Financial transparency is essential to nonprofits as it helps donors understand that their monetary donations are being spent wisely. Having strong accounting practices can help a nonprofit achieve this goal. A study showed that nonprofits that proactively shared information relating to their financial status received significantly more contributions one year later. This is because more transparent organizations are perceived as being better governed and managed.
Internal Controls
Like for-profit businesses, nonprofit organizations must institute internal controls to protect against fraud and mismanagement. These procedures are layered on top of standard operating procedures to mitigate risk and ensure accuracy and reliability in accounting for non profit organization data and financial reporting. Whether implemented to prevent theft or ensure compliance with laws and policies, these controls are crucial to sound financial practice. The type and structure of internal control varies, depending on the risks involved. For example, separating duties over cash handling (assigning different individuals to tasks such as collecting money, maintaining documentation, and preparing deposits) helps deter cash theft. Requiring pre-approval for reimbursements also helps to reduce the likelihood of fraudulent activities. In addition, it’s essential to document all controls thoroughly so that they are effective. The effectiveness of internal controls is evaluated through an audit, which assesses whether they’re functioning correctly to meet established objectives and goals. Generally, the more robust the internal controls, the less testing an external auditor needs to conduct to determine the accuracy of the organization’s financial statements. This, in turn, lowers the costs associated with the audit and allows more of the organization’s funds to be directed toward operational efforts.
Financial Reporting
Nonprofits must file four statements yearly to comply with IRS rules and be transparent to donors. This financial audit statement reviews the organization’s financial health and performance. They include a statement of activities, a statement of net assets, a balance sheet, and a statement of functional expenses. The statement of activities lists changes to the nonprofit’s net assets over an accounting period. It compares gross receipts and expenses to determine the organization’s operating income or loss. Net assets are the organization’s total assets minus its liabilities. Nonprofits can report their revenue in various ways, including cash or accrual. The statement of net assets displays the nonprofit’s current and historical net worth at a particular date. This shows how much the nonprofit earns from its operations and investing in itself for the future. The nonprofit must also reconcile its bank statements monthly to support findings in the statement of activities and to help prevent fraud. These reconciliations verify that account balances in the nonprofit’s records match those in its bank accounts.
Fundraising
A nonprofit organization’s fundraising is an essential indicator of its financial transparency. Donors want to know that the nonprofit they give their money to will use it wisely and put it toward its ultimate mission. Research has shown that donors are more likely to donate to a nonprofit when it’s transparent about its financial management and costs. In a world without trust, nonprofits can leverage transparency to improve donor retention. However, a nonprofit’s ability to inspire confidence depends more than flashy graphics or blog posts. It also depends on how thoroughly and consistently the nonprofit checks its accounting. The financial statement of functional expenses explains how each dollar is used within the nonprofit. Nonprofits will often separate these expenditures by program, fundraising, and management. Another critical financial transparency measure for nonprofits is independent audits of their accounting records and year-end financial statements. An audit is not only an IRS requirement but can help ensure that the nonprofit’s finances and records are accurate, according to generally accepted accounting principles.
Reporting to the IRS
As tax-exempt organizations, charitable nonprofits rely on transparency to preserve community members’ trust in their mission and attract donors. Being transparent also helps them earn a higher rating from the Better Business Bureau Wise Giving Alliance and maintain compliance with state laws. A critical aspect of financial transparency is submitting tax-related documents to the IRS on time. It is best practice for nonprofits to make these documents easily accessible by listing them on their website, which can help avoid requests for hard copies of reports. It is also recommended that nonprofits list the names of all board members (including non-compensated members of a governing body) and principal staff. The IRS reviews Form 990s and other data from exempt charities to identify potential areas for examination or concern. When deciding to open an audit, the agency looks for specific items, such as excessive compensation and a lack of disclosures. Referrals can come from the public or state agencies, such as a state’s attorney general or auditor. Nonprofit annual reports provide an excellent opportunity for a charity to highlight its impact and to show that it is trustworthy and financially viable. The report should include detailed program information, including the funding received and the percentage of expenses allocated to the program, fundraising, and administrative activities.
