The Importance of Internal Controls for Nonprofits

Most nonprofits know that proper internal controls are essential to protect their organizations against fraud, embezzlement and inaccurate financial reporting. The difficulty with implementing a plan to safeguard an organization often lies with limitations on budget and staff to properly set effective financial controls and separation of duties. So where do you start? No matter the size, the top priority of any nonprofit should be to put in place basic financial controls.

What Are Internal Controls?

The goal of internal controls is to create organizational practices that protect the organization by reducing the risk of fraud or the misappropriation of funds. These practices serve as checks and balances for the organization and have three main attributes: they protect assets by ensuring they are being handled appropriately, divide responsibilities among several people and provide financial transparency.

Establish Policies & Procedures

It is important to have written policies in place that detail the procedures to be followed. This is important for a number of reasons but it also provides a mechanism for maintaining the procedures in the event that there is a change in the staff or if discovered staff are operating under alternate procedures. Procedures should be reviewed periodically (at a minimum annually) to compare your actual processes to those in your procedures documentation. It’s valuable to take corrective action to either close the gap between expected vs. actual processes or, if appropriate, to update your procedures manual.

Example policies & procedures:

• A full background check must be completed for all employees who handle money, as a condition of hire
• Staff will keep all cash in a locked drawer and to deposit cash and checks in the bank, within xx # of days after it is received
• For expenditures over a pre-determined amount, two signatures are required on checks and two authorizations are needed for all cash disbursements

Organization-Level Controls

Another important financial control is the segregation of functional responsibilities. A separation of duties should be incorporated throughout the entire chain of financial transactions. It’s important to appoint different staff to collect and disburse funds, record Board minutes, prepare financial reports and sign checks. The person who writes the checks should not be the person signing them. The staff member who orders a product or requests a service should not be the only person who sees the invoice.

Every organization, at a minimum should ask themselves:

• Where are the weak links in the chain?
• Where in the process are our assets the most likely to be lost/stolen?
• How can we separate duties in order to protect ourselves better and mitigate risk?

Control of Assets, Liabilities, Revenues and Expenditures

An authorization system should be developed to address controls over assets, liabilities, revenues and expenditures. Physical controls such as locking up checks, petty cash, credit cards, etc. should be put into place to prevent misuse.

Without going into too much detail about technology-related controls that should be put in place, it is also important to point out that securing computers, especially those with access to financial software or online bank accounts is critical. All laptops should utilize a lockout within a certain period of inactivity.

Setting the right internal controls is important to your nonprofit’s reputation and an important step in meeting your fiduciary responsibility to funders, donors and the general public all non-profits serve. It can help ensure financial integrity and protect you from fraud. Each organization will need to strike the right balance for what works operationally without getting bogged down with too many unnecessary internal controls or unnecessary costs in doing so.

In smaller nonprofits where there may not be the internal resources to establish adequate financial controls, outsourcing may provide an alternative and cost effective solution. Outsourcing can provide access to part-time staff who can serve as resources for developing adequate policies and procedures and these resources can implement financial reporting standards or provide greater oversight to safeguard the organization.

If you’d like to learn more about establishing financial controls or best practices for internal controls, contact us at insource@insourceservices.com or 781-235-1490.