principle is to create plenty of checks and balances on donations and how they flow throughout the organization and into the community. This starts with separation of duties; ensure that multiple individuals are involved with the collection, recording and distribution of outside funds.
Other ideas for achieving clean audits include:
Assess your accounting and financial processes and systems. If you are only using spreadsheets to track the money, it might be time to invest in a nonprofit accounting solution. Increasingly, these systems live in the cloud, so that you don’t have to worry about installing or maintaining them.
Hire an accountant with experience in nonprofits. Fund accounting is vexing even for seasoned CPAs. Compared with the clean assets and liabilities records of corporations, each fund in a nonprofit is like a mini-company itself.
Support the auditors. It’s a natural response to recoil from somebody seeking out wrongdoing, but it’s best to not fight the process and help auditors as much as possible do their job. That will help you in the end be more effective in your cause and grow your organization.
Conduct audits annually. This provides regularity to your reporting, benchmarks, and much appreciated transparency for donors.
Expand internal controls to technology. With so much processing being done through electronic networks and software, it’s important to make sure that your systems and banking partners are working within compliance and good practice. If your organization is not using accounting software, instill a manual verification process for spreadsheets. Always maintain good documentation and a paper trail for all financial transactions, including invoicing any outside vendors.
Whether and when to conduct an audit is at the discretion of the nonprofit’s senior management board. Nonprofits don’t have the same budget leeway and resources to do audits like corporations, but that doesn’t mean audits are a frivolous waste of time. Regular auditing for nonprofits of a certain size and complexity can help ensure the long-term stability and credibility of the organization.
About the author: Alex Acree is Head of Services at Aplos.