Independent financial audits may be mandated by your state’s charitable solicitation licensing requirements. Although they can seem like a lot of work and expense, audits can help ensure responsible financial management and transparency with stakeholders. However, they can also present challenges such as reputational damage and legal penalties if they uncover discrepancies, inefficiencies, or fraud within your organization.

If you’re like most nonprofit leaders, the thought of an audit can be intimidating! Your area of expertise is your mission—not accounting best practices. How can you make sure your organization passes its audit with flying colors?

3 Top Mistakes Caught in Audits

1. Documentation and Reporting Mistakes

Among the various ways your supporters contribute to your organization—from cash donations to in-kind gifts to volunteer hours—and the fluctuating expenses associated with your programs and operations, proper recordkeeping is critical for allocating your resources properly. However, thorough and accurate financial records are also essential for audits, impacting the efficiency of the auditing process and the accuracy of its findings.

Documentation and reporting mistakes can lead to delays in the audit timeline, complications on the auditor’s end, and inaccurate findings. In the worst case, it can suggest mismanagement or financial statement errors, which could result in legal repercussions and damaged donor trust.

Solution: Implement a robust recordkeeping system to ensure accuracy and consistency in financial documentation.

Your recordkeeping system and procedures should include:

  • Standardized recordkeeping: Establish a simple recordkeeping process to ensure every team member records financial data properly and in a uniform manner. For example, NPOInfo recommends ensuring numeric data entries (dollar amounts, percentages, etc.) have the same format. Accounts should have obvious titles such as rent, gas & electric, or food (if your organization feeds unsheltered people). Clear titles will help ensure that income and expenses are coded to the proper categories.
  • Review financials monthly: Obtain and read financial statements every single month, especially a budget vs actual report, to make sure your organization is on target to meet its financial and operational goals and to ensure your records are accurate.
  • Account reconciliation: Reconcile your accounts by comparing internal documentation to external records, such as bank statements.

Taking these steps can ensure your recordkeeping is thorough and accurate from the start. If any inconsistencies or mistakes slip through the cracks, your team can catch them early and correct the errors before they mislead financial decision-making and affect audit results.

2. Misallocation of Funds

In contributing to your nonprofit, donors place a significant amount of trust in your organization. Along with trusting that you’ll protect their sensitive information and truly work to fulfill your mission, donors also act under the assumption that your nonprofit will use their gift according to their intent for the donation.

For instance, donors who donate to help an animal shelter afford food for the animals in its care might be upset to learn their donation was actually set aside for the nonprofit’s reserve funds. While building your nonprofit’s emergency fund isn’t a bad thing, you must be respectful of donors’ wishes for their contributions, especially if they place restrictions on their gifts.

Even if you don’t intentionally neglect donor designations, failing to properly track and report restricted funds can cause your team to accidentally mishandle donations. As a result, you may jeopardize compliance and damage your nonprofit’s reputation.

Solution: Establish clear accounting practices to ensure all funds are used according to donor restrictions and organizational procedures. 

These accounting practices should include:

  • Guidelines for clearly separating and tracking different types of funds within your recordkeeping system
  • A process for regularly monitoring and reporting fund usage
  • Audit trails and documentation to make your financial data easy to access and review

Having these practices in place not only prepares your team for future audits but also paves the way for smooth bookkeeping during major campaigns. When team members have a clear understanding of how to record different types of funds, you’ll ensure restricted donations are recorded properly from the get-go and are then used for their intended purposes.

3. Inadequate Internal Controls

Internal controls are procedures and oversight measures established to ensure the integrity of your nonprofit’s financial data and resources. Without strong internal controls in place, your financial data could be inaccurately recorded, accessed by unauthorized users, or otherwise misused. This leaves your organization’s finances vulnerable to fraud, errors, and mismanagement.

Solution: Strengthen internal controls and maintain strict oversight to minimize the risk of fraud and accounting errors.

Strong internal controls safeguard your nonprofit’s assets and help ensure data integrity. Important internal controls include:

  • Checks and balances: To ensure no individual has too much power or control over financial transactions, implement checks and balances. According to Chazin & Company, this could include segregating duties or requiring dual authorization for financial transactions.
  • Board oversight: Task your board of directors with reviewing financial reports and budgets to ensure alignment with your nonprofit’s strategic plan. Additionally, consider creating a designated audit committee (consisting of board members and staff with financial experience) to oversee the entire audit process.
  • Internal control assessments: Evaluate the current internal controls within your organization and identify areas for improvement. This should involve reviewing your nonprofit’s financial policies and procedures, and then refining your internal controls as needed.

Internal controls will look different for every organization. Consider consulting a nonprofit financial expert for specific guidance on which controls make the most sense for your nonprofit’s unique financial situation.

How to Avoid Common Audit Pitfalls

Your organization can use a robust bookkeeping system, establish clear accounting practices, and strengthen internal controls to prepare for an upcoming audit. However, each of these strategies requires thorough planning and execution; nonprofit accounting is a full-time job!

Professional accountants are well versed in the complexities of nonprofit accounting, as well as various compliance requirements for charitable organizations. Their expertise can help you prevent and correct financial errors without placing more administrative burdens on your organization’s team. In addition, they can provide ongoing assistance with any financial challenges your nonprofit faces in its day-to-day operations.

Whether you choose to research nonprofit accounting and tackle an audit on your own or reach out to a professional, keep in mind that a proactive strategy is the key to avoiding audit pitfalls. With thorough planning, your team can approach audits with the confidence that your financial records are in order and fully compliant.

The first step to ensuring a smooth financial audit is familiarizing your team with the common pitfalls that nonprofits face and the top strategies for avoiding them. With these warnings in mind, your nonprofit will be equipped to reinforce its financial integrity and avoid costly mistakes. As a result, you’ll not only pass your audit—you’ll build trust among stakeholders, engage donors, and continue to make a meaningful impact on your community.