Nonprofit Internal Controls

Nonprofit organizations play a critical role in serving communities and fulfilling important missions, but they face various risks in achieving their goals. One of the significant risks is not having proper internal controls in place. Without these controls, NFPs are vulnerable to financial loss, damage to their reputation, and legal non-compliance.

These consequences can ultimately hinder their ability to serve their beneficiaries and achieve their mission. By prioritizing strong internal controls, NFPs can establish a culture of accountability and transparency, contributing to their overall success and sustainability.

What are Internal Controls?

Internal controls are financial management practices that are systematically used to promote integrity and prevent the misuse and misappropriation of assets, such as theft or embezzlement. These practices are written into company policies and are enforceable, creating foundational best business practices for all departments. Internal controls can be divided into two categories:

Preventative controls aim to prevent errors, fraud, and theft before they happen. To prevent theft, for example, money is locked in a safe. It’s important to continue to take preventative measures, like regularly changing the combination or password to the safe.

Detective controls aim to identify and address any issues that do arise. In NFP accounting, for example, a bank reconciliation statement ensures all transactions have been properly recorded and accounted for. Discrepancies can be investigated to determine the cause, whether it’s an oversight or theft.

The Importance of Internal Controls

Internal controls are essential for nonprofit organizations as they help reduce the risk of fraud and ensure accurate financial reporting. Nonprofits can use the Sarbanes-Oxley Act as a standard for their financial practices to improve their internal control.

By creating a segregation of duties, staff members know who is accountable for certain duties, and the duties are shared to manage the signing power of one person. This relieves pressure on staff and creates a trail for all transactions, making investigations easier. A breach in procedure quickly highlights where the fraud took place.

Internal Controls Relating to Governance

Nonprofit organizations are governed by a board of directors who have fiduciary duties and responsibilities. The board carries the burden of potential liability, as directors who fail to exercise their fiduciary duties with a basic standard of care may be held accountable for damages.

It is crucial for directors to comprehend and regularly assess the risks within the organization, establish appropriate internal controls, and ensure that they function correctly. When the board actively discusses internal controls and takes measures to verify their effectiveness, it sets a strong tone at the top, demonstrating that internal controls are indispensable to the NFP.

Improving Internal Controls Using Technology

Internal controls help to maintain proper governance and mitigate risks. Implementing effective internal controls can be challenging for NFPs, but technology can offer a range of solutions to help streamline and automate them. Below are some examples of how technology can be used to enhance internal controls in NFPs:

• Accounting Software: Accounting software can improve internal controls by automating financial transactions, reducing the chances of errors and misstatements. This can help NFPs to establish effective internal controls over financial reporting, maintain accurate financial records, facilitate audit processes, and ensure compliance with regulatory requirements.

• Internal Audit Software: Internal audit software can enhance internal controls by automating the audit process, from planning to reporting. This can help NFPs to identify control deficiencies, mitigate risks, and improve the reliability of financial information. Internal audit software can also provide real-time insights into internal control weaknesses, allowing NFPs to address issues proactively.

• Document Management Systems: Document management systems can enhance internal controls by improving document management, version control, and access management. This can help NFPs to maintain proper documentation, reduce the risk of losing important documents, and improve the accuracy of document management. Document management systems can also help NFPs to ensure that only authorized personnel have access to important documents, improving internal controls over information security.

• Segregation of Duties: Technology can help enforce segregation of duties, an essential internal control mechanism. For example, technology can be used to ensure that the same employee is not responsible for both approving and processing financial transactions. This can help NFPs to improve internal controls over financial reporting, reduce the risk of fraud and errors, and improve the accuracy of financial reporting.

• Access Controls: Access controls can improve internal controls by restricting access to sensitive information and systems. This can help NFPs to prevent unauthorized access, data breaches, and cyberattacks. Access controls can also help NFPs to ensure that only authorized personnel have access to critical systems, data, and information, improving internal controls over information security.

NFPs should also consider leveraging software solutions such as Sage Intacct to automate financial processes and enhance internal controls. Sage Intacct’s financial management platform helps improve internal controls and cash management by providing centralized control and distributed responsibility, with features for managing funds by various dimensions, achieving accuracy, setting budgets, tracking actuals, and managing capital budgets.

Implementing Internal Controls

Implementing internal controls can be a time-consuming process and is based on the nonprofit organization’s set of risks based on operations and resources. Nonprofits can consider:

• Assessing their Risks: To identify risks, NFPs must first evaluate their operations and available resources. This evaluation will enable them to create a risk management plan that addresses potential risks. It is also essential for NFPs to evaluate their current internal control practices and identify areas that require improvement. Identifying the risks and areas that require improvement is a crucial first step towards effective internal control practices.

• Establishing Policies and Procedures: NFPs should develop written policies and procedures that reflect their risks, goals, and strategies. The policies and procedures should be communicated to all staff members and consistently enforced. They should include financial management, record-keeping, budgeting, and personnel management policies, among others. A comprehensive set of policies and procedures is essential in promoting accountability and transparency in NFPs.

• Training Staff Members: Staff members play a critical role in ensuring that internal controls are effective in preventing fraud and misuse of assets. As such, NFPs should provide training to all staff members on internal control policies and procedures. Staff members should understand their roles and responsibilities in safeguarding the assets of the organization. Training staff members also ensures that the policies and procedures are followed consistently.

• Monitoring and Evaluating Internal Controls: NFPs should regularly monitor and evaluate their internal controls to ensure that they are effective in preventing fraud and misuse of assets. Regular monitoring and evaluation enable NFPs to identify any weaknesses in their internal control systems and address them before they become more significant issues. Monitoring and evaluation also demonstrate a commitment to transparency and accountability to donors and other stakeholders.

Outsourcing Internal Controls

By engaging the services of experts in financial management practices and internal controls, nonprofit organizations can benefit from specialized skills and knowledge that may not be available in-house. Some of the benefits of outsourcing include:

• Access to Expertise: Outsourcing can provide access to a team of experts who have extensive experience in financial management practices and internal controls. These experts can bring new perspectives to the organization, identify areas of improvement, and implement best practices.

• Cost-Effective: Offsite accounting can be more cost-effective than maintaining an in-house team. Nonprofit organizations can avoid the costs associated with hiring, training, and retaining staff members. Outsourcing also provides flexibility, allowing organizations to pay for services as needed.

• Reduced Risk: Nonprofits can reduce the risks associated with internal control failures. Experts can implement robust internal control systems, reducing the likelihood of fraud and errors. Additionally, outsourced services may come with guarantees, providing additional protection to the organization.

• Increased Efficiency: Outsourcing can increase efficiency by allowing organizations to focus on their core activities. By delegating internal control tasks to experts, staff members can concentrate on the organization’s mission and objectives.

Nobody likes to think about fraud, but the reality is that it happens. Internal controls can help prevent financial losses and protect NFP’s reputation. By regularly assessing their risks, establishing policies and procedures, and training staff members, NFPs can ensure that their internal controls are effective and that they’re well-equipped to prevent fraud and errors.

Rather than spend time creating, implementing, and enforcing internal controls, organizations should also consider outsourcing the tasks to a firm that specializes in NFP accounting. With the onus off their shoulders, NFPs can focus more on their core initiatives for positive change.