When not-for-profits lose funding sources, default on loans or leave employees unpaid, board members can clearly see that they’re in financial crisis. Often, a board can avoid such disasters by noticing the signs of financial distress. By keeping an eye out for the following problems, a board can take prompt action to minimize the damage and ensure the organization’s long-term survival.
Looking at Budgets
Several budget-related issues hint at rocky financial times to come. Most obviously, board members should worry about a nonprofit with no budget. The lack of an operating budget suggests an undisciplined approach to fiscal matters. Larger nonprofits also should not only have an overall operating budget, but should also have budgets for each program or department. Ideally, board members will see that budgets proposed by management are in line with the strategies already developed and approved by the board.
Once a budget has been approved, the board should monitor it for unexplained variances. Some variances are bound to happen, but staff must explain significant discrepancies. There may be a reasonable explanation. The staff might, for example, point to program expansion, funding changes or economic factors beyond the organization’s control. Where necessary, the board should direct management to modify activities to mitigate negative variances, for example by instituting cost-saving measures.
Board members also should beware of overspending in one program that is funded by another. Also, watch for dipping into the organization’s “rainy day” fund, raiding an endowment or engaging in unplanned borrowing. Such moves might mark the beginning of a financially unsustainable cycle.
Importance of Financial Statements
Inconsistent financial statements — or statements that aren’t prepared using U.S. Generally Accepted Accounting Principles (GAAP) — can lead to poor decision-making and undermine a nonprofit’s reputation. They also can make it difficult to obtain funding or financing if deemed necessary. Financial statements not prepared in accordance with GAAP, or another comprehensive basis of accounting, also can be unreliable and are difficult to compare to others in the industry.
For larger nonprofits, the board or audit committee should also insist on annual audits and expect to select the audit firm. Members of the responsible group should communicate directly with auditors before and during the process. And all board members should have the opportunity to review and question the audit report.
The board generally should receive the nonprofit’s financial statements within 30 days of the close of a period. Late or inconsistent financials could signal understaffing, poor internal controls, an indifference to proper accounting practices or efforts to conceal.
If the board starts hearing from long-standing, passionate supporters who’re harboring doubts about the organization’s finances, that’s a very bad sign. What are they seeing or hearing that prompts their concerns? The board also should note when development staff begins reaching out to historically major donors outside of the usual fundraising cycle. These contacts could mean the organization is scrambling for cash and hoping its most dependable donors can help fill the gaps.
It’s understandable that board members who have full-time jobs and other responsibilities might cede some of their responsibilities to a trusted executive director. It’s also risky. The board should think about making some changes if the executive director is allowed to ignore expense limits or makes strategic decisions without board input and guidance.
While board members need to remain alert for trouble spots, it’s important not to jump to immediate conclusions if a red flag is uncovered. Further investigation is almost always required. The mere existence of a warning sign doesn’t necessarily merit a dramatic response, especially if it’s the only warning sign.
Some problems prove easily correctable by, for instance, outsourcing some accounting functions if the finance department is understaffed. On the other hand, multiple or chronic issues could call for significant strategic changes. One thing is certain, though: Inaction in the face of trouble spots is a mistake.
McConnell & Jones knows that a a strong board and solid financial controls is the essential foundation of any effective nonprofit organization. Contact our team today with your questions – we’re ready to help.
Johnson Olatunji, CPA
Senior Assurance Manager
Public Assurance Services
Marlon Williams, CPA
Public Assurance Services
Odysseus Lanier, CPA
Risk Advisory Services