When most people think of financial audits, they’re filled with dread. However, audits aren’t a bad thing at all!
When your organization undergoes a financial audit, the auditor will examine your nonprofit’s financial statements, records, transactions, accounting principles, and internal controls. From there, they can identify new opportunities for better financial management and security.
That means that the funds you’ve worked so hard to raise (especially amongst the current economic climate) will be kept safe and used responsibly by your organization. When you look at it this way, financial audits are actually an aspect that’s necessary for organizations to maximize their funding and advance their missions as much as possible.
Here at Jitasa, we help nonprofits with their accounting and bookkeeping needs every day. We have a passion for financials! We recommend only the best auditing firms and can help organizations prepare for these important processes. With this experience, we want to smash the myth that audits are intimidating and something to be dreaded.
Instead, we aim to help nonprofits understand audits better so that they can comfortably decide to invest in an auditor and get the most from the experience. That’s why we put together this guide to walk organizations like yours through the basics of nonprofit auditing. Specifically, we’ll walk through the purpose of these audits and the essentials of the audit process.
This guide simply provides an overview of the auditing process. If you like what you read here and are interested in further breaking down the barriers to conducting a financial audit for your organization, be sure to take a step further in your research. The Jitasa guide to nonprofit auditing provides a more in-depth look at the auditing process and what you can expect from the experience. It’s a great next step in your research.
But first, you should make sure you have a basic understanding of nonprofit audits. Let’s get started.
Purpose of Financial Audits
While for-profit businesses and individuals might find themselves faced with an IRS-mandated financial audit to ensure they’re paying their fair share in taxes, nonprofits don’t face these same surprises when it comes to auditing. This is simply because nonprofits don’t pay taxes.
However, there are circumstances in which nonprofits are required to conduct audits. Federal stipulations require organizations that receive more than $750,000 in federal funding to conduct an audit and some states may require audits for organizations that earn over a certain amount. Nonprofits may also require themselves to conduct audits in their bylaws, or grantmakers may ask for one.
Even if nonprofits aren’t required to conduct audits by a third party, they may consider doing so voluntarily simply because of the benefits that a well-conducted audit can provide.
When nonprofits conduct audits, they may see a number of benefits such as:
- Increased financial transparency. Communicate to your supporters that you’ve elected to undergo an audit and have implemented improvements as a result. This shows them that you care about financial security, helping supporters further trust your organization. In turn, you’ll effectively improve your fundraising strategy by establishing a reputation as a responsible organization.
- Regular accountability. By conducting regular audits (no matter the frequency), you’ll find that your organization is held accountable at the same high standards at all times. You won’t just conduct an audit and forget the results. The accountability will ensure you implement the suggestions that come from the process.
- Opportunities to improve. While we all want to get 100% on all tests, you may not get a perfect score on your audit. That’s ok! That’s what the audit is all about: to help your organization find opportunities for improvement in your current financial strategies.
Whether you’re required to conduct an audit or not, it’s important to understand the benefits of doing so. The purpose of audits is simply to help nonprofits improve their financial strategies for optimal security and efficiency.
The Audit Process
The audit process can take anywhere from 8 to 20 weeks to complete from searching for an auditor to incorporating the recommendations that come from the experience. The graphic below shows a rough timeline that a nonprofit can expect for a nonprofit audit:
We’ll break down each of these stages in the nonprofit audit process so that you can better understand exactly what happens during each one.
Select an Auditor
Ernest Hemingway once compared a blank sheet of paper to a “white bull,” saying that it was a terrifying prospect to start from scratch on a new project. It can be just as terrifying to start the search for an auditor for your organization.
That’s why we suggest asking for recommendations from a trusted source such as your accounting team. You won’t have to stare down a “white bull” if you already have a starting point for selecting an auditing firm for your organization. Of course, you can always expand that initial list with potential firms you find through a basic Google search or other recommendations from other nonprofits.
After you’ve selected an initial list of potential auditors, narrow your search by comparing the:
- Percentage of the auditing firms’ clients who are nonprofits.
- Estimated timeframe and deadlines for the auditing process.
- Fee structure and total cost of each auditor.
Once you’ve narrowed down your selections, draft up a formal request for proposal (RFP) to compare the shortlist. From there, you should have everything you need to make your final decision. Congratulations!
Prepare for Your Audit
While you definitely deserve a pat on the back after you’ve chosen your ideal auditing firm, your job isn’t quite done. There is some preparation work that needs to be done before an audit is completed.
Before you can dive into the audit itself, your organization needs to run through a very specific checklist of items to be sure you’re ready. This checklist includes the following items:
- Have you captured every transaction?
- Have you reconciled all bank accounts?
- Have you analyzed adjustments for prepaid expenses?
- Have you reviewed expenses for items that should be capitalized?
- Have you taken a first pass at creating financial reports?
In addition to the items listed above, your auditor will likely ask for some specific documentation that you should compile as a part of a PBC list (pull by client). PBC lists are anywhere from 40 to 120 items that you’ll need to compile in order to prepare for the audit. These items may include:
- Bank reconciliations
- Bank statements
- Prepaid item lists
- Unpaid invoices
- Grant files
- Grantor advances
- Contracts payable
- Payroll information
- Details of fundraising contributions
After you’ve collected all of the necessary information and documentation for your auditor, the wait will be over! They can conduct the actual audit.
Conduct the Audit
Your nonprofit has very little control over what happens during this phase. The auditing firm will take a few weeks to review all of the documentation you provided. Once they’ve completed the analysis, the auditor will compile reports for your organization. Included in this documentation will be recommendations for improvement.
Generally, the industry best practice is to make sure your audit is completed before it’s time for you to file your Form 990. That way, you can incorporate the recommendations for the audit before compiling the tax forms.
Similar to how you’d never hire a consultant without heeding their advice, there’s no point in conducting a nonprofit audit if you don’t plan to incorporate the suggestions from the analysis. Some of the fixes recommended by the auditor might be simple opportunities that have a massive impact while others may be more time-intensive and challenging.
Either way, be sure to share your results with your organization’s accounting team. They can help you implement the suggestions, ensuring better financial management in the future.
Healthy financial management is a key aspect to any organization, especially nonprofits that need to remain accountable to their dedicated supporters. In order to maintain your finances, you need to make sure you have an organized bookkeeper, an informed accounting team (which differs from your bookkeeper in several ways), and regular audits to hold the team accountable and fill in any strategy gaps.
Getting a hold on accounting and auditing is the first step to ensuring proper financial management. After all, how can you ensure proper finances without understanding them first?
Author: Jon Osterburg
Jon Osterburg has spent the last nine years helping more than 100 nonprofits around the world with their finances as a leader at Jitasa, an accounting firm that offers bookkeeping and accounting services to not-for-profit organizations.