Internal controls are measures designed to safeguard an organization’s assets, ensure accurate financial reporting, and promote operational efficiency. They range from simple procedures like segregating duties to more complex systems like automated financial software. In this blog post, we will delve deep into the most important internal controls for nonprofits, providing a comprehensive guide for those seeking to enhance their organization’s financial integrity.
Whether you’re a seasoned nonprofit professional or new to the sector, understanding these controls can make a significant difference in your organization’s financial health. So let’s dive in and explore the essential internal controls for nonprofits and the best practices in accounting.
Public Relations Nightmare
Stories about nonprofit fraud have unfortunately become all too common in the media. However if a nonprofit implements strict internal controls, fraud can easily be prevented.
Take for example the Douglas County, Kansas branch of Just Food. In August of 2015 it came to light that their, now former, Executive Director (Name Withheld) had taken the nonprofit for quite a ride, including embezzling at least $52,000 and neglecting to pay at least $60,000 in payroll taxes.
The news of the Executive Director’s misdeeds hit the press and immediately the nonprofit had a black-eye. Questions about board accountability arose, why hadn’t they kept a closer eye, what about all of the money that had been donated? It was a public relations nightmare. This sort of press could easily ruin a nonprofit if not handled properly.
However, the board of Just Food was quick to react, instead of hiding from the press and the public, they spoke with them about their plan of action to make sure that the nonprofit could recover from the disaster. Having strict nonprofit internal controls in place could have saved this organization the embarrassment and public distrust caused by one dishonest and greedy employee.
Importance of Reviewing Invoices
One of the key internal controls that every nonprofit organization must implement in accounting is reviewing invoices. Invoices represent commitments and obligations to pay for goods or services received, and they are a common source of errors, omissions, and fraud. Failure to review invoices can lead to duplicate payments, overpayments, payment of unauthorized invoices, or even payment of fraudulent invoices.
Reviewing invoices includes verifying that the invoice is accurate, contains the correct amount, vendor information, and that the goods or services requested have been received. By implementing this control, nonprofits can prevent loss of funds and ensure that payments are made only for goods and services that were received or authorized.
How to Review Invoices
To review invoices effectively, nonprofits should establish an invoice review process that includes the following steps:
- Verify receipt of goods or services: Ensure that the goods or services have been received before processing any payments.
- Check invoice accuracy: Ensure that the invoice amount is correct, and the vendor information is accurate.
- Match the invoice with purchase orders: Ensure that the invoice matches with the purchase order.
- Approve invoices for payment: Only authorized personnel should approve invoices for payment.
- Record invoice details: Record the invoice details in the accounting system for easy tracking and monitoring.
Benefits of Reviewing Invoices
By implementing a review process for invoices, nonprofits can benefit from the following:
- Reduced risk of errors: Reviewing invoices ensures that all payments are accurate and that overpayments, duplicate payments, or unauthorized payments are avoided.
- Improved vendor relations: Reviewing invoices regularly helps identify billing errors promptly and resolve them before they become issues, which can improve relationships with vendors.
- Better cash flow management: By reviewing invoices, nonprofits can ensure that payment terms are adhered to and that cash flow is managed effectively.
- Improved internal controls: Invoice review is an essential control that can help prevent fraud, ensure compliance with policies and procedures and protect the nonprofit’s financial assets.
Review Employee Reimbursements
Nonprofit organizations often rely on employee reimbursements for expenses such as travel, office supplies, and other business-related expenses. Ensuring that these reimbursements are legitimate and reasonable is essential to maintain good financial health and avoid any discrepancies.
Importance of Reviewing Employee Reimbursements
Reviewing employee reimbursements is important because it guarantees that the expenditures are within the budgeted amount, comply with the organization’s policy, and are legitimate business expenses. By doing so, it helps nonprofits prevent overpayment, double reimbursement, and fraudulent activities.
How to Review Employee Reimbursements
Reviewing employee reimbursements requires a process that includes the following steps:
- Verify receipts: Verify that the receipts submitted by employees match the expenses claimed.
- Determine legitimacy: Check if the expenses are appropriate, valid, and reasonable for business operations.
- Promote compliance: Verify reimbursement claims comply with the organization’s policies and budget limits.
- Approval: Only authorized personnel should approve the reimbursement requests.
- Record keeping: Keep a record of the reimbursement requests, approved receipts, and other related documents.
Overall, reviewing employee reimbursements is an essential internal control that helps nonprofits maintain financial accountability, compliance with regulations, and transparency in their operations.
Review Payroll Reports
Payroll is one of the most significant expenses for most nonprofit organizations, essentially confirming related processes and transactions are accurate, consistent, and compliant with organizational policies and regulations. Reviewing payroll reports regularly is a key internal control mechanism that helps nonprofit managers identify any discrepancies, errors, or fraud in the payroll processing system.
Importance of Reviewing Payroll Reports
By reviewing payroll reports, nonprofits can verify that employee wages, taxes, and benefits are correctly calculated, paid on time, and comply with relevant laws and regulations. This control maintains that only authorized personnel have access to the payroll system, reducing the risk of fraud and misuse of resources.
How to Review Payroll Reports
To review payroll reports effectively, nonprofits should establish a payroll review process that includes the following steps:
- Verify pay rates: Ensure that employee pay rates are accurate, and all overtime, bonuses, or other compensations are correctly calculated.
- Check deductions: Verify that all deductions such as taxes, health insurance, or retirement plans are accurate.
- Review timesheets: Review employee timesheets to ensure they are accurate and comply with the organization’s policies.
- Audit access controls: Ensure that only authorized personnel have access to the payroll system and can make changes.
- Monitor compliance: Review payroll reports regularly to ensure that they comply with internal policies and relevant laws and regulations.
Reviewing payroll reports is an essential internal control that helps nonprofit organizations maintain financial accuracy, compliance with regulations, and transparency in their operations. It also helps to minimize the risk of fraud and errors and ensures that payroll processes are fair and equitable for all employees.
Limit Accountant Authority
Nonprofit organizations typically rely on accountants to manage their financial operations, including bookkeeping, accounting, and financial statement preparation. While accountants play an essential role in managing the organization’s finances, it is equally important to limit their authority to maintain financial accountability.
Importance of Limiting Accountant Authority
Limiting accountant authority is critical because it helps to prevent any single staff member from having complete control over the organization’s finances. It reduces the risk of fraud, embezzlement, or abuse of power by ensuring that all financial transactions are reviewed, authorized, and monitored by multiple personnel.
How to Limit Accountant Authority
To limit accountant authority, nonprofits can consider implementing the following controls:
- Establish segregation of duties: Duties such as reconciling bank accounts, processing checks, and making deposits should be assigned to different personnel.
- Limit access to accounting software: Only authorized personnel should have access to accounting software to perform their designated functions.
- Enforce dual controls: All major financial transactions should require approval from at least two authorized personnel.
- Require regular financial reporting: Regular financial reports help nonprofit managers monitor the organization’s financial performance and identify any discrepancies or fraud.
- Conduct periodic audits: Periodic audits help nonprofits detect fraudulent activities and identify financial risks.
Limiting accountant authority is an essential internal control mechanism that helps nonprofit organizations maintain financial accountability, reduce the risk of fraud, and comply with regulatory requirements. By establishing proper controls and processes, nonprofits can ensure that all financial transactions are authorized, reviewed, and monitored by multiple personnel, thereby minimizing the risk of financial impropriety.
Free eBook Download: How to Prepare and File Form 990
Secure Your Assets
Nonprofit organizations handle a significant amount of financial resources, from donations to grants and investments. As such, nonprofit entities must establish a framework of internal controls to manage and safeguard these assets effectively. One of the primary internal controls that every nonprofit must implement in accounting is the security of its assets.
Importance of Securing Assets
Asset security is essential because it helps protect the organization’s funds and physical assets from theft, fraud, or mismanagement. Nonprofits can use a variety of strategies to ensure asset security, including limiting access to financial records, establishing security protocols for physical facilities and assets, and implementing financial software and technology solutions to monitor transactions.
How to Secure Assets
The benefits of ensuring asset security are numerous and far-reaching. Not only does it provide peace of mind to the organization’s leadership and stakeholders, but it also demonstrates the nonprofit’s commitment to financial integrity and accountability. In addition, effective asset security measures can reduce the risk of legal and reputational damage that could result from financial mismanagement or theft.
Checks and Balances
Another crucial internal control that every nonprofit must implement in accounting is the use of checks and balances.
Definition of Checks and Balances
Checks and balances refer to the process of dividing financial responsibilities among different employees or departments to ensure that no single individual has complete control over an organization’s finances.
How to Implement Checks and Balances
Implementing checks and balances involves separating financial duties by assigning different responsibilities to different individuals. It includes the following steps:
- Conduct a risk assessment: Identify potential risks and vulnerabilities in your accounting and financial processes.
- Separate duties: Ensure that no single individual has complete control over any one process. Segregating duties reduces the opportunity for fraud, errors, and other forms of financial mismanagement.
- Implement a system of approvals: Designate appropriate individuals to approve various financial transactions, such as invoices, purchases, and reimbursements.
- Reconcile accounts regularly: Perform regular reconciliations of bank statements, credit card statements, and other financial records to identify errors or discrepancies.
- Implement a budget process: Create a budget and monitor it regularly to ensure that actual expenses are in line with projected expenses.
- Conduct audits: Perform regular internal audits of financial accounts and processes to detect errors or fraud.
- Maintain accurate and complete records: Ensure that all financial records are up-to-date, accurate, and easily accessible.
- Implement password and security protocols: Ensure that financial software and systems are secured with strong passwords, and limit access to those with a legitimate need to use them.
- Requires two signatures on a check.
- Periodic review of the list of vendors receiving fees/checks from the nonprofit to prevent payment to fictitious vendors.
- Keep all cash in locked drawer and deposit cash and checks in the bank as soon as they are received.
By implementing these internal controls, nonprofits can increase accountability and transparency around their financial activities, and build confidence among their stakeholders and donors.
Benefits of Implementing Checks and Balances
The benefits of implementing checks and balances are numerous, including increased transparency, accountability, and accuracy of financial records. By requiring multiple individuals to be involved in financial transactions, nonprofits can reduce the risk of fraud or errors. Additionally, checks and balances can provide a system of checks against any potential conflicts of interest.
Not-for-profits must establish a framework of internal controls to manage their financial resources effectively. Checks and balances are a crucial component of this framework and can be achieved by separating financial duties among different individuals or departments within the organization. The implementation of checks and balances provides increased transparency, accountability, and accuracy of financial records, reducing the risk of fraud or errors and ensuring the nonprofit’s continued success and integrity.
Clear Roles and Full Transparency
Clear roles and full transparency are vital components of any nonprofit’s financial management framework.
Importance of Clear Roles and Transparency
Nonprofit organizations must have a clear understanding of the roles and responsibilities of each employee involved in financial transactions. This understanding ensures that each person is accountable for their actions, and it helps prevent conflicts of interest or unethical behavior.
How to Implement Clear Roles and Transparency
The implementation of clear roles and transparency involves establishing policies and procedures that define each employee’s role in financial management. These policies should also outline the organization’s expectations for financial transparency and guide how to maintain accurate and complete financial records. By ensuring that everyone understands their role and responsibilities, nonprofits can reduce the risk of fraud, errors, and mismanagement.
Benefits of Clear Roles and Transparency
The benefits of implementing clear roles and transparency are numerous and far-reaching. Clear roles and responsibilities promote accountability and can help build trust among stakeholders, such as donors, board members, and regulators. Additionally, full transparency in financial management demonstrates the nonprofit’s commitment to ethical behavior and can increase its credibility and reputation.
Nonprofits must establish clear roles and full transparency in financial management to safeguard their assets and maintain public trust. The implementation of policies and procedures that define employees’ roles and responsibilities and promote transparency in financial reporting are crucial steps in achieving this goal. By prioritizing clear roles and transparency in accounting, nonprofits can ensure the continued success and integrity of their operations.
Set Forth Written Policies and Procedures
Internal controls are crucial for nonprofit organizations to ensure accountability, transparency, and compliance. One of the most critical internal controls is to set forth written policies and procedures. Written policies and procedures provide clear guidance on how to perform certain tasks or handle specific situations, which can help prevent errors, fraud, and mismanagement.
Importance of Written Policies and Procedures
Written policies and procedures are essential for nonprofit organizations because they establish expectations and provide a framework for decision-making. They help ensure that the organization’s operations are consistent and efficient, reducing the risk of errors, omissions, and misunderstandings. Additionally, written policies and procedures can help ensure compliance with laws and regulations governing nonprofit organizations.
How to Create Written Policies and Procedures
Creating written policies and procedures requires careful consideration and planning. The first step is to identify the key areas of the nonprofit’s accounting operations that require written policies and procedures. This may include cash management, accounts payable and receivable, financial reporting, and budgeting, among others. Once these areas have been identified, the nonprofit should determine the appropriate level of detail required for each policy or procedure.
Here are some examples of written policies and procedures that nonprofits can implement to strengthen their internal controls in accounting:
- Cash Management Policy – This policy outlines the procedures for handling cash receipts, cash disbursements, petty cash, and bank reconciliations.
- Accounts Payable and Receivable Policy – This policy establishes the processes for accounts payable and receivables, including invoice processing, payment schedules, and collections.
- Financial Reporting Policy – This policy provides guidelines for financial reporting and analysis, including the frequency and format of financial statements, budgeting, and financial performance metrics.
- Budgeting Policy – This policy outlines the process for preparing, approving, and monitoring the annual budget, including revenue projections, expense categories, and budget variance analysis.
- Fixed Assets Policy – This policy covers the management of fixed assets, including the acquisition, depreciation, disposal, and tracking of assets.
- Purchasing Policy – This policy sets forth the procedures for purchasing goods and services, including requisition forms, vendor selection, purchase orders, and approvals.
- Inventory Control Policy – This policy governs the management of inventory, including receiving, storing, tracking, and reporting inventory levels.
- Donor Contribution Policy – This policy outlines the procedures for recording and acknowledging donor contributions, including the documentation and reporting of gifts in kind and non-cash donations.
- Record Retention Policy – This policy establishes the retention periods for financial records, including bank statements, invoices, receipts, and payroll records.
- Conflict of Interest Policy – This policy addresses conflicts of interest and requires employees and board members to disclose and manage any potential conflicts that may arise.
Benefits of Written Policies and Procedures
The benefits of written policies and procedures extend beyond simply providing clarity and consistency. They also help promote accountability and transparency within the organization. Written policies and procedures ensure that everyone in the organization understands their roles and responsibilities and that processes are in place to ensure compliance with ethical and legal standards. Additionally, written policies and procedures can help protect the nonprofit from legal and financial risks by providing evidence of due diligence and compliance efforts.
Schedule a FastFund Online Demo: Learn more about our unique software approach to nonprofit accounting, payroll and fundraising.
Bottom Line
Implementing effective internal controls is crucial for the financial health and sustainability of any nonprofit organization. By incorporating proper checks and balances in accounting procedures, nonprofits can reduce the risk of fraud, errors, and financial mismanagement. It is important to remember that internal controls should be tailored to each organization’s unique needs and circumstances. By following the top internal controls outlined in this post, nonprofits can ensure transparent and accountable financial management, which inspires trust and confidence in stakeholders and donors alike.
Want to read more? Check out these insightful articles:
Did you find this article useful? We welcome your thoughts and comments.
I have work in nonprofit finance for three decades and endorse financial transparency at all costs. I believe the healthiest nonprofits limit the number of years in a term and number of times an individual can serve on a board and as an officer of a board. Organizations that have board members serving since the founding of the nonprofit should be viewed with significant suspicion.
Reimbursing employees for expenses approved in advance, in writing is a good thing. However, what if the employee makes $20,000 to $30,000 annually and reimbursement is time sensitive? Does the amount of time “in advance” become malleable?
Thanks for your comment and insight. Not sure what the relationship is between an employee’s earning and their expense reimbursement? And no, I don’t think the in advance time is malleable.