Shoring Up Financial Stability: Budgeting, Internal Controls and Red Flags
Originally published on February 21, 2022
Updated on October 27th, 2023
When it comes to financial stability, Mark Payne emphasizes that knowledge is power.
“I have seen a lot of nonprofits through my 30-year career,” said the James Moore partner and leader of the firm’s Nonprofit Services Team. “But I’m always amazed when I do presentations and see what a nonprofit’s board knows and does not know.”
The key is to understand the basics about your nonprofit’s finances and know the danger signs that something is wrong. Thankfully, you don’t need to be a seasoned financial professional to understand your budget and implement some sound basic practices.
In an installment of our 2021 Nonprofit CPE Series, Mark discussed financial literacy for nonprofits. Areas covered included budgeting basics, internal controls and the red flags every board member should know.
Look at your budget from both an entity-wide perspective and at the individual grant level.
Your budget is the business side of your mission, and it needs plenty of attention to make sure it facilitates your work. If you’re a nonprofit board member, the first two items you should look at in your budget are your total revenues and total expenditures for your overall entity. If those numbers agree, you’re not earning extra income for that rainy day.
You should also survey each individual contract and grant to give you a better picture of your income needs.
“Most clients I’ve dealt with never receive enough money from the state or the feds to cover all costs,” said Mark. “So you should be having some contribution revenues coming in, some fundraising revenue coming in, things along those lines to supplement what you can’t cover with grants.”
Studying each grant will also give you a heads up on potential issues. For example, if you’ve budgeted for a million dollar grant but halfway through the year you’ve spent a million dollars, you know something needs to be adjusted.
Adopt a business mindset.
Despite what many people think, nonprofits need to make money. Just like any business, a nonprofit benefits by having extra funds for emergencies, contribution shortfalls and other unexpected events. So they should adopt the same mindset a business has when it comes to earning extra income.
“The only difference between a nonprofit and a for-profit is that a for-profit has stockholders and they generally pay income taxes,” he explained. “Even though we’re a nonprofit, we need to make money because whenever we run into hard times, like COVID-19, we’d better have some reserves out there.”
Your budget is more than just a way to see whether you have enough to pay the bills. It’s a valuable tool to gauge whether your organization is making money.
Don’t set your budget in stone.
Your budget can be amended if the unexpected happens (like a pandemic). It might sound counterintuitive to the discipline required to stick to a budget. When circumstances shift, however, modifying your budget is necessary to accommodate changes in income, environment, etc.
Review your financial statements monthly.
A nonprofit’s board should receive financial statements at least once per month. You should also have adequate time to review them before a board meeting. Five business days before the meeting is a reasonable amount.
Develop and maintain solid internal controls.
It’s often a subject leaders want to avoid. We like to trust that our employees would never do anything fraudulent. But fraud is often where nonprofits get hit the hardest, and internal controls are your defense.
“No one cares about internal controls until something went wrong,” said Mark. “’Somebody stole money or didn’t sign off on something. Then everybody’s pointing at each other.”
The sad fact is that even good people sometimes do not-so-good things. They’re generally motivated by one of three components in what Mark called the fraud triangle:
- Pressure – Maybe someone has a gambling habit and will do things they wouldn’t normally do to pay it off.
- Rationalization – Perhaps an employee was passed over for a raise they felt they deserved. They might use that to justify the financial gain of fraudulent activity.
- Opportunity – If an employee knows there’s a lack of oversight in procedures or surveillance, they’re more likely to commit fraud with that reduced risk of getting caught.
One key to effective internal controls is to have as many people as possible involved in their creation and enforcement. Mark also recommended having a fidelity bond —business insurance that protects you against losses caused by employee fraud.
That said, internal controls can also have limitations. Sometimes a control is just too costly to justify its implementation. There’s also the potential for management override and opportunities for collusion if staff members decide to work together to defraud your organization.
Know the red flags of financial trouble.
Subtle signs of trouble can pop up before budgets and internal controls can do their jobs. Watch for these financial red flags at your organization. Some might seem obvious, but others can tell a story you otherwise wouldn’t know.
- Continued losses year after year – Two years of losses in a row isn’t uncommon when you have initiatives or capital campaigns. More than that, however, is cause for concern.
- Late payroll or sales tax deposits – Sometimes these can simply be oversights.
- Management saying things are better than what financial statements reflect – “I have seen this throughout my career,” said Mark. “Things are always going to be better ‘in the future.’”
- High concentration of income from one grantor/contributor – If your relationship sours with that grantor, you’ll have a huge gap in your income.
- High turnover in your accounting department – When things start going south financially, accounting staff is often the first to leave because they see the writing on the wall.
- Lack of board access to the CFO (all conversations must go through your executive director) – There should be open communication between the board and the CFO. In fact, the CFO should be at board meetings.
- Accounts payables grow each month – Ask yourself why your nonprofit isn’t paying its bills.
- Financial statements are from an Excel spreadsheet instead of the accounting software – Excel documents are too easy to edit so discrepancies can be hidden.
- Delayed audit reports – If your audit is being put off again and again, at the very least your financial information hasn’t been maintained. That said, it could be even worse.
- Financial information is provided last minute (for example, the day of the board meeting), leaving no time for review – Sadly, sometimes this is done by design if things aren’t going well.
- Lines of credit are tapped out – This one is fairly obvious.
- Continual debt restructuring – If your organization regularly refinances debt without actually paying it down, its overall net position never increases and the interest it must pay increases.
- Credit cards are not paid off each month – Mark recalled a client that kept paying exactly $500/month on credit cards. It turns out the liability was actually $95,000; the organization was just surviving on revolving credit card debt.
- Responses to board questions are vague (or questions receive no responses) – You should always be able to ask questions and get direct answers regarding your nonprofit’s finances.
- Board members assume the treasurer has everything under control – A board member’s job is to know everything going on, including finances.
- Your CPA has the same findings year after year but nothing is corrected – This is a sign that problems are being ignored. Issues must be fixed.
- Bank statement shows a negative balance – This red flag needs no explanation.
- Lack of working capital – Working capital is your current assets minus your current liabilities. If that number is negative, you don’t have any cash on hand and can’t pay your bills.
- Receivables show as 90 days past due – This is when contributions or grants are not collected, and it’s often a sign of inaction. “I guarantee you, there’s somebody on your board that probably knows somebody that they can pick the phone up and call to get that receivable collected,” said Mark.
While this might seem like a lot to take in, much of what Mark discussed can be done in simple habits developed over time. Ask questions. Look at your financial statements. Be agile when it comes to your budget. Keep your eyes and ears open for red flags. And work with a nonprofit CPA who knows the ins and outs of your financial picture.
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