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Nonprofits: Remain Alert for Financial Trouble Spots

9/23/19 – Lauren Kreutzinger

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When a nonprofit is having trouble meeting payroll obligations, defaulting on loans, or losing key donors, it’s easy for the board to tell that they’re in financial crisis. Often, though, the board could have avoided these financial disasters if it had recognized some of the earlier and less obvious signs of distress. By watching out for the following problems, a board can act swiftly to minimize the damage and ensure the organization’s long-term survival.

Budget indicators

Several budget-related issues hint at rocky financial times to come. Most obviously, board members should worry a great deal about a nonprofit with no budget. The lack of an operating budget suggests an undisciplined approach to fiscal matters. Larger nonprofits also should have budgets for each program or department. Ideally, board members will see that budgets proposed by management are in line with the strategies already developed and approved by the board.

Once a budget has been approved, the board should monitor it for unexplained variances. Some variances are bound to happen, but staff must explain significant discrepancies. There may be a reasonable explanation. The staff might, for example, point to program expansion, funding changes or economic factors beyond the organization’s control. Where necessary, the board should direct management to modify activities to mitigate negative variances, for example by implementing cost-saving measures.

Board members also should beware of overspending in one program that is funded by another. Watch, too, for dipping into the organization’s “rainy day” fund (its “reserves”), raiding an endowment or engaging in unplanned borrowing. These tactics might indicate the beginning of a financially unsustainable cycle.

Financial statement flaws    

Untimely, inconsistent financial statements — or statements that aren’t prepared using U.S. Generally Accepted Accounting Principles (GAAP) — can lead to poor decision-making and undermine a nonprofit’s reputation. They also can make it difficult to obtain funding or financing if deemed necessary.

Financial statements not prepared in accordance with GAAP, or another comprehensive basis of accounting, also can be unreliable and are difficult to compare to others in the industry. For larger nonprofits, the board or audit committee should also insist on annual audits and oversee the selection of the audit firm. Members of the responsible group should communicate directly with auditors before and during the process. Further, all board members should have the opportunity to review and question the audit report, adjustments proposed during the audit, and any recommendations that the auditors have for the organization.

The board generally should receive the nonprofit’s financial statements within 30 days of the close of a period. Late or inconsistent financials could signal understaffing, poor internal controls, an indifference to proper accounting practices or efforts to conceal mistakes, financial troubles, or fraudulent activities.

Donor doubts

If the board starts hearing from long-standing, passionate supporters who’re harboring doubts about the organization’s finances, that’s a very bad sign. What are they seeing or hearing that prompts their concerns?

The board also should note when development staff begins reaching out to historically major donors outside of the usual fundraising cycle. These contacts could mean the organization is scrambling for cash and hoping its most dependable donors can help fill the gaps.

Excessive executive power   

It’s understandable that board members who have full-time jobs and other responsibilities might cede some of their responsibilities to a trusted executive director. It’s also risky.

So, what are the signs of an executive director who wields too much power? The board should think about making some changes if the executive director chooses the auditor or adds board members, is allowed to ignore expense limits, or makes strategic decisions without board input and guidance.

Proceed with caution

While board members need to remain alert for trouble spots, it’s important not to jump to immediate conclusions if a red flag is uncovered. Further investigation is almost always required. The mere existence of a warning sign doesn’t necessarily merit a dramatic response, especially if it’s the only warning sign.

Some problems prove easily correctable by, for instance, outsourcing some accounting functions if the finance department is understaffed. On the other hand, multiple or chronic issues could call for significant strategic changes. One thing is certain, though: ignoring the indicators of financial trouble is a mistake. Contact your VonLehman advisor for further guidance.