We’re a small nonprofit. What internal controls do we need to have in place?

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This guest post is an excerpt from The Board Member’s Easier Than You Think Guide to Nonprofit Finances, by Andy Robinson and Nancy Wasserman, published by Emerson & Church:

We’re a small nonprofit. What internal controls do we need to have in place?

If you’ve spent time in airports, you’ve undoubtedly seen unaccompanied minors. Maybe they’re off to see Grandma, or heading to summer camp, or shuttling between parents who live in different cities.

Airlines have elaborate procedures for handing these children from one responsible adult to the next: from parent to check-in staff to gate agent to flight attendant to gate agent to Grandma. When they’re not on planes, the kids are herded from one secure holding area to another. Every movement and handoff is tracked. If the system fails, as it rarely does, it’s big news.

When we talk about financial controls, it might be useful to think about all the ways your organization can receive, hold, or spend money (grant payments, bank accounts, credit cards, and so forth) as unaccompanied children. Without appropriate procedures, and without designated people engaged throughout the process, money can be misdirected or embezzled.

Effective financial controls have three attributes: they ensure safe care of your assets; divide responsibilities among several people; and are fully disclosed to, and understood by, all concerned parties.

Let’s begin with custody of assets: The first step is to create strong physical controls in the workplace. All your cash and the means of transferring it – checks, bank account numbers, passwords, petty cash, credit card numbers, and even the cards themselves – should be locked up.

Sounds obvious, right? Well, we recently learned about an enterprising nonprofit employee who took a few blank checks each month from the box of extra checks, forging the executive director’s signature before cashing them. A total of $11,000 disappeared. Now the only people with keys to the check drawer are the executive director and the treasurer.

And we’re not just talking about physical assets, such as credit cards. Secure your computers – especially those containing financial software – with passwords and restricted access. Use lockouts to close computer programs when staff members are away from their desks. Back up important data regularly and store it off-site.

The second principle of good financial controls is separation of duties so that multiple people are involved in most transactions, making it harder for someone to run off with the money. Smaller organizations commonly ignore this principle, which can lead to disaster.

A sad-but-true story: A parent-teacher organization in the Pacific Northwest was raising money for a middle school field trip through the usual means – bake sales, car washes, and raffles. One volunteer parent handled all financial duties, including depositing cash and reconciling the bank statements. When she needed money for personal expenses, she secretly borrowed from the account, then paid it back. After a while, she stopped paying it back. By the time the crime was discovered, this well-meaning volunteer had stolen $10,000, and the field trip was cancelled.

How did this happen? No one else ever looked at the bank statements.

To create appropriate separation of duties, many organizations require board approval for expenditures above a certain amount, and may also require two signatures on checks. (Beware: banks sometimes disregard your two-signature policy and will cash the check anyway.)

If the bookkeeper prepares checks to pay the bills and records payments, someone else should sign the checks. Ideally, a third person receives the unopened bank statement (or has a unique password for online access) to reconcile the account. In small to mid-sized organizations, that third person is often the volunteer treasurer.

In cases where the executive director or finance director prepares financial statements, the finance committee or treasurer should review the numbers before presentation to the full board. These outside eyes often find discrepancies: “How come our travel expenses tripled last month?” or “We have $4,000 in miscellaneous expenses; what does that mean?”

Separation of duties should be incorporated into your entire chain of financial actions, from authorizing, executing, and recording expenditures through receiving, recording, and depositing income. Ask yourselves: In our organization, where are the weak links in the chain? Where are our assets most likely to be lost or stolen, and how do we separate duties to protect ourselves better?

The third principle of good financial controls is transparency. In exchange for serving the public good, nonprofits are exempt from most state and federal taxes. Because your group literally belongs to the community, your IRS returns and other government filings are public information.

Like it or not, everybody knows your business. Smart organizations embrace this reality and use it to their advantage. For example, many organizations receiving high marks on rating services such as Charity Navigator – these services evaluate your nonprofit, in large part, by reviewing your government paperwork – tout their scores to show that they use money efficiently.

Begin by clarifying who does what, so everyone on the staff and board understands your financial system. Create a flow chart or map showing how money moves through your organization, both in and out, and who is responsible at each stage. On the following page you’ll find an example for handling income that might work well for a small organization with a limited number of staff:

This is bit like the airline employee informing the parent, “I’m going to bring Johnny through security myself. When we get to the gate Maria takes over; she’s the gate agent. She’ll keep an eye on him until he’s safely on the plane. From there, the lead flight attendant will take care of him until they land in Los Angeles.”

An outside accountant can help you build a culture of transparency within your organization. Accountants often raise concerns about your financial management systems, share those concerns with leadership, and assist you in making corrections and improvements. By conducting an audit certified by an accountant, you announce to the world that you strive to manage your finances effectively, you welcome professional scrutiny, and you have nothing to hide.

If your organization is affiliated with a larger network, you may be required or encouraged to meet standards set by the national office. The Planned Parenthood Federation of America has a rigorous review process for local affiliates that covers a variety of business practices, including financial management and board governance. The Land Trust Alliance offers voluntary certification for local and regional land trusts. Peer reviews such as these add another level of credibility to your work; your staff should know if something similar exists for your category of nonprofit.

Like Johnny’s reunion with Grandma, the nuts and bolts of financial controls are largely invisible unless they fail.

About the Authors

Andy Robinson (www.andyrobinsononline.com) provides training and consulting for nonprofits in fundraising, board development, marketing, earned income, leadership development, and facilitation. Over the past 16 years Andy has worked with organizations in 47 U.S. states and Canada. He specializes in the needs of groups working for human rights, social justice, environmental conservation, arts, and community development. Andy is the author of several books including How to Raise $500 to $5000 from Almost Anyone and Great Boards for Small Groups, both available from Emerson & Church.

Nancy Wasserman is the principal of Sleeping Lion Associates (www.sleepinglion.net), a consulting firm that works with mission-driven ventures to identify, analyze, and address strategic questions and develop plans for implementing new programs or ventures. She has helped businesses, nonprofits, cooperatives, and government agencies better understand their financials, prepare feasibility analyses, and develop business and program plans. Nancy has extensive experience with groups working in social finance, sustainable development, energy efficiency, agriculture, and affordable housing.

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