Chapter 8
Finance
Programs and services are often the thing that comes to mind when people think about a nonprofit organization, but finance and financial operations are what they think about first when they focus specifically on nonprofit risk. It looms large for nonprofit organizations, and those risks take many forms.
This chapter looks at three major activities in the financial area of nonprofit organizations that can pose significant risks.
The risks that are described in this chapter are:
–Managing the organization’s cash, investments, and financial reputation
–Accounting for grants, activities, and overhead
–Dealing with discretionary, ad hoc, and emergency projects
Managing the Organization’s Cash, Investments, and Financial Reputation
This is the heart of financial operations for any organization, including a nonprofit one. The differences between nonprofit and other types of organizations are significant enough that whoever manages your financial operations (either a part-time, preferably expert, volunteer in a small organization or an in-house staff expert or team aided by outside accountants in a large organization) needs to be aware of the differences and of all the generally accepted accounting practice rules that pertain.
In the past, some nonprofits managed accounts payable and cash flow by letting vendors know that the library, hospital, museum, or other nonprofit organization was “good for it,” so there shouldn’t be concern if payments were late. Whether or not this was ever really true, it is certainly no longer true today. In fact, recent failures of large nonprofit organizations have made it clear that when it comes to financial stability and reliability, good deeds and good intentions are no substitute for a reliable and well managed financial operation and board oversight of financial performance and practices.
What to Watch For
A notable red flag for nonprofits is the absence of budgeted cash reserves—too many function with a minimal cushion of cash reserve operating funds. For organizations that rely on grant funding—which, in turn, relies on approvals from funders—the time it takes to process a payment or claim can be significant. Payment delays are common but payroll and program operating expenses happen on a fixed schedule. Many nonprofit organizations, no matter how large or small in size, operate on a shoestring and too often have to juggle or stagger vendor payments to keep the lights on. It is important to have operating policies regarding the handling of payables that have been reviewed by your board and an outside accounting professional, particularly when there are new staff or pro bono volunteers handling your bookkeeping and finances. Simply paying bills late or handling nonprofit budgeting as you do your personal budget is not a good strategy.
There are ways to mitigate cash flow and late payment problems. In addition to traditional practices, such as lines of credit, if your nonprofit organization is dependent on one or more organizations to authorize your payments, see if you can work with your funder to change the payment calendar to better align with your expense cycle. Too many nonprofits get into trouble with lines of credit, not accounting for interest or payback in current year budgets.
As an example of an administrative solution, a public library board must approve an annual budget and certain expenditures. Once approved by the library board, those same expenditures may need to be approved by the town in which the library is located. In a situation like this where the approval process is long and where payments are often delayed, some library boards pass a resolution authorizing the payment of routine bills for routine expenses. Other nonprofits make similar administrative adjustments through annual board resolutions to allow the executive to continue spending up to a set amount for a set period of time with board approval and oversight. This type of structure preserves the board’s role in approving payments, but does not require a board meeting or board vote to authorize each individual payment.
Unforeseen circumstances can arise in the course of the year, and their expenses need to be covered in one way or another. The organization can prepare for contingencies with a line of credit, cash reserves and a board approved spending plan. However, beyond the immediate need to handle an emergency, each organization needs a way to do periodic reviews of emergency or unbudgeted expenses to improve planning and reduce risks. Regardless of cause, an organization needs to keep track of emergency or off-budget spending which can be costly and be a flag for risk.
Since it is now possible to file many reports and tax documents online, your policies and procedures must include rules governing access to and handing of submissions by approved staff. Modern security best practices no longer rely on a single password, so it’s necessary to test periodically to be sure that security protocols, such as two-factor authorization, are being followed and can be used properly.
Prevention
It is a best practice for boards to review tax returns and financial statements before they are submitted. Every organization is different, so this practice is followed in different ways. Make certain that you have the appropriate time and skills devoted to presenting the information clearly and understanding it in detail. “That’s the normal format for a balance sheet,” is not explaining things clearly. Similarly, saying, “We trust our accountants,” is not a review. Not understanding a financial statement is not a sign of ignorance, nonprofit financial statements are often complex. Offering an orientation to the organization’s finances and financial reporting is good practice when bringing anyone on board. Providing clear explanations and welcoming questions can be part of that process. It is better to make the time to do this early on in a member’s board service than to explain a deficit, lost grant or audit finding to a roomful of angry board members about why you didn’t. The fact that these conversations happen repeatedly means that everyone will become more familiar with the data, which is a good thing.
–Periodically review your internal controls and procedures, particularly when there is any change in industry rules or in the people managing them. Accounting skills and experience in other organizations—particularly commercial organizations—may not be directly applicable, so make certain that your finance staff and volunteers are trained and understand where the differences are. This is not to say that nonprofit organizations can’t improve practice by learning from commercial organizations, but be sure that any change in practice is appropriate in a nonprofit context.
–If your organization has cash transactions, ensure that they are properly documented, handled and controlled. Small fundraising items sold informally are often targets of opportunity in as much as they may be handled carelessly. Cash transactions are a temptation and risk regardless of situation. Many organizations prefer to accept credit cards or checks or payment through other platforms.
–Similarly, make sure that checks given to staff by hand are properly processed and entered into your accounting system. It is not uncommon for organizations to accept checks at events or community activities where there is a lot going on. All receivables, regardless of source, must be coded to the proper activity, event or program. Since event checks or cash donations warrant a thank you or receipt this can be another way to check for process gaps.
–In small organizations where a volunteer may do the bookkeeping, provide adequate training and support and regular supervision. Make certain that you know what accounting software or spreadsheets are being used and how they are secured and maintained. Establish a process for monthly review of your financial information and build in other integrity and accountability measures to prevent theft or misuse of funds or accounting errors.
Tip: If it is discovered that your spreadsheet or financial reports don’t add up, consider that a warning sign that warrants immediate investigation. Adding or changing an item on your spreadsheet or in your financial software should not create a calculation error. If it does and correction requires manual intervention, the spreadsheet is not properly set up and may mask improprieties.
–Does the board set and enforce a basic level of understanding of the organization’s financial structure for all board members and management staff, including subsidiaries and partners?
–Does the board review financial statements and budgets quarterly, and the US Form 990 or other tax submissions prior to filing them with the authorities?
–Do board minutes reflect regular review of the organization’s financial statements and annual review of tax submissions? A Treasurer’s report that does not include financial review by the board or a named board committee is a red flag.
–Is there a financial management system in place that is sized to the needs and complexity of your organization? This might be a data system, spreadsheet, or sophisticated financial management software package. Can it produce reports regularly and on demand? Is detail available for review by board, Treasurer, and executive management?
–How many times in the last year has someone (such as a member of the board, staff, or public) asked a financial question that could not be answered? This is a red flag.
Mitigation
Problems with financial management and cash flow typically need to be handled with contingency procedures and earmarked resources, so their mitigation should be built into operating budgets and reserves and operating policies as is standard accounting practice.
Accounting for Grants, Activities, and Overhead
Many nonprofit organizations have a multitude of programs, projects and are managing support from multiple funding sources. As government and foundation funders expect increasing accountability from grantee or contract organizations, the administrative burdens add up for nonprofit organizations. This is becoming a very big risk across the nonprofit world. What was acceptable or even a best practice a year ago may no longer apply. It’s important to read the fine print in every contract or grant agreement and to keep abreast of all changes in government regulations. (This is one of the examples of risks that affect multiple areas: in this case, finance and compliance. Such risks are heightened because instead of two areas attempting to deal with the risk, each may assume the other is doing so and no one is ready to act.) Accepting contracts or grants that come with reporting or administrative requirements your organization cannot manage is a major risk for nonprofits today. Additionally, some grants and contracts require an organization to do upfront spending with reimbursement to follow. It is not unusual to hear of long reimbursement delays, mid-year changes in allowable expenses or mid-year funding reductions.
What to Watch For
From the beginning of any grant-funded project (even before the application is prepared), review and highlight grant requirements that go beyond what your organization can handle operationally. Keep in mind that grants and contracts often come with unfunded mandates—compliance, accountability or operating requirements that add administrative burden and financial risk with no funding to support them. This can become a serious issue in short order if it is not recognized early on. In particular, look for items such as:
–Accounting requirements that differ in details and timing from your existing process or procedures.
–Requirements for bonds, contingencies, insurance, legal settlements, disallowances, and other expenses, even if they will eventually be reimbursed, refunded, or waived.
–Conditions or requirements for hiring, use of consultants, multi-year leases, or operational requirements that will add to your organization’s expenses.
Prevention
Preventing risks with grants, activities, and overhead includes simply deciding whether an otherwise worthwhile grant or mission-related activity is worth pursuing, or whether your organization can afford to subsidize these costs with private funds or fundraising activities. This can be an incredibly difficult choice to make, particularly if it involves withdrawing from or canceling a long-standing project or program loved by staff, the public, or clients. Assessing financial sustainability is a critical ERM activity, especially if your organization will be asked to commit to a multi-year contract or grant agreement that does not include funding for the increased cost of doing business over the term of the grant or contract.
–Does the organization have reserves, a line of credit available to smooth cash flow while waiting for reimbursement?
–Have management and board updated policies for handling reserves and borrowing on the line of credit? Does leadership understand the scope and limits of these policies? (Many organizations borrow money from contingency reserves or lines of credit for immediate needs that will definitely be reimbursed, but if the reimbursement doesn’t come, the reserve will be diminished and you may hit the cap on your line of credit and be unable to pay it down in a timely fashion.)
–Accounting for all grants or special project funding must hold up to a rigorous independent audit and meet generally accepted accounting practice standards (GAAP).
–Make certain that passwords, codes and access to your accounting system are functions handled by several staff members and that knowledge of how to use the software and generate reports is the responsibility of more than one person. Multiple people in the organization should be able to generate financial reports. Note: your password security should include a formal and protected protocol for handling a situation in which one person with a password is unavailable. A protocol based on quick reaction, “Here, use mine,” is always a risk. Sharing passwords is a breach of security standards. To avoid such a situation, make certain that there is redundancy built into your processes. (Many organizations have procedures whereby an authorized user can create a temporary password to permit access without sharing passwords.)
Mitigation
It is not uncommon for an organization to discover changes to requirements or procedures by a funder when it is already working on a grant-funded project. Although both the funded organization and the funder addressed this possibility at the outset mid-year or mid-project changes —particularly when they involve changes in procedures—can still sometimes crop up.
These issues don’t go away by themselves, so it is important to work together to manage the change in a way that limits damage or dislocation.
Dealing with Discretionary, Ad Hoc, and Emergency Situations
Unplanned events happen. Having resources your organization can utilize in an emergency or when a unique opportunity presents itself is essential. Experts advise budgeting three-six months of cash reserves or establishing a budget for new programming. On this point, nonprofit leaders often note that that they are already functioning in a precarious financial situation and cannot afford to put extra cash away. Absent budgeted reserves or new funding that includes resources for start-up, nonprofit leaders are left with few good options. The pressure to maintain funding for current programming, handle emergencies and impulse to take on new projects can create serious organizational tensions and can lead to choices that undermine the financial stability of a nonprofit.
What to Watch For
It may not seem possible to plan for unexpected circumstances, but it can be. There are almost always warning signs. Sometimes, the warning signs are present for such a long time that they become part of the background noise. Other times, they aren’t recognized at all.
When assessing your organization’s risk, as described in Part I, remember to consider likelihood and impact. Periodically review your list of risks to make certain that the likelihood that the risk will occur remains as expected previously. One reason for using an automated tool such as The Nonprofit Risk App is that you can adjust the likelihood rating so your vulnerabilities are recalculated when conditions change.
Prevention
Evaluating risk in an organization requires people who know the organization, its history, and its operations to bring their experiences to bear. Formalizing risk assessment is an essential way to monitor emerging risk or vulnerabilities. Testing systems and practices and using checklists are ways to formalize tracking of recurring risks. Another source of intelligence on risk is to solicit fresh perspectives from new employees, board members, and members of the public who may view the organization with fresh eyes. The loose doorknob or exposed wires may have “always” been like that, until it comes off in someone’s hand or begins to spark and you need to find a locksmith or electrician in an emergency.
Mitigation
Having resources for emergencies doesn’t always mean cash. Contingency planning for a critical event in advance can encompass a variety of strategies. For example, is possible to partner with peer organizations to provide assistance in the event of a fire, flood, or structural collapse. The details of this kind of planning depends on the organizations involved and their resources, but mutual aid for basic contingency operations for emergencies, extreme weather, loss of power, or threats to public safety can help both organizations maintain operations in an extraordinary situation.
Summary
If programs and services are the most visible representation of an organization, the financial operations are the fuel that make programs run.