Nonprofit accounting is unique when compared to for-profit accounting. This is primarily because nonprofits agree to reinvest all of their revenue back into the mission at hand in exchange for tax-exempt status. This means nonprofits need to be a lot more transparent about their finances in order to ensure accountability to their generous donors.
Due to this transparency and the need to be accountable to donors, nonprofits carefully implement internal controls designed to keep finances safe and prevent misuse. Internal controls are policies and decisions made to prevent the misappropriation of nonprofit funds.
In this guide, we’ll dive into ten common internal controls implemented by nonprofits and how they’re used to protect the organization’s finances and ensure effective financial management. Let’s dive into the first one!
1. Requiring two signatures on a check
While nonprofit accounting differs from that of for-profits, both types of organizations experience similar expenses that must be paid in order to keep the organization afloat. From bills to rent to event venue rentals, nonprofits may be ripping the checks out of their checkbooks on a regular basis. Especially for large transactions, many expenses must be made in person with a check or ACH transfer.
The first internal control is to require two signatures on every check that your nonprofit writes.
This policy ensures no one can write a check that hasn’t been authorized or approved by one other member of the nonprofit. You might even tighten the security for this control and require the second signature to be made by someone in a leadership position.
2. Segregating staff duties
There’s a reason that the approach of checks and balances is so effective. It’s important to prevent anyone from having complete control over more than one phase of your nonprofit’s financial operations. This is both for the protection of the organization and of those who have a hand in your finances.
Multiple eyes on your financial transactions and allocations can help your organization prevent any accidental misuse of funds or mistakes made in records. This is why you should segregate financial duties among team members. Generally, they’re segregated into four categories:
- Financial managers or leadership
- Those exercising financial oversight
- Staff with access to assets
- Staff with access to accounting records
When your organization undergoes a financial audit, the segregation of financial duties is one of the items that your auditor will look for to ensure effective internal controls.
3. Conducting background checks of staff who handle money
While a lot of fundraising activities moved online during the pandemic, your organization still needs to be prepared for when supporters provide in-person cash or checks. Oftentimes, major donors or supporters at events still prefer to give money the old-fashioned way instead of providing credit card information.
Many organizations choose to conduct background checks on all employees before hiring them, but especially for those who will be handling money in any way. Any in-person transactions should be conducted by someone who has cleared the background check and meets your organization’s preset expectations.
4. Keeping cash locked in a drawer
This internal control seems almost too simple. When you have cash located on-site at your nonprofit’s office, keep it locked up to prevent it from being stolen. In addition to this, lock the office doors and ensure your security measures are up to date.
This not only protects your cash reserves in the office, but also computers, equipment, and other valuable possessions held by your organization.
Try enacting a policy that requires your organization to check on your physical security measures on an annual basis to prevent theft. Within this policy, you might also discuss security online and in technology to prevent your staff from being the victims of hacking as well.
5. Reconciling bank statements monthly
Jitasa’s guide to fund accounting explains that one unique aspect of fund accounting is that it is more focused on an organization’s accountability rather than its profitability. This means your organization needs to be able to “account for” all funding and report on the use of that funding to supporters, the IRS, and other interested parties.
Therefore, recognizing any discrepancies and determining why they may occur is vital to ensuring the accountability of your organization, and that’s just what reconciliation allows you to do.
Reconciliation involves comparing your nonprofit’s bookkeeping records with your bank statements to determine any discrepancies. Your accountant can then determine if all funds are accounted for or if anything is potentially missing from your records. Reconciliation should be completed regularly, usually on a monthly basis, and by someone who does not write the checks for your nonprofit.
6. Preauthorizing expense reimbursements
From time to time, your nonprofit employees may spend money from their own pocket for the good of the organization. For example, a fundraiser may reserve an event venue space for an event and put it under their personal credit card. In this case, the employee will likely want to be reimbursed for the expense.
When a staff member understands that they will be spending money out of pocket for the good of the organization, they should let the organization know ahead of time so that the transactions can be preauthorized by the proper individuals.
Add a nonprofit policy to ensure that no employee approves their own expenses for reimbursement. Expenses should always be approved by another person at the organization before they’re reimbursed.
7. Approving timesheets
Timesheets can be incredibly helpful tools for business and nonprofit leadership to ensure staff members are paid the correct amount given the hours they worked for your organization. It can also be used to ensure proper recording of volunteer hours as well.
If your nonprofit uses timesheets, assign a leader to approve these timesheets and ensure correctness on a regular basis.
This approval process should be spelled out in a nonprofit policy, but it can also be built into your software system. Double the Donation’s list of online timesheet software provides a starting place to consider when looking for timesheet solutions with this feature built in. An approval process will be easier when you’re able to keep your timesheets organized and easy to review.
8. Reviewing financial reports by the board
Financial reports provide a lot of information necessary for your board members and leadership to understand in order to lead to the organization successfully. They will be able to provide better advice and direction for the organization when they understand what finances are available.
More than that, though, your board members serve as a second set of eyes on your financial information. They review the numbers outside of your financial department and will aid in catching any potential problems or mistakes.
For example, during the board’s quarterly review of the financials, one board member noticed that one of your crypto investments is not being categorized correctly. No one on the financial department caught this because it is a pretty new topic, but this board member has years of experience with these types of transactions, so it was able to be resolved in a timely manner prior to an audit.
9. Adopting a conflict of interest policy
Conflicts of interest, even if only perceived ones, can greatly damage trust in your organization and your reputation with supporters. That’s why it’s essential to create a conflict of interest policy to prevent situations that could be construed as conflicts of interest.
For example, let’s say one of your board members works in sales for a software company. The organization decides they need that same software the board member sells. So, the board member decides to sell to the organization, votes with the board in support of the purchase, and earns a commission for the sale from their employer. This is a conflict of interest because the board member directly benefits from the decision they helped the board make.
Instead, the organization should have a policy in place that the board member cannot vote in that type of situation.
10. Adopting a compensation policy
The IRS set rules about the amount of money nonprofit leadership can make, stating that executive directors’ compensation must be “reasonable, but not excessive.” In order to define this and ensure the organization is meeting the expectations of the IRS, your organization should set a nonprofit compensation policy.
Your compensation policy should outline the research your nonprofit conducts to ensure the executive salary is in line with other, similar organizations.
This means your nonprofit should conduct research to see what other organizations pay their top executives in a similar geographic location and at a similar size nonprofit. Outlining this research will help in audits to ensure your nonprofit isn’t overcompensating employees.
Internal controls are essential to helping nonprofits keep their finances safe and correct. Moreover, they help your nonprofit maintain trust with your community of supporters. When supporters give to your cause, they want to know that their funding is being taken care of and used appropriately. If you breach that trust, your nonprofit will lose many supporters.
So use these as a basis and continue expanding on your organization’s own internal controls policies to ensure a secure financial system.