New Fiscal Year, New Internal Controls

As nonprofits begin their fiscal-year closing process and plan for the coming year, it is the time to evaluate internal processes and procedures. Some common areas to consider include:

1. Properly tracking restrictions on donations, gifts and grants
2. Properly documenting existing approval processes
3. Addressing cash flow issues in a timely manner

Tracking restricted donations, gifts and grants

Country singer Garth Brooks made national headlines five years ago when he requested that Integris Canadian Valley Regional Hospital of Yukon, Oklahoma return the $500,000 donation he had made in his late mother’s honor. Brooks alleged his endowment was mishandled and violated the parameters of his agreement with hospital administrators. He ultimately sued the hospital for breach of contract and won a million dollar settlement after a jury trial in 2012.

The case is a nonprofit organization’s nightmare, both financially and in terms of public relations. Nonprofits often receive donations, gifts and grants restricted to a particular purpose. As well, while many endowments are made for perpetuity, some are designated for use within a particular period of time. Regardless of the specific restrictions and stipulations of a given donation, it must be tracked and its mandates adhered to in order to provide evidence that the funds were used in the manner intended by the donor. If restrictions, including those that were verbally communicated, are not properly tracked, the nonprofit’s staff could find itself buried under a mountain of e-mails, board minutes, and donor letters trying to piece together the uses for the donors or their auditors. And where no documentation can be located, such as in the Garth Brooks case, a nonprofit organization could be obligated to return the funds to the donor.

The beginning of the fiscal year is a great time to put in place a process to effectively track restricted donations, gifts and grants. It is imperative to either adopt or create a standard process for documentation of a donation when it is received to ensure that all restrictions are recorded and subsequently followed.

Additionally, with the adoption of Accounting Standards Update 2016-14, which becomes effective in 2018, organizations are required to keep strong internal records reflecting whether donations are restricted in perpetuity or if another restriction of time or purpose poses limits. By adding this simple process of revenue record keeping, the organization will have up-to-date financial information readily available to management, the board of directors, donors and auditors.

Documentation of approval process

Internal controls are set in place by nonprofit organizations to safeguard assets, provide reliable accounting records, and deter fraud or theft by unauthorized users. As noted in the 2014 Report to the Nations on Occupational Fraud and Abuse, published by the Association of Certified Fraud Examiners, “The presence of anti-fraud controls is associated with reduced fraud losses and shorter fraud duration.” However, breakdowns in internal controls can also expose the organization to employee fraud or theft.

Internal controls audits commonly unearth a lack of documentation of the review and approval processes. Often a review and approval control is taking place but is not officially documented with a signature or initials – and without proper documentation, it is difficult to prove internal control procedures are being performed. It is important to train staff on the importance of internal controls. In addition, management should access and evaluate internal control processes and procedures and their effectiveness throughout the year. Hiring outside auditors can help identify areas in need of improvement.

Cash flow issues

Chief Financial Officers (CFOs) and Controllers of for-profit organizations understand the importance of budgets and cash flow projections. But many nonprofit organizations do not address diminishing cash flow issues until they find themselves in the unfortunate position of not having sufficient funds to operate. The longer cash flow issues are ignored, the harder they are to fix. The most common cause of a cash flow shortage in a nonprofit organization is a reduction in funding by the government, foundations or private, individual donors. It is important for a nonprofit organization to react to any and all funding cuts immediately by finding alternative funding or reducing costs to offset the loss. If a proper budget is implemented and evaluated regularly for accuracy, it will help administrators and boards avoid significant cash flow issues.

Good internal controls result in the highest quality financial information for users. They allow management to make timely decisions in response to changes in financial positions as they provide potential donors with transparency and comfort that their gift will be put to good use. It’s far better to be proactive than risk operational deficiencies or worse.