Regulating the Flow

Regulating the Flow

In today’s world, almost everyone who makes a donation to a nonprofit wants to know that their contribution is being used adequately, responsibly, and honestly. Nonprofits that mismanage their funds often make headlines that outrage members of the public, and it’s easy to understand why. When an individual chooses to support a particular cause and their funds are wasted on administrative negligence, the perception of the organization that the donor is left with is essentially tantamount to theft and deception.

That’s why it’s so important for the governing bodies of nonprofit organizations to establish financial controls to protect the assets of the group and ensure that its funding is being allocated for the proper reasons. Ultimately, these controls are about accountability and mitigating risk – which many small nonprofits are particularly vulnerable to.

“A staff person who wants to commit fraud is in prime position if he or she processes the whole transaction from start to finish.”

 

-Nonprofit Overhead Cost Project

The Nonprofit Overhead Cost Project published a study on several specific ways in which nonprofits can improve their financial controls and better protect themselves from things like fraud and waste. The project, which is a collaboration between the Center on Philanthropy at Indiana University and the Center on Nonprofits and Philanthropy at the Urban Institute, was created to better understand how nonprofits raise, spend, measure, and report funds for fundraising and administration, and to work with practitioners, policymakers, and people in the accounting profession on the national level to improve standards and practice in these areas.

The researchers’ findings and recommendations for nonprofits fell into four key areas:

  • Financial controls
  • Financial reporting
  • Financial staffing
  • Organizational effectiveness

Implementing these strategies will help your nonprofit accurately track and report your overhead expenditures in financial statements. Let’s take a closer look at the specific advice the researchers detailed in their study:

Financial Controls

The need for adequate financial controls was recognized by members of the Nonprofit Overhead Cost Project when researchers began to notice obvious financial risk factors among nine in-depth case studies that were performed as part of the initial phases of the project. Specifically, researchers found that smaller nonprofit organizations are uniquely exposed to risks in that their low staff numbers typically mean that only a few individuals – or only one – are responsible for most of the financial management.

“Smaller organizations often had only one person who handled financial matters,” researchers said. “This makes is hard to implement separation of duties—a basic principle of financial control—such as having different people entering invoices, cutting checks, and signing checks. A staff person who wants to commit fraud is in prime position if he or she processes the whole transaction from start to finish.”

Based on these findings, researchers advise nonprofit administrators to conduct a special review of their financial controls with an outside financial advisor. For nonprofits that work with auditors, they too are advised to have the auditor provide reports on the adequacy of the organization’s financial controls on an annual basis. While contracting an outside party might consume already scarce resources, it must be made a priority to ensure the organization’s assets are safeguarded.

Financial Reporting

“In our study,” researchers noted, “the biggest problem area in both kinds of financial documents (audited financial statements and Forms 990) was the reporting of functional expenses. Analysis of over 220,000 Forms 990 found widespread reporting that defies plausibility in the functional expenses used to make those calculations. The widespread reporting of zero fundraising costs has been a focus of both Congress and the media.”

The study continued, in fact, to say that reporting errors are so widespread among such a high percentage of nonprofits that researchers’ only recommendation would be that all nonprofit boards should initiate a full review of any and all financial reporting that the organization is responsible for. They recommend bringing in an outside financial consultant and not relying on in-house auditors to raise these issues.

Financial Staffing

“The quality of financial controls and reporting at the nonprofits we studied was a direct reflection of the amount and qualifications of staff devoted to the work. It is an especially serious problem at smaller nonprofits,” researchers wrote.

Their recommendation on this front was pretty cut-and-dry. Every nonprofit organization should have at least one individual qualified to perform assessments with the quality of financial staff. Don’t let under-qualified employees work your books.

Organizational Effectiveness

The last item that researchers noted relates directly to a nonprofit’s organizational infrastructure, or lack thereof, and how it can effect operational efficiency. This directly refers to a nonprofit’s accounting, fundraising, information technology, human resources, and other physical resources.

“Far from making them good stewards of the contributions they receive, the excessively low overhead at many nonprofits, especially smaller ones and those receiving significant public sector funding, is hampering their overall effectiveness. To meet their responsibility, boards must find ways to provide for adequate organizational infrastructure to support organizational effectiveness,” researchers said.

For smaller organizations, the researchers recommend considering alternatives, such as merging with an entity that has adequate infrastructure, outsourcing infrastructure services, or perhaps restructuring into a smaller or more volunteer-centered organization where infrastructure issues are less critical. Basically, the bottom line is, if your facilities are holding you back, then you’re unlikely able to fulfill your mission.

 


Need to vet a nonprofit before donating? There are several online resources you can use:

  • ProPublica’s Nonprofit Explorer
  • Charity Navigator
  • GuideStar
  • CharityWatch

 

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