Nonprofits are created to solve problems or meet needs that for-profits are not addressing because there is no profit in it. Yet, nonprofits cannot be successful unless they can generate revenues in excess of expenses from grants, donations, contracts, and fees. The truth is that it's a lot harder to generate more revenue than expenses in the nonprofit world. In almost all cases, we cannot total up our costs, add a slice for profit and new investment, and charge it back to a customer. In fact, for most nonprofits, our customers are a source of costs, not revenue.
Adding to the difficulty of our business model is that there are many reporting requirements and special rules attached to money in the nonprofit sector. There are special tax rules at the federal, state, and local level and very specific accounting rules to follow.
Four Essentials of Nonprofit Financial Management
For these reasons, having top-notch financial management is essential. There are four essentials to managing your money:
- Periodic outside review by an independent professional
- Clear policies and procedures and strong internal controls
- Transparency, accuracy, and careful monitoring of financial conditions
- Board and leadership understanding of the financial reports
Audits and Financial Reviews
Neither donors nor boards and managers should rely on the audit process alone to assure that the organization is managing its finances appropriately. Most organizations should receive some level of independent financial assurance service. Annual audits are highly recommended for large organizations and those with federal contracts, while a two-to-three year cycle of audits and financial reviews are suggested for smaller organizations. If your organization is preparing for a financial audit, you will find some helpful information in this article: Approaching an Audit.
An organization too small to pay for an audit should periodically find an accountant or bookkeeper familiar with nonprofit financial requirements (a volunteer or someone paid on contract) to look over their books, financial reports, and processes. This will not be the same as an audit, but it can help you avoid major problems.
Policies and Internal Controls
The tools below provide guidance, so your organization will have key policies and internal controls in place:
- Internal Controls Checklist
- Five Internal Controls Designed for a Small Nonprofit
- Checklist for Monthly Closing Process
Monitoring Financial Performance
The executive and the board must monitor the organization's financial performance to be sure that it's:
- Fulfilling its grant and donor requirements
- Complying with GAAP financial practices
- Managing cash flow
- Monitoring the budget
- Meeting all tax obligations
- Ensuring that staff have the resources they need to do their jobs
Speaking of taxes, read What Not-for-profits Need to Know About Tax Compliance (Jacobson Jarvis & Co.) to ensure you understand your obligations, especially those unique to nonprofits.
Ensure that Leadership and Board Understand the Financial Reports
Your financial statements tell your story to government, donors, volunteers, and foundations. If you do not understand the story the statements are telling, you may not know what is helping or hurting your success with fundraising.
- The income statement, also known as the statement of activities, reports on the organization's income and expenses for the period. It can hurt your fundraising efforts if this shows an unexplained large deficit or large surplus.
- The balance sheet, also known as the statement of financial position, describes the organization's assets, liabilities, and net value. If you have high liabilities compared to your cash, the organization may be seen as unstable.
- Funders and donors are also interested in understanding how broad the organization's sources of income are and the ratio of overhead and fundraising expenses to direct program expenses.
This Financial Red Flags Checklist gives you some ideas about concerns a foundation, government contract officer, or individual donor may have based on a review of your financial statements.