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Internal Controls for Small Nonprofits: Monitor Financial Statements

best practices board finances fraud reporting Sep 28, 2023

     As nonprofit organizations, we have to remain committed to protecting and stewarding all of our resources. Yet, I’m often asked, “What do you actually do? How do you even do that if you only have a small staff with one finance member?”  To help with these common questions, I've provided a series of five articles and videos outlining the specific elements I recommend for small nonprofits to better protect themselves. Today we'll take a closer look at monitoring your financial statements. 

     You should be monitoring your financial statements regularly. So what does that look like? It's a process that helps you detect any fraudulent activity or any errors that are happening in your financial records. Monitoring your nonprofit’s financial statements will also empower you to spot trends early that need to be acted upon sooner, rather than later. It's important to establish a timeline that ensures frequent review of financial statements. I recommend reviewing statements monthly, but at a minimum, they should be reviewed at least quarterly  by your board. 

5 Steps to Monitoring Financial Statements

1. Understand the Purpose of Each Financial Report

     First of all, we need to understand the purpose of the financial reports. There are essentially two basic types of reports. The first type is a statement of financial position or balance sheet. This report includes your assets (what you own), your liabilities (what you owe), and the resulting net assets, which should be further broken down into restricted net assets and unrestricted net assets according to donor restrictions or internal designation by your board. 

     The second type of report is an activities report or an income statement. It is used to show the financial performance of the nonprofit. It includes all the money that came in, or revenue, and all the money that went out- the expenses. This report should also include a comparison of budget to actual results. Most of your financial reports will generally fall into one of these two broad types of reports. 

2. Establish Clear Policies for Preparation of Financial Statements

     Next, you should establish clear policies for how the financial statements should be prepared. I know I say it again and again, but you need to know how it's done and you need it documented. You need a financial handbook or a financial policy and procedure manual that addresses the protocol for how these tasks are done, how they're recorded, how they're approved, and how they're reconciled, and how the financial statements are prepared. I’d also like to point out here that all financial reports should be generated directly from your software system. They should be printed, and they should be coming straight out of your accounting software, not manipulated in Excel. Every accounting program I’ve ever worked with has the ability to create a presentable financial report and it doesn't need to go to Excel to have it done. Introducing Excel into this process is high risk. If you're getting Excel financials, you have no assurance that what you're seeing is actually in the accounting records. Excel reports can easily be manipulated! Rather than using Excel, let's slow down and learn how to use our software to create the reports that we need.

3. Utilize a Second Reviewer

     The next step in effectively monitoring your financial reports is to have a second reviewer. Having an extra set of eyes review your financial statements reinforces the importance of separation duties. If your financial staff member is also the person preparing the financial statements, then you need a board member, a volunteer, or a trusted friend of your organization  to review those financial reports and highlight anything that they find questionable. This will not only help reduce errors, but also ensure that someone is frequently and intimately familiar with the financial reports. 

4. Use Financial Reports to Monitor Your Progress

     Your financial reports aren't just a rear view mirror showing you what happened behind you! They are tools for monitoring your current progress towards your current goals. They can help you look at whether or not enough revenue is being generated or whether expenses are being managed. They can help you make big decisions about programs that need to grow or shrink or even go away. When leadership has the right financial information, the organization is going to be able to adjust its strategy in real time to meet its goals. That's what matters.

     I want to tell a quick story to illustrate this. I worked with a nonprofit who had several events that were being planned collaboratively by multiple departments. And as I was watching the finances happen, I started noticing a ton of expenses that were going above and beyond what I saw the budget to be. So, as the person assisting with financial reporting on the backend, I introduced to them the concept of a post-event financial report. It's just a report that shows all the event revenue by type, and all the expenses by type, and the net income.  In this example, their net income was negative, meaning it was  costing them something to put this event on. We also included participant information in order to quantify not only the net cost of the event, but also the cost of that event per participant. This report proved to be incredibly enlightening and brought attention to some areas of concern that would have otherwise been overlooked, simply because the  information was rolling in one little piece at a time rather than in one comprehensive event report. Organizing and reviewing the event information in this way empowered that nonprofit to make much more intentional and strategic decisions moving forward. My point in sharing this example is to illustrate how you too can transform your financial reports from  mere historical records to relevant and effective tools for making current strategic decisions and setting goals for the future.

5. Share Financial Reports with Department and Program Leaders

     The final element of utilizing your financial reports as an internal control is to make sure financial reports are being given to department or program leaders. You should ensure that the people closest to the transactions are seeing their financial results. These leaders will be most likely to know if the numbers on these reports align with what they expected or if something seems way out of whack. Sometimes it's helpful to review these reports in a leadership team meeting where everyone is given an opportunity to report on their financial results, the struggles they’re having, the challenges they anticipate, and what they currently need. This collaboration can dramatically increase the accountability and transparency of finances in your nonprofit. 

     I hope this series has been helpful to you! This five-part series is all about giving you some elements that can become actionable for you as a small nonprofit to put some practices in place that will prevent fraud and misuse of finances in your organization. If this has been helpful for you but you'd like to dive deeper and talk one-on-one with someone about your specific situation, I'm available! You can book a strategic consult with me to talk about your own unique questions. I'm here to serve you!

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