Look at ALL requirements of such grants, or you can get in trouble and may need to return the funds. This can get really sticky.
Look at ALL requirements of such grants, or you can get in trouble and may need to return the funds. This can get really sticky.
Nonprofit Finance: A Practical Guide is available now as a kindle book on Amazon:
The second edition of my book, “Nonprofit Finance: A Practical Guide,” is out. It includes detailed coverage of FASB update regarding reporting, details about liquidity and other details effective in 2018. For example, the official financial reporting will show only two net assets, but internally, a nonprofit should maintain the three net assets separately and combine the temporarily and permanently restricted for reporting only.
Internal controls are covered in detail for cash, payables and computerized systems, giving ideas about how to minimize certain risks specific to the nonprofit sector.
Like the first edition, nominated for a McAdam Book Award, this second one has many examples and suggestions based on real-life experience, not just theories. It was written with both the accountant and the non-accountant in mind, so that people of different backgrounds can benefit from the material and put it to good use right away.
You can check the new edition at https://goo.gl/M563u9
If the program is the heart of a nonprofit, overhead is its backbone. Overhead is known as general and administration costs and, in some circles, it includes fundraising as well. Since the definition of overhead may vary, you should be clear on what it means. For example, in government agencies, fundraising is usually not part of overhead, while other entities consider anything besides program costs, overhead.
Overhead rate on grants –Many grantors use “overhead rates” to reimburse nonprofits for administrative costs. This rate, a percentage, is usually calculated based on prior financial numbers and negotiated with grantors. The calculations can be complicated and detailed.
To decrease this complexity, the Federal government pays nonprofits a standard 10% overhead rate on their grants. This means that after reimbursing direct costs, it adds a 10% for overhead. If direct costs are $100, the reimbursement will be $110. This setup may be fine for smaller organizations, but not for larger ones that may negotiate a higher rate. The idea is for the overhead rate to cover costs that cannot be allocated easily to a program, like an electric bill for a building that houses many programs.
This rate should be reviewed every year to make sure that indeed the overhead rate is at least equal to actual overhead costs. If the rate of 10% reflects $100,000, but the actual overhead costs are $120,000, then the organization may need to negotiate a higher rate with the grantor for the next fiscal year.
Overhead requirement on grants and gifts–Another reason overhead is important is that it must be part of every grant proposal or gift. Some nonprofits have funds restricted for certain programs only with nothing much left over for overhead, forcing many to fundraise for overhead mostly. It’s a strange situation where an organization may have money to fund research programs, but cannot pay its phone bill and other basic needs. Quite real and disconcerting situation.
To avoid this issue, nonprofits have started to require a percentage for overhead to be included in the gift or grant or they cannot accept it. I have seen a large nonprofit say no to a large gift because of this issue.
Overhead should NOT be zero –Overhead exists for a reason and if it shows as zero on financial statements or tax forms, you have a problem. It could be an accounting error in classification or not understanding what overhead is. Whether fundraising is included or not, there should be something allocated to overhead in items like insurance policies, salaries or supplies. Even if all employees are unpaid, expenses exist that cannot be specifically assigned to a certain program and are part of overhead. While it’s understandable the wish to keep overhead costs low, it’s not realistic to keep it at zero.
The first thing to think about when someone mentions overhead is to understand what it means. That is very important to make sure everyone is talking about the same thing. The overhead definition and calculation may vary among grantors and even government agencies. So, ask questions about it, don’t assume anything and don’t forget about it in proposals.
Check out the book”Nonprofit Finance: A Practical Guide- Second Edition First edition nominated for a McAdam Book Award.
Financial statements of nonprofits will look at bit different in 2018. The changes may not be that noticeable to the untrained eye, but they will happen due to FASB (Financial Accounting Standards Board) attempt to make financial reporting easier to understand. Even though current reporting rules have been in place for over 20 years, many people have complained that the financial statements of nonprofits are confusing not providing enough information to assess liquidity and ability to pay bills. This update, known as ASU 2016-14, focuses on these concerns.
“Not-for-profit organizations that will be affected include charities, foundations, colleges and universities, health care providers, religious organizations, trade associations, and cultural institutions, among others” (FASB.org)
The main changes regarding this accounting update are:
Only two classes of net assets
As you may know, net assets are elements that hold information about nonprofits, accumulating increases and decreases in revenues and expenses throughout the years. A nonprofit account always belongs to a net asset, traditionally classified as unrestricted, temporarily and permanently restricted. No more. After this update, we will have only two classifications of net assets:
1-Net Assets Without Donor Restrictions, comparable to the “old” unrestricted net asset
2-Net Assets With Donor Restrictions, combining the “old” temporarily restricted and permanently restricted net assets.
So, instead of reporting on three net assets, as has been the case until now, with statements showing three columns or lines, there will be only two net assets. It doesn’t mean that the accounting of temporarily and permanently restricted net assets need to change internally, but these are now combined in the “official” financial statements. Most likely, the reporting on the accounting software will need to be modified to accommodate the update requirements.
Underwater value of endowments
Organizations may receive endowment funds that are held for long-term or perpetuity. When the fair market value of such investments is lower than the original value of the gifts, they are said to be “underwater.” Unfortunately, that has been the case with the volatility of the stock market and other losses. Currently, such losses are reported under the unrestricted net assets area. However, after this update, accumulated losses are to be shown within the endowment fund — net assets with donor restrictions.
Detailed information about endowments is also required as disclosures on the official financial statements, such as the current fair market value of the endowment, any amount required to be maintained, and any deficiencies of the underwater endowment fund.
Liquidity is the ability of a nonprofit to pay its bills, a valid concern to many donors and grantors. As many donors restrict gifts, it can be hard to determine if an organization has the money necessary to pay its current bills. Financial flexibility is essential for any nonprofit to be viable long-term, so this update requires disclosures about how an organization will be able to meet its financial obligations for the next 12 months. Specific resources available should be disclosed, such as prior year’s reserves and any money restricted by the board.
For more information, check out the book “Nonprofit Finance: A Practical Guide – Second Edition”
Nonprofits need to plan for their future as any other firm. However, because of the nature of nonprofits, planning can be quite a challenge. While for-profits rely on the sale of goods and services, nonprofits must count on grants and donations for operations. Expenses are mostly related to programs and are very dependent on the income stream. Since the point of a nonprofit is not to generate profits, many don’t have that much left over after they spend all revenues. So detailed planning is a must. Some of the challenges of planning for nonprofits are:
Bills are a sure thing, but income may be received after a campaign, a gala event or gifts and grants. Nonprofits may not be able to ascertain the amounts and timing of such income as donors that may have given certain funds in the past may not be able to keep on giving at the same level. Grants may be cut or delayed with no prior notice. Also, grant income may decrease if auditors find noncompliance items and those could be substantial and unexpected. The key here is for the organization to learn of any changes in income stream the earliest possible time to be able to adjust for those.
Because of this instability, it’s always good for a nonprofit to keep a “cushion,” also known as a reserve to be used when the unexpected hits. Add a bit to budgeted expenses, just in case, and contact major donors and grantors to verify any changes in revenue.
Lack of financial knowledge
Many nonprofits are headed by kind people with the best intentions and good contacts. But too often the organization lacks financial education and experience. Basic financial concepts may be missing. Sometimes people are not aware that they need help in this area until something happens that doesn’t make sense to them. This vacuum can pose additional challenges on planning since many concepts may be new to management.
Boards of directors must have people with financial expertise to help in this process and provide guidance in these matters. Also, management should make efforts to learn about accounting and finance so that they can make right decisions. Usually, having a bookkeeper with some experience with nonprofits is not enough to see “the big picture.”
Lack of Time
Typically, nonprofit managers wear many hats, are hands-on, and there is no time to focus on planning and financial matters. It’s hard to think about financial planning and strategy when so many things need to be done today. The result is that usually information is pulled in a hurry and not analyzed, resulting in poor planning and errors.
It’s a good idea to have appointments and set schedules for managers to talk about planning and strategy, A bookkeeper or accountant can only do so much in financial planning. He or she needs input from various areas such as from managers regarding new programs and fundraising folks about new grants or changes in donations.
Planning for nonprofits pose particular challenges but can be done. Management can learn from past mistakes and try to get a better planning model moving forward. The concept here is that nonprofits must take planning seriously and keep on improving it. Donors and grantors like to see a nonprofit planning ahead and not just putting off fires.
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Not to be too paranoid here, but I just read an article about the Simi Valley Community Foundation whose former executive director stole over $45,000. According to the news, she forged a second signature on the checks used to pay her own mortgage. Sadly, this embezzlement cost the organization its reputation as it had to stop operations, at least for now. A total disaster.
It’s not clear how exactly the theft was discovered, but board members noted something odd, hired a forensic accountant to review the records, and went to the police with evidence of embezzlement. So, I give credit to the board for finding this out, but this theft had been going on for awhile.
So, what can a board do to prevent or identify financial fraud faster?
1- Knowledge –Get people on the board who understand financial matters and can ask the right questions. The board cannot have the obligation to fundraise and provide oversight only. Board members should have different backgrounds with least one person having the education and experience to really understand the information provided and ask good questions. Had this person been on the board of this Simi Valley nonprofit, the fraud may have been identified earlier.
2- Online Access –Have someone from the board check on the bank accounts of the organization online. He or she should review checks and deposits, looking for checks that don’t look right. Just having a policy about this review may deter fraud. Employees may think twice before forging signatures or doing something odd when they know that someone would be looking at the bank transactions regularly.
3- Pay attention –Listen to complaints from staff, donor, and vendors. Oftentimes, information that could be construed as gossip can be useful in pointing you in the right direction. People talk. Even though it’s not clear how the board of the nonprofit became aware of something wrong, my bet is that someone saw something and talked about it. Some nonprofits have started using hotlines for people to report possible fraud anonymously, a very good idea.
4- Variances –Pay attention to the actual vs. budget reports. Looking at this fraud, one may wonder how the $45,000 theft was classified and shown on the financial reports. The amount didn’t show up all at once, but it was likely classified as a budget item. So, if an overage is noted, the board should ask for back up documentations, such as bills.Talk only doesn’t explain financial issues.
5- System reports –Review new vendor/change vendor reports once a month to question any odd new vendor or changes. In this situation, the bank where the mortgage was paid to would have been added at a certain point to the accounting system. Had this report been reviewed, it may have flagged the bank as an odd vendor. Some accounting systems can send an email whenever a new vendor is added or changed, making this task automatic.
6- Bank reconciliations — Check on bank reconciliations, making sure they are done monthly. Keep an eye on deposits that are recognized in the accounting records, but don’t seem to be in the bank. Also, look at the detailed outstanding checklist. This can be done online using the accounting system and can be emailed to someone at the board. If a check shows up at the bank, but not on the accounting records of the organization, it could be a red flag.
7- Self-reliance –Don’t count on auditors to notice embezzlement. Audits are designed to assure reasonableness of financial statements and they may identify fraud, but not always, especially when done by management. When something seems wrong, not it, and don’t wait for the auditors to figure it out. Insiders are the first people to note things that don’t seem right.
8- Education — Educate all employees on fraud and embezzlement. Nonprofits should have this topic on its policies and procedures documentation and not be embarrassed about it. Fraud happens not just with stealing funds, but in other areas as well, such as equipment theft and overtime pay without authorization. Just showing this awareness and clarity over fraud may prevent it in the first place.
It’s a shame that nonprofit boards must be always on alert for fraud and embezzlement, but that’s the reality of the situation. Once a scandal happens, it’s hard for the organization to regain the trust and respect of donors, making it hard to move forward.
So, it’s time to talk about this issue openly and set up written policies and procedures with tasks specifically designed to prevent and identify fraud and theft. The ideas presented here won’t assure boards that they are safe from this issue, but are steps in the right direction. Each organization is different and I’m sure many will need more control features than the ones presented here. The crucial point here is that fraud signs cannot be ignored by the board.
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Budgets are financial guidelines to make sure the organizations are going in the right direction. Like any other business, nonprofits need to plan ahead using budgets, often based on prior financial data and expectations for the future. This process, done a few months before the new year starts, involves managers and board members, to make sure the budget is reasonable and attainable.
There are many ways to start the budgeting process. Many organizations develop budgets based on income first and then expenses, while others start with expenses and then work on the revenue — it depends on the nature of the organization. For example, when a nonprofit receives most of its income from grants, it’s easier to estimate income first and then work on expenses.
Budgeting is a group effort
In order to develop a good budget, you need to be realistic and detailed-oriented. A lot of research is required, and not just financial, but programmatic as well — is the nonprofit going to expand or shrink certain programs? Are there any plans for construction or another capital improvement? You cannot do it in a bubble –you need a lot of information from the past and from the future, and that usually involves many meetings and discussions.
Use prior financial reports
The first step to create a budget is to print out current revenue and expense detailed report by account and use that as your basis for the future. For example, if you see rent expense of $1,000 a month, then you should budget for this amount for the following year unless you know that the rent will increase or decrease in the near future. Look at each account and try to forecast the best you can about the following year. This type of work is often done during the last months of the prior year so that any trends or new information is included in the budget.
Consider major changes and grants
Although budgets are usually done once a year and then the numbers remain static, there are instances where budgets are changed and re-approved by the Board during the year. This may happen when a nonprofit loses or gains major funding by surprise, making the original budget obsolete.
Nonprofits receiving government funds incorporate grant budgets as their own. It doesn’t make sense to use multiple budgets — it creates confusion. Organizations also need to consider government cuts and how that would affect operations. As a rule, budgeting for a bit more revenue than expenses, allowing for cuts and unexpected expenses is a sensible approach. It’s always good to have a bit of a financial cushion.
Budget follow up is a must
Once budget numbers are approved by the Board and entered in the accounting system, the next step is to get actual vs. budget reports starting with the first month of the new year. Be sure to look at budget variances for the month and year-to-date. If you only look at monthly numbers, you may miss variances that may be small on a month-by-month basis, but significant for the year. For instance, if you see that your revenue is down $10,000 this month, it may not mean much, but if you compare year-to-date actual to budget numbers, you may have a $100,000 hole in the budget that needs to be corrected by using funds from prior years or by cutting down expenses.
Note that many nonprofits count on restricted funds to operate and that’s when confusion may start up. When developing an operating budget, differentiate between restricted revenues and others and be sure that donor documentation supports the decision to use restricted funds. You cannot unilaterally decide to use restricted funds — the donor must have given express permission for the money to be used a certain way.
More than one budget
Some organizations have separate budgets for capital expenditures to be used in major construction or another major project, which can be a sensible budget approach. Keep the operating budget separate and review both, looking for discrepancies and double counting. For instance, you may receive funds to construct a school and that should go towards the capital budget only — not towards operations. In some cases, the same funding may show up in two different budgets by mistake. Look out for those that can create a major problem.
Keep good documentation
As discussions are done and decisions are made regarding the budgets, keep good records that are always important when looking at budget vs. actual reports. If numbers are not going according to plan, it’s crucial to look at the reasons for the budget amounts. For example, if expenses for postage are way over budget, maybe the budget numbers didn’t account for a new campaign or for all campaign expenses. This can help budgets be more accurate in the future. Documentation can also help management in analyzing the financial reports to identify areas of real problem.
>>>BEWARE Accounting or the financial department folks should NOT prepare the budget by themselves —- they need to contact others within the organization to finalize the budget process.
Check out the book “Nonprofit Finance: A Practical Guide” –– Nominated for the 2016 McAdam Book Award