I’ll admit it: I’m a nerd. I’m a trained accountant and very few things get me more fired up than internal controls, the process that protects an organization’s people and finances. It is music to my ears when a nonprofit tells me they have two people count the money, have separate people to cut and sign the checks, and have a board member approving the financials each month.
It takes a lot of work to get a full set of strong internal controls off the ground for a church or nonprofit, but they are so valuable. Internal controls are your financial linebacker, keeping things in check and tackling problems like theft or unintentional errors when they pop up.
One of the most common internal controls used by nonprofits is having a trusted leader or board member review monthly financials. But this is also the source of one of the most common nonprofit mistakes.
Let’s find out how Molly’s nonprofit made a mistake when reviewing their monthly financials and what they missed.
Hi, Molly here. One of my least favorite things about managing my animal shelter was keeping track of the finances. I had run into problems when I created too many funds. I had sorted that out, only to run into a new financial problem.
Roland, the “money guy”” on our board, was out sick for a few weeks so our monthly financial statements were being looked over by a different board member, Arthur, “the law man.”” He didn’t ask any questions, so I assumed he knew what to do with the reports while Roland was out. That was my first mistake.
Around this time, I hired one of our volunteers to be a part-time bookkeeper. She deposited donations, tracked our bookkeeping, and helped me prepare our reports.
She knew the drill and I trusted her, so I didn’t watch her too closely. Arthur had reviewed the reports she prepared the previous month and hadn’t caught anything out of the ordinary.
I was feeling pretty good about our arrangement, until it all came to a screeching halt.
When the end of the month came, Roland was feeling better, so I printed our monthly reports for him to look over.
“Hmmm, why are the supplies more this month than last month?” he asked.
Puzzled, I grabbed the statement and sure enough there was a $200 increase over the previous month.
Roland checked the prior month’s statements and noticed that there was some unusual activity on those reports as well. The donations received were lower than normal.
How did Arthur not catch this? He told me he could manage these statements in his sleep, but it was obvious he had no idea what to look for. I was tempted to say Arthur shouldn’t have reviewed them, but I knew he was still better than nothing. We just needed to fix it and have a better game plan moving forward.
I didn’t want to think the worst, but either someone had stolen the donations or something had gone wrong with our new bookkeeper.
Roland and I dug through receipts, deposit slips, and bank statements. I’m not a math person, and certainly not an auditor. I was looking through so many numbers my eyes went crossed. But I needed to be sure before I started making accusations.
Finally, I uncovered a deposit slip and a receipt for dog food that hadn’t been recorded correctly.
I was so relieved. Our volunteer bookkeeper must have accidentally entered the wrong number; or maybe our office dog, Chip, jumped on the keyboard when she was keying in the amount.
I fixed the mistake and Roland signed off on it.
When I told the bookkeeper about the mistake, she was more devastated than I was. Together, we decided to have me review the new transactions each week and compare them to the receipts, and I asked Roland for a tutorial on how to review the statements so I could help spot errors before they made it to my board.
It was a tough lesson to learn but it opened my eyes to the importance of our accounting internal controls.
Digging through our records also ended up being surprisingly helpful in analyzing how we used our donations. I’ll tell you more about that next week.
Before founding Aplos, I worked as a CPA, auditing companies and advising organizations on establishing strong controls. The situation Molly faced is extremely common among nonprofits, but if corrected, can lead to one of the most effective methods of internal controls.
So where did Molly go wrong? Her board members understood the importance of reviewing their monthly financial reports as an internal control. However, when the experienced person was unavailable, the person reviewing the financials didn’t know what to look for and missed unusual financial activity.
What are Internal Controls?
Internal controls are your defense against financial error and fraud. There are two different types of internal controls: preventive and detective. Together, these not only protect your finances, but they also protect your employees and volunteers from being accused of wrongdoing.
One church that I worked for trusted the people who collected the tithe each week, but wanted to make sure they were never accused of wrongdoing. To protect them, they relied on a buddy system so that there were always two people counting, collecting, or depositing donations. This is a great example of preventative controls.
Want to know more about internal controls? Check out our Academy lesson “What are Internal Controls?”
Detecting errors on monthly financial reports
Reviewing monthly financials is an extremely powerful detective control. I always recommend nonprofits establish a full set of internal controls, but if you are wondering what to do first, start with a monthly financial review. When done correctly, it can catch unusual financial activity to prevent fraud and costly data-entry errors, which will help keep your organization financially sound.
The right person for the job
When deciding the in’s and out’s of your monthly financial reviews, your first step should be deciding who should do it. Here are a few points to keep in mind when identifying the right person for the job:
- Not your bookkeeper: This falls under the best practice of “segregation of duties.” The person preparing the report shouldn’t be checking the report; otherwise there is no accountability.
- Knows your organization: They should be familiar with the organization, know how money is generally spent, and be up to speed with major activities that may affect the finances.
- Understands how accounting works: They should have a general knowledge of financial reports and how to analyze the data.
What to look for in a monthly financial review
There are three standard nonprofit reports , but the one you will likely look at the most closely is the Statement of Activities (AKA: the income statement). Here is a breakdown of the main points you should examine:
1. Compare this month to the previous month
- Analytical Testing – Is there any unexpected change such as salary cost increases?
- Detail Testing – If an unusual variance is seen, examine all transactions in the line item to determine the cause of the change
Below is a sample expense report that shows a line item with an unusual change when comparing month to month. The reviewer would then examine the transactions in this line item to determine the cause of the change.
2. Use your knowledge of the organization
Confirm that any major activities that have financial impact are reflected on the financials. This is where your familiarity with the organization comes in hand. For example, if a new employee was hired, the salary line item would be expected to increase. If a new computer was purchased, the equipment line item should have increased.
3. Randomly test transactions
Select a few transactions at random each month and request to view the receipts. This will encourage financial record keeping, ensure that expenses are being tracked consistently, and will deter fraud.
An extra level of protection
If you are looking for additional protection beyond a monthly financial review, I recommend doing an in-depth review of your finances annually or bi-annually with a professional auditor to make sure you are staying on track.
Not sure where to start? Here is a sample financial review checklist that a PTA organization uses to review their finances and internal controls regularly. It is a pretty thorough list to give you a good feel of what types of things you should keep in mind.
Wondering if your internal controls are up to snuff? Here is a free Internal Control assessment. It is designed for churches, but can apply to nonprofits as well. You can also use an external professional accountant for a more formal audit or for assistance setting up internal controls.
So tell me, who reviews the monthly financials for your organization? What internal controls do you use to keep your nonprofit strong? Share your advice in the comments section below.