Internal controls are a must for nonprofit organizations. It should be a priority to establish proper internal controls from the start to ensure that assets are protected, and risks are mitigated. NPOs often struggle with limited staff and resources, which makes them particularly vulnerable to the risk of fraud or mishandling of funds. Nonprofit leaders, including the Board of Directors, should be especially concerned about internal controls. Internal controls bring credibility and demonstrate sound financial management to donors who may invest in their mission; as well as help to fulfill fiduciary responsibility requirements.
There are mechanisms and management practices that will help protect your organization’s assets and ensure the integrity of your financial data. Read on to learn why internal controls are so important to the success of a nonprofit organization.
What Are Internal Controls?
Internal controls are practices implemented and followed by an organization to protect assets, promote effective cost management, prevent and detect errors, and ensure compliance with laws and regulations. Simply put, internal controls provide checks and balances to ensure funds are not misused. Internal controls protect not only the nonprofit’s assets, but also the organization’s stakeholders. A common misconception is that internal controls are simply segregation of duties, which can be a challenge for some nonprofit organizations, but internal controls are much more than that.
How Many Internal Controls Does My Nonprofit Need?
Nonprofits should strive to develop a system of internal controls in the form of safeguards and organizational practices. Establishing a good internal control system is an important aspect of running a nonprofit organization regardless of its size. As a general guideline, internal controls can be broken down by two main categories:
- Preventative controls
- Detective controls
Preventive controls are important because they work from the inside, preventing errors and fraud before they ever occur. They operate as a powerful way to protect the reputation, assets, and mission of the organization because, by design, they discourage internal fraud and limit harmful mistakes. Nonprofits can implement several preventative controls at once. Here are a few common ones:
- Physical protection of assets: This includes simple things like having locks on file cabinets where sensitive information is stored and restricting office access to only authorized personnel. Another example would be locking cash in a safe.
- Separation of duties: Having different employees in charge of different organizational responsibilities, particularly throughout the receipts and recording processes, creates checks and balances.
- Review/Approvals: Nonprofits should put safeguards on spending with approval processes and signatures guidelines. Requiring two approvals before issuing payments over a specified amount is a great example of a pre-approval system that is easy to implement. Final payroll reports should be regularly reviewed and approved by the CEO/Executive Director.
Sometimes, despite the organization’s best efforts, things can slip through the cracks, resulting in mistakes or even fraud. Detective controls kick in after the fact and are designed to identify what happened, how and why it happened, and how to prevent it from happening again. These safeguards also help a nonprofit determine if their preventative controls could be improved. Here are some commonly implemented detective controls:
- Bank reconciliation. Monthly bank reconciliations, that are reviewed and approved by someone other than the person performing the reconciliations, offer an effective way to identify improper transactions.
- Physical inventories. Keeping track of physical items on hand will help nonprofits quickly realize if anything is out of place or missing.
The Importance of Nonprofit Internal Controls
The critical role that internal controls play in an organization is clear. To keep your nonprofit’s mission on track, prevent fraud, catch mistakes early, and preserve your nonprofit’s reputation, you must implement strong internal controls and consistently evaluate how effective they are.
Setting Up Internal Controls
Though necessary, creating and maintaining internal controls can be a challenge for some nonprofits and quite often is not given the priority that it should. Many nonprofits do not have the expertise available to set up internal controls and it can be daunting to set up an internal control system when the organization has limited staff and resources. The good news is, tackling this important task is not something nonprofits need to do alone. Accounting firms dedicated to nonprofits are specially equipped to help nonprofits create management practices that prevent fraud and misuse of assets.