Not-for-profit organizations don’t lose as much to occupational fraud as for-profit businesses do. According to the Association of Certified Fraud Examiners’ (ACFE’s) 2018 Report to the Nations, nonprofits lost a median amount of $75,000 during the 21-month study period, compared with $164,000 for private for-profit companies. Yet few nonprofit budgets can afford a $75,000 shortfall or the bad publicity associated with fraud. Here’s how nonprofits open the door to fraud — and how your organization can shut it.
How thieves slip through
The core of any organization’s fraud-prevention program is strong internal controls — policies that govern everything from accepting cash to signing checks to training staff to performing regular audits. Most nonprofits have at least a rudimentary set of internal controls, but employees bent on fraud can usually find gaps.
Nonprofits typically devote the largest chunk of their budgets to programming, and can be stingy about allocating dollars to enforcing internal controls. This can be especially problematic if executives or board members indicate that fraud prevention is low on their priority list. Nonprofit boards may also inadvertently enable fraud when they place too much trust in the executive director and fail to challenge that person’s financial representations. Unlike their for-profit counterparts, these members may lack financial oversight experience and the knowledge to spot irregularities.
Trust is another Achilles’ heel for many nonprofits. Organizations often regard their staff and dedicated volunteers as family. They may allow managers to override internal controls and let volunteers accept cash donations without oversight — both very risky activities.
Fortify your defenses
Check tampering, expense reimbursement fraud and billing schemes are the three most common types of employee theft found in nonprofit organizations. But proper segregation of duties — for example, assigning account reconciliation and fund depositing to two different staff members — is a relatively easy and effective method of preventing such fraud. Strong management oversight and confidential fraud hotlines are also associated with lower losses due to employee theft.
Indeed, when it comes to employees, you should trust but verify. Conduct background checks on all prospective staff members, as well as volunteers who will be handling money or financial records. Also, provide an orientation to new board members to ensure they have a clear understanding of their fiduciary role.
Finally, handle fraud incidents seriously. Many nonprofits choose to quietly fire thieves and sweep their actions under the rug. However, this tends to encourage fraud by telling potential thieves that the consequences of getting caught are relatively minor. If an incident is hushed up, rumors could do more reputational damage than publicly addressing the issue head-on. It’s better to file a police report, consult an attorney and inform major stakeholders about the incident.
If you suspect fraud in your organization, contact us for help investigating it.
The IRS’s staffing shortages have been well publicized and audits of individuals have decreased in the past several years. But it’s a mistake to assume that the agency has stopped scrutinizing not-for-profits and conducting audits when it deems necessary. If your organization receives an audit letter, you need to know what the process involves and how you can help resolve it as quickly as possible.
Igniting a spark
An audit begins with the initial contact via letter from the IRS and continues until a closing letter is issued. Before closing an audit, an officer of your nonprofit, your CPA and the IRS agent will discuss the agent’s conclusions at a closing conference. Both the conference and letter will explain your appeal rights.
Audits can cover many areas. For example, the IRS may want to learn whether your organization has filed all returns and forms as required by law. Or it might delve into whether your activities have been consistent with your tax-exempt purpose, or whether unrelated business income tax or employment taxes were properly paid.
The igniting spark for an audit might be an IRS examination initiative or project, or complaints to the agency about potential noncompliance. In general, Form 990 plays a strong role in the selection process. For instance, the IRS may apply risk models to your organization’s Form 990 data related to governance or the incidence of fraud.
Types of audits
If your initial contact letter schedules an agent to visit, the IRS is conducting a field audit, which falls into one of two categories: 1) general program exam, which typically is conducted by a single IRS agent; or 2) Team Examination Program audit, which focuses on large, complex organizations and may involve a team of examiners.
If, on the other hand, your initial IRS letter asks you to deliver documents to an IRS office by mail, the agency is conducting a correspondence audit. An agent generally will perform the audit via letters and phone calls to your officers or representative. If a correspondence audit grows more complex or your nonprofit doesn’t respond to requests, it can turn into a field audit.
The IRS might also contact you to announce a compliance check. This isn’t an audit; it’s a determination of whether your organization is adhering to record-keeping and information reporting requirements. However, a compliance check can lead to an audit.
Handle it right
Whether you’re facing a field or correspondence audit, don’t try to handle the matter yourself. Contact us for help. © 2019
Do you want to control costs and improve delivery of your not-for-profit’s programs and services? It may not be as difficult as you think.
First, you need to know how much of your nonprofit’s expenditures go toward programs, as opposed to administrative and fundraising costs. Then you must determine how much you need to fund your budget and withstand temporary cash crunches.
4 key numbers
These key ratios can help your organization measure and monitor efficiency:
1. Percentage spent on program activities. This ratio offers insights into how much of your total budget is used to provide direct services. To calculate this measure, divide your total program service expenses by total expenses. Many watchdog groups are satisfied with 65%.
2. Percentage spent on fundraising. To calculate this number, divide total fundraising expenses by contributions. The standard benchmark for fundraising and admin expenses is 35%.
3. Current ratio. This measure represents your nonprofit’s ability to pay its bills. It’s worth monitoring because it provides a snapshot of financial conditions at any given time. To calculate, divide current assets by current liabilities. Generally, this ratio shouldn’t be less than 1:1.
4. Reserve ratio. Is your organization able to sustain programs and services during temporary revenue and expense fluctuations? The key is having sufficient expendable net assets and related cash or short-term securities.
To calculate the reserve ratio, divide expendable net assets (unrestricted and temporarily restricted net assets less net investment in property and equipment and less any nonexpendable components) by one day’s expenses (total annual expenses divided by 365). For most nonprofits, this number should be between three and six months. Base your target on the nature of your operations, your program commitments and the predictability of funding sources.
Orient toward outcomes
Looking at the right numbers is only the start. To ensure you’re achieving your mission cost-effectively, make sure everyone in your organization is “outcome” focused. This means that you focus on results that relate directly to your mission. Contact us for help calculating financial ratios and using them to evaluate outcomes. © 2019
Not-for-profit board members — whether compensated or not — have a fiduciary duty to the organization. Some states have laws governing the activities of nonprofit boards and other fiduciaries. But not all board members are aware of their responsibilities. To protect your nonprofit’s financial health and integrity, it’s important that you help them understand.
In general, a fiduciary has three primary responsibilities:
1. Duty of care. Board members must exercise reasonable care in overseeing the organization’s financial and operational activities. Although disengaged from day-to-day affairs, they should understand its mission, programs and structure, make informed decisions, and consult others — including outside experts — when appropriate.
2. Duty of loyalty. Board members must act solely in the best interests of the organization and its constituents, and not for personal gain.
3. Duty of obedience. Board members must act in accordance with the organization’s mission, charter and bylaws, and any applicable state or federal laws.
4. Board members who violate these duties may be held personally liable for any financial harm the organization suffers as a result.
One of the most challenging — but critical — components of fiduciary duty is the obligation to avoid conflicts of interest. In general, a conflict of interest exists when an organization does business with a board member, an entity in which a board member has a financial interest, or another company or organization for which a board member serves as a director or trustee. To avoid even the appearance of impropriety, your nonprofit should also treat a transaction as a conflict of interest if it involves a board member’s spouse or other family member, or an entity in which a spouse or family member has a financial interest.
The key to dealing with conflicts of interest, whether real or perceived, is disclosure. The board member involved should disclose the relevant facts to the board and abstain from any discussion or vote on the issue — unless the board determines that he or she may participate.
Your donors, clients, employees and other stakeholders depend on the honesty and good faith of your board members. To ensure they’ll make informed decisions and disclose any conflicts of interest, provide new members with a list of fiduciary duties. And regularly remind long-serving members, as appropriate. Contact us if you have any questions about fiduciary responsibilities. © 2019
What would happen if one of your managers was suddenly forced to take long-term disability leave? Or an accounting staffer quit without notice? It’s possible that your not-for-profit’s work could come to a standstill — unless you’ve cross-trained your employees.
Problem and solution
Cross-training employees — teaching them how to do each other’s jobs — can help protect your organization from an absence in the short or long term. The potential reasons for an absence are almost countless: An employee may suddenly die, become sick or disabled, have a baby, take a vacation or military leave, be called to jury duty, retire or resign.
Having someone else on staff set to jump in and take the reins can keep your nonprofit up and running without much of a hitch.
Your organization benefits
Cross-training involves teaching accounting department and other staffers the basics of one another’s jobs. With cross-trained employees, you can temporarily shift people to fill an empty seat until the missing staffer returns or you’re able to hire someone. Cross-training can also provide relief when certain departments go through busy periods and need extra help.
For example, let’s say your accounts receivable function is hectic in the fall when annual membership dues are processed. Cross-training could enable you to, for example, move a development or admin employee to help out for a few weeks.
There’s also the value of a fresh pair of eyes. An employee who’s temporarily filling in for another person will bring a new perspective to operations and may be able to come up with process improvements. Cross-training can also help prevent fraud because potential thieves know that another employee may view their files at any time.
Staffers also gain
Employees also benefit from cross-training. If the task the cross-trained person learns is vertical — it requires more responsibility or skill than that employee’s normal duties — the cross-training will likely make the employee feel more valuable to the organization.
If the task is lateral — with the same level of responsibility as the employee’s routine duties — the cross-trained employee still gains by getting a better understanding of the department as well as a change of pace.
You can start the cross-training process by appointing a small task force to 1) determine which positions should be cross-trained, 2) segregate the duties of those positions and 3) create an implementation plan. Make sure you reassure staffers that cross-training doesn’t mean that their jobs are in jeopardy. In fact, everyone in your organization is likely to benefit from the process. © 2019
Not-for-profits increasingly are taking on big issues, such as global warming and economic development. Some are turning to a relatively new approach known as “collective impact.” Such cross-sector coordination may help nonprofits achieve greater change than isolated interventions by individual groups.
More than collaboration
Collective impact is more than just collaboration. Its originators describe it as the commitment of important players from different sectors to a common agenda for solving a specific social problem. Players include nonprofits, government agencies, businesses and communities.
For example, a few years ago, the Hampton Roads Community Foundation in Southeast Virginia initiated a regionwide process to improve early care and education programs. Almost 100 stakeholders planned a program that would unite previously disparate efforts and participants. Since then, the “Minus 9 to 5” initiative has been able to align actions across five cities in Virginia.
Collective impact adherents typically cite five prerequisites necessary to produce successful initiatives:
1. Common agenda. All participants must have a shared vision for change based on a common understanding of the problem. Everyone doesn’t need to agree on every facet of the problem. But differences of opinion about the problem — and goals for addressing it — must be resolved to prevent division.
2. Shared measurement systems. A shared agenda will be of little value unless participants agree on how success will be measured and reported. All participants must take the same approach to data collection and metrics to foster accountability and facilitate information sharing.
3. Mutually reinforcing activities. Although collective impact depends on stakeholders working together, that doesn’t mean they all must do the same thing. Each participant should be encouraged to harness its strengths in a way that supports and coordinates with other participants.
4. Continuous communication. Perhaps the biggest challenge to collective impact is the need for trust among stakeholders. Trust generally develops over time and across interactions. So, the most effective initiatives keep the lines of communication open and encourage stakeholders to meet in person regularly.
5. Backbone support organizations. Collective impact requires a separate organization with its own infrastructure to provide the project’s “backbone.” This includes a dedicated staff to plan, manage and support the organization.
Collective impact projects can succeed in ways that simply aren’t available to individual organizations — or even joint ventures. But the process is complicated and time-consuming. Make sure you know what you’re getting into before signing on to such an initiative. © 2019
Outsourcing human resources can give your not-for-profit’s staff more time to spend on core duties and mission-driven programs and it may be cost-effective. Here are some suggestions if you’re thinking about outsourcing part or all of your HR tasks.
First, decide which segments of the HR function to farm out. Take a look at payroll, recruiting, training, benefits planning and administration, compliance monitoring, leave management and performance reviews. These are all labor-intensive responsibilities where expertise counts. Transferring all or some of them to the right outside party can vault your organization to a higher level of professionalism and efficiency.
Next, perform a cost-benefit analysis. Even if the cost is more to outsource, you may decide that the extra dollars are worth freeing up staff hours for other initiatives.
Factor in the drawbacks to outsourcing. Certain tasks may require an understanding of your organization’s culture and history to be effective. Also think about the impact of letting go any HR people currently on staff.
Questions to ask
Before you contact outsourcing service providers, make sure you have buy-in from your staff and board of directors. The Nonprofit Coordinating Committee of New York suggests asking several questions of potential HR service providers:
- What is the scope of your service?
- How long have you been in business?
- Where are your services typically provided: on-site, off-site or a combination?
- How many nonprofit clients do you have in our area, sector and size?
- How do you charge for services — hourly or on retainer?
- Whom will we be directly working with?
- What will you expect of our organization, including the board and staff?
Once you’ve met with outside service providers and selected one, ask your attorney to review the contract. Before you make the big change, be sure that you have controls in place to monitor the quality of the new arrangement. We can assist you with this. © 2019
In recent years watchdog groups, the media and others have increased their scrutiny of how much not-for-profits spend on programs vs. administration and fundraising. Your organization likely feels pressure to prove that it dedicates most of its resources to programming. However, accounting rules require that you record the full cost of any activity with a fundraising component as a fundraising expense.
How then can you maintain an appealing fundraising ratio? That’s where allocating joint costs comes in.
Nonprofits are allowed to combine program and fundraising activities to achieve efficiencies. For example, a literacy nonprofit uses a mailing to recruit volunteer tutors and ask for donations. The organization prefers to assign most of the cost to program expense, reasoning that the fundraising part of the mailing is relatively minor. But charity watchdogs may allege this overstates the program component, skewing the nonprofit’s fundraising ratio.
Allocating costs between fundraising and other functions can solve the problem, but only if three criteria are met:
1. Purpose. You can satisfy this condition if the activity is intended to accomplish a program or management purpose. A program purpose requires a specific call to action — other than “donate money” — for the recipient to help further your mission. In the mailing example, this means encouraging recipients to become volunteers in a literacy program.
2. Audience. Meeting this criterion can be challenging if your activity’s primary audience is prior donors or individuals selected for their ability or likelihood to donate. But you can strengthen your position by showing that you selected the audience for its potential to respond to your nonfundraising call to action.
3. Content. This criterion is satisfied if the activity supports program or management functions. If that’s not obvious, explain the benefits of the action that’s called for. Note that the “purpose” criterion focuses on intention, while the “content” criterion considers execution.
You should allocate costs using a consistent and systematic methodology that results in a reasonable allocation. The most common method is based on physical units, with costs proportionally allocated to the number of units of output. Other approaches include the relative direct cost and stand-alone joint cost allocation methods. The former uses the direct costs that relate to each component of activity to allocate indirect costs. The latter determines proportions based on how much each component would cost if conducted independently.
Don’t forget disclosure
You must disclose the methods you use for joint cost allocation in your nonprofit’s financial statements, including whether joint activities comply with the three criteria. Also include a disclosure on your Form 990. If you have any questions about allocating joint costs, contact us. © 2019
Whistleblower policies protect individuals who risk their careers — or take other kinds of risks — to report illegal or unethical practices. Although no federal law specifically requires nonprofits to have such policies in place, several state laws do. Moreover, IRS Form 990 asks nonprofits to state whether they have adopted a whistleblower policy.
Adopting a whistleblower policy increases the odds that you’ll learn about activities before the media, law enforcement or regulators do. Encouraging stakeholders to speak up also sends a message about your commitment to good governance and ethical behavior.
Your policy should be tailored to your organization’s unique circumstances, but most policies should spell out who’s covered. In addition to employees, volunteers and board members, you might want to include clients and third parties who conduct business with your organization, such as vendors and independent contractors.
Also specify covered misdeeds. Financial malfeasance often gets the most attention, but you might also include violations of organizational client protection policies, conflicts of interest, discrimination and unsafe work conditions.
And how should whistleblowers report their concerns? Must they notify a compliance officer or can they report anonymously? Is a confidential hotline available? Whom can whistleblowers turn to if the designated individual is suspected of wrongdoing?
Covered individuals and other stakeholders need to know how you’ll handle reports once they’re submitted. Your policy should state that every concern will be promptly and thoroughly investigated and that designated investigators will have adequate independence to conduct an objective query. Also describe what will happen after the investigation is complete. For example, will the reporting individual receive feedback? Will the individual responsible for the illegal or unethical behavior be punished? If your organization opts not to take corrective action, document your reasoning.
Don’t forget to stress confidentiality. Explain in your policy that it may not be possible to guarantee a whistleblower’s identity if he or she needs to become a witness in criminal or civil proceedings. But promise you’ll protect confidentiality to the extent possible. Finally, be sure to have your attorney review your whistleblower policy. © 2019
Directors and officers (D&O) liability insurance enables board members to make decisions without fear that they’ll be personally responsible for any related litigation costs. Such coverage is common in the business world, but fewer not-for-profits carry it. Nonprofits may assume that their charitable mission and the good intentions of volunteer board members protect them from litigation. These assumptions can be wrong.
Here are several FAQs to help you determine whether your board needs D&O insurance:
Whom does it cover?
A policy can help protect both your organization and its key individuals: directors, officers, employees and even volunteers and committee members.
What does it cover?
Normally, D&O insurance covers allegations of wrongful acts, errors, misleading statements, neglect or breaches of duty connected with a person’s performance of duties. Examples include:
- Mismanagement of funds or investments,
- Employment issues such as harassment and discrimination,
- Failure to provide services, and
- Failure to fulfill fiduciary duties.
Are there coverage limitations?
D&O policies are claims-made, meaning that the insurer pays for claims filed during the policy period even if the alleged wrongful act occurred outside of the policy period. The flip side of this is that D&O insurance provides no coverage for lawsuits filed after a policyholder cancels — even if the alleged act happened when the policy was still in place.
What if we need to make a claim after our policy has been canceled or expired?
You might still be covered if you bought extended reporting period (ERP) coverage. It generally covers newly filed claims on actions that allegedly occurred during the regular policy period.
How do we file a claim?
When a legal complaint is filed against your nonprofit, contact your insurer to determine whether the matter is insurable and includes defense costs. Most policies reimburse the insured for reasonable defense costs, in addition to covering judgments against the insured.
How can we keep costs down?
Think seriously about the people and actions that should be covered and the amount of protection you need — and don’t need. For example, you probably don’t need coverage of bodily injury or property damage because these claims usually are covered by general liability and workers’ compensation insurance. As with most insurance coverage, D&O premiums are likely to be lower if you opt for higher deductibles.
Making the decision
Not every organization needs D&O insurance. In some states, volunteer immunity statutes provide limited protection for negligence. Such protection, however, doesn’t extend to federal statutes. If you’re unsure, contact us. © 2019