Understanding Nonprofit Financials

Nonprofit Board responsibilities encompass many areas, including financial oversight to fulfill the stewardship role known as “Fiduciary Responsibility.” Understanding fiduciary responsibility is critically important because nonprofits collect and spend other people’s donated money. Failing to act with due care in the best interest of the nonprofit has serious consequences, such as loss of public trust. Lost trust equals lost donations.

One fiduciary activity is monitoring the nonprofit’s financial performance to ensure that funding requirements are met to support the mission. Board members, usually those serving on the Finance Committee, must receive complete periodic financial statements to oversee financial performance in relation to the budget, financial ratios, etc. 

Even if the Finance Committee is made up of experienced financial professionals, they may not have experience with reading nonprofit financials, which are presented differently than “regular” financials. Getting all committee members up to speed on reading nonprofit financials is no small task. Many nonprofits need help. 

Well, I have some good news for Nonprofit Boards to fulfill their fiduciary responsibility – two options for help with Understanding Nonprofit Financials:

  1. The Arlington Chamber of Commerce is hosting a virtual event, Nonprofit Forum: Understanding Your Nonprofit Organization’s Financial Health on Tuesday, July 20, from 11:00 a.m. to12:30 p.m. This educational event includes a dive deep into the details of financial statements, such as statements of financial position and cash flows to help nonprofit Boards understand and place value in these financial reports. Follow this link for details and registration – https://web.arlingtonchamber.org/events/Nonprofit-Forum-Understanding-Your-Nonprofit-Organizations-Financial-Health-3623/details
  1. BoardSource is an organization that provides resources for nonprofit governance and management, including financial oversight. Some resources are free, and others require paid membership. Check out their resources for Nonprofit Boards at https://boardsource.org/board-support/, including a free white paper describing how Boards can identify “yellow” and “red” flags in their financial statements. https://boardsource.org/financial-statement-flags/ 

Nonprofit Board responsibilities include financial oversight and fulfilling fiduciary responsibility. Understanding nonprofit financials, which are presented differently than “normal” financials, is critically important to making appropriate financial decisions and ensuring donated funds are used in support of the mission. Even experienced financial professionals serving on nonprofit Boards need help. Good news for them that BoardSource and the Arlington Chamber of Commerce have resources to help them understand their nonprofit financials.

Prevent Fraud in Your Nonprofit

Nonprofits are even more susceptible to fraud losses than other organizations because of typically lower levels of staffing and technology. Fraud is also more prevalent in nonprofits due to a common assumption that everyone working there, especially volunteers, is nice, honest, and trust-worthy.

Unfortunately, high levels of trust and low levels of staffing and technology can give free reign to people who are unscrupulous or experiencing extreme financial pressures. A lack of processes and controls can give those individuals the opportunity to steal donations that nonprofits work really hard to raise. Not to mention that being a good nonprofit steward is part of the trust relationship with financial donors.

Recognizing that fraud can happen and implementing a proactive action plan help to prevent nonprofit fraud. Nonprofits can implement practical and cost-effective steps to minimize the chance that a fraudulent act will occur by taking these three fraud prevention tips:


  • Separate Tasks – The most powerful weapon against fraud is separating tasks or duties. Separation of duties prevents one person from having too much control over financial activities, like separating expense approval and check signing from the person who reconciles the bank account.


  • Report Anomalies – Identify anomalies, or exceptions, from expected conditions or results highlights events or actions for additional review and action. Reporting unusual activity or results to an independent reviewer could end up drawing attention to and ending fraudulent activities.


  • Independent Oversight – Periodic independent reviews performed by a knowledgeable party is another way to safeguard nonprofit financial assets. Methods include audits and effective governance, such as the Board’s financial statement review and the Treasurer’s review of all expenses incurred by the Executive Director.


Recognizing that fraud can happen and implementing a proactive action plan to minimize the risk are important steps for preventing nonprofit fraud. Powerful weapons like separating tasks, reporting anomalies and independent oversight reduce the risk of losing donations that nonprofits work really hard to raise.

Nonprofit Stewardship Requires Good Processes

Stewardship is a promise to engage in responsible planning and management of resources. The stewardship concept can be applied to nature, economics, health, property, and information. For nonprofits, stewardship usually means the responsibility to make sure that the organization spends donations cost-effectively in support of the mission.


Nonprofits need to have good processes and systems to fulfill their stewardship role. Nonprofit Board members and management each have roles and responsibilities to implement and manage the processes needed to fulfill the promise to spent donations wisely and sustain the organization.


Nonprofits need to have good processes in three important areas to manage donations and make sure they are spent effectively:


  1. Verification – Collecting financial information and verifying that it is complete and accurate sounds basic, sure, but it’s so important! Capture donation information from all sources, like credit cards, checks and third parties. Reconcile deposits to donation reports. Confirm that all donor restrictions are documented so that promises to use funds for a specific purpose can be fulfilled.


  1. Anomaly Management – Identifying and following-up on occurrences that shouldn’t happen, or anomalies, helps nonprofits correct issues. Managing anomalies early in the process helps people work more efficiently and saves time researching issues. This approach can also help to identify the root causes that cause anomalies so they can be corrected to avoid recurrences.


  1. Independent Oversight – An important role of nonprofit Boards is to perform independent reviews of the organization’s financial performance and to take remedial action to address any issues. The Board is also tasked with assuring that financial accounting and standards of practice for nonprofits are followed and that financial functions are performed by qualified staff or consultants.


Nonprofits have a stewardship responsibility to use donations effectively to support their mission. By focusing on three important areas to manage donations and make sure they are spent effectively, the Board and management can fulfill those stewardship responsibilities.


Players for a Winning Advisory Team

As a business owner or nonprofit leader, you are an expert in your field. But one individual cannot be an expert in all the areas required to run an organization. You need a team of trusted and qualified advisors to guide you through setting up the organization, planning for sustainability and growth, and managing the operations.


Who are the Players you should have on your Winning Advisory Team? Every organization should recruit Players for these five Advisory Team Positions:


  1. Legal – You need input from an attorney to decide what type of entity to form (e.g., sole proprietor, partnership or corporation), know the applicable laws for your organization, develop contracts, and establish human resource and other policies. Nonprofits also need guidance for establishing bylaws and protecting the Board.


  1. Financial – Setting up your financial record keeping, reporting, and processes is not as easy as loading the accounting software. You need a financial professional with experience establishing and performing the accounting, financial reporting, and monitoring necessary for accurate and reliable information to run the organization.


  1. Insurance – Protecting your organization, its people, and its assets could mean transferring risk to insurance coverage. An experienced insurance professional will help you understand what types of coverage are needed and how much. Working with an independent insurance broker provides more choice in coverage options.


  1. Taxes – Even if you prepare your own income taxes, you are probably not equipped to keep up with all the business income, payroll, property, real estate, sales, excise, and other tax rules and requirements. Not to mention the special information filing requirements for nonprofits. A tax professional is needed on every team.


  1. Information Technology – Organizations depend on technology for their day-to-day operations and to secure their information. Every organization needs an IT professional to keep its operating system, applications, phone system, e-Commerce, and other connectivity up-and-running and secure. If your systems go down, you go down.


Your business or nonprofit must have a Winning Advisory Team to set up, manage, and grow the organization. Recruiting for the right Winning Advisory Team members will put you on track for a winning season this year, and in future years.


Managing Nonprofit Risk

Nonprofits are always focused on serving the community, raising funds, and recognizing volunteers. They often overlook identifying and managing the organization’s risks. That can result in some nasty and expensive surprises.


Nonprofit organizations have all the risk exposures that for-profit businesses have. Plus, they are exposed to other risks peculiar to nonprofits, like risks associated with taking donations and engaging a volunteer workforce.


Failure to appropriately manage nonprofit risk can result in reputational damage and a drop in fundraising. In addition to the “normal” processes and insurance coverages used by for-profits, nonprofits should also manage risks related to these four groups of stakeholders:


  1. Directors & Officers

Board directors and key officers, such as the Executive Director, are responsible for making decisions and taking actions using donated funds. The Board should have a robust set of financial policies to establish risk tolerance and decision-making parameters. To further protect those individuals, consult an insurance specialist about appropriate coverages for various liabilities, based on activities and size.


  1. Employees

Every work environment requires guidance for its employees to communicate employer and employee responsibilities, work conditions, benefits, and rights. Employee or Personnel Manuals assist with training and holding people accountable. Employee candidate screening, especially for staff who work with vulnerable populations or financial assets, is a common risk mitigation tool.


  1. Volunteers

Even though they don’t get paid, volunteers should also have set of procedures to guide their recruitment, training, supervision, and expected conduct. Volunteers should also undergo a screening process and be supervised to ensure that she or he is following the organization’s rules and standards. Volunteers involved with serving vulnerable populations or handling donations should undergo additional screening, training, and supervision.


  1. Clients/Participants

Most for-profit businesses provide services or goods to anyone who needs them. Nonprofits can’t necessarily do that because they have a mission and policies that strictly define who is eligible to receive their services. Managing the risk of providing service outside the mission is mitigated by clear, consistent client in-take and screening procedures.


Nonprofits that manage risk for their directors, employees, volunteers and clients experience fewer surprises that can interrupt service delivery and damage reputations. Getting ahead of those risks with a few preventive measures allows nonprofits to focus time and energy on the mission — serving the community.

Monitoring Nonprofit Finances

Nonprofit Boards have a big job. One of the biggest parts of that job is fiduciary responsibility — making sure that the organization is funded, and that funds go to supporting the mission. Reviewing organization’s financial condition is one way that Boards fulfill their fiduciary responsibility.


How do Boards review the organization’s financial condition? It all starts with receiving and reviewing periodic financial statements, and analyzing financial performance in relation to the budget and financial ratios.


Nonprofit Boards should monitor financial performance and take action in four areas:


  1. Budget vs. Actual Performance

The year-to-date budget should be compared to actual performance. Analyze variances between budget and actual performance, especially for key income and program or administrative expense categories. Identify why variance from plan are occurring for significant differences and line items.


  1. Liquidity

Periodically assess four financial ratios to identify trends and their impact on fundraising and other plans:

  1. Days Cash on Hand – days of operation with no funds received and no investments liquidated
  2. Days Cash and Investments on Hand – days of operation after liquidating investments and before borrowing funds
  3. Current Ratio – divide current assets by current liabilities to assess overall financial health
  4. Debt Ratio – divide total liabilities by total unrestricted net assets to assess the need to reduce leverage


  1. Fund Raising

Assess the potential for overreliance on one individual funding source, indicating the need to diversify. Benchmark fundraising expenses in relation to funds raised against Charity Navigator or another metric to determine the return-on-investment of individual fund raising events and activities.


  1. Program Expenses

Measuring the relationship of each program’s expenses to overall expenses helps the Board to prioritize their attention on programs where more organizational resources are invested.


Nonprofit Boards fulfill fiduciary responsibility by monitoring the organization’s financial condition and making prudent decisions to maintain financial stewardship. By focusing on the four financial areas above, Boards can assess and act appropriately on financial performance.


The “Overhead Myth” Starves Nonprofits

Last week, a Tweet I saw really grabbed me – “Underinvesting is expensive! Starving nonprofits leads to inefficient systems.” It was from The Bridgespan Group, a global nonprofit that helps other nonprofits in the hard work of developing strategies.


Working with less means you get less.


For some reason, non-profits are expected to run on a shoestring. Starving nonprofits limits investments in the necessary people and systems to perform effectively.


GuideStar USA, Inc., used the nonprofit data they collect and report to form a business case to help break the “overhead myth” about limiting overhead costs. They offered steps to debunk the myth and shift the conversation from overhead to the need to invest in people and systems.


Five Steps to Debunk the “Overhead Myth”:


  1. Clearly document objectives and the intended impact of meeting those objectives. This informs donors about your mission and community, and sets the framework for measuring impact.


  1. Describe the strategies employed to achieve stated objectives and impacts. Donors are more inclined to support nonprofits that connect strategic goals with action plans and expected results.


  1. Discuss the capacity to deliver the programs and services to meet stated objectives. Describe capacity investments needed to establish and sustain the necessary infrastructure to support programs.


  1. Tell donors how you measure progress. This communicates that you are monitoring the achievement of your organization’s goals and helps donors trace the impact of their gift.


  1. Share results from recent work and describe additional results that you want to achieve. Highlighting successful projects illustrates how goals are achieved and helps donors visualize their gift in action.


Charting your non-profit’s objectives and impact, and the investment needed to deliver effective programs debunks the overhead myth. Helping donors understand infrastructure needs will compel them to give.


More tools and information to help non-profits to re-direct donor conversations from the “overhead myth” to performance and results are found at www.overheadmyth.com.

Nonprofit Board Treasurer Duties

A few weeks ago, I blogged about nonprofit Board duties required to fulfill the financial stewardship and oversight role. This legally-defined role is known as “Fiduciary Responsibility.” This week, I provide more details about the Board Treasurer’s important financial oversight role.


The Treasurer is the primary financial officer of the organization. As such, she or he should have the experience and background to be knowledgeable about financial policies and functions necessary effectively manage and understand nonprofit finances. Some professions that make good Board Treasurers were described in another previous blog post.


Four important Treasurer Duties and Responsibilities are to:


  1. Assure that the organization is following appropriate financial policies and that qualified individuals perform financial functions. The right policies and people are more likely to provide the desired results, such as reliable and complete financial information.
  2. Understand regulatory and legal requirements for financial accounting and standards of practice for nonprofit organizations and assist other Board members in understanding and fulfilling their oversight and fiduciary responsibilities.
  3. Assure that accurate financial records are being kept, monitored, and used to take necessary action to sustain and protect the organization’s finances. Regularly provide the Board Chair and the Board with an accounting of the organization’s financial condition.
  4. Assist in preparing the annual budget and presenting the budget to the Board for approval, and in selecting an independent auditor, reviewing the annual audit results, and answering Board members’ questions about the audit.


Nonprofits with Treasurers who fulfill these four fiduciary duties are more likely to make appropriate financial decisions, meet donor expectations to protect and preserve financial assets, and ensure that regulatory and legal requirements are addressed.