Spotting Financial Warning Signs for Not-for-Profits

Board members governing notorganizations can’t miss signs of financial distress such as losing funding sources, defaulting on loans or leaving employees unpaid. Most of the time, though, such crises aren’t sudden; instead, there were subtle indicators that went unnoticed. By keeping an eye out for the following problems, a board can recognize problems early and act to ensure the organization’s long-term survival.

Warning bells

When reviewing budgets, board members should look at a few key items that can hint at rocky financial times to come. Most obviously, board members should worry a great deal about a not-for-profit with no budget. The lack of an operating budget suggests an undisciplined approach to fiscal matters. And larger not-for-profits also should have budgets for each program or department. Ideally, board members will see that budgets proposed by management align with the strategies already developed and approved by the board.

After a budget has been approved, the board should monitor monthly reports 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 plans in response to such issues — for example, cutting discretionary expenses in order to cover an unavoidable cost increase.

Board members also should beware of overspending in one program by taking money from another program. Watch, too, for dipping into the organization’s “rainy day” fund (its reserves), raiding an endowment or engaging in unplanned borrowing. Such moves likely mark the beginning of a financially unsustainable cycle.

Flawed financials

Untimely, inconsistent financial statements — or statements that aren’t prepared using U.S. generally accepted accounting principles (GAAP) and the latest audit rules — can lead to poor decision-making and undermine a not-for-profit's reputation. They also can make it difficult to obtain funding or financing.

Financial statements not prepared in accordance with GAAP (or another recognized standard) can also be unreliable and difficult to compare to others. For larger not-for-profits, the board or audit committee should also insist on annual audits and expect to select the audit firm. Members of the audit committee should communicate directly with auditors before and during the process. And all board members should have the opportunity to review and question the audit report.

The board generally should receive the not-for-profits 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 unpleasant facts.

(Significant changes to financial reporting rules went into effect this year. Weaver offered a webinar to help not-for-profits make sure they’re ready to comply; if your organization’s staff is struggling, this webinar may help.)

Doubting donors

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 concern?

The board also should take note if development staff begins reaching out to 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.

Responsible oversight

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.

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 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 from an understaffed the finance department. On the other hand, multiple or chronic issues could call for significant strategic changes. One thing is certain, though: Inaction in the face of trouble spots is a mistake.

Do you have questions about not-for-profit governance or best accounting practices? Weaver’s not-for-profit industry group can help. Contact us with your questions or browse for the latest not-for-profit news.

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