What Every Nonprofit Needs to Know About Financial Audits
When individuals get audited, it’s to make sure they’re paying the correct amount in taxes on a regular basis. As a nonprofit, you don’t pay taxes on behalf of your organization. So does that mean you don’t have to worry about audits? Not exactly.
Nonprofit financial audits function a little differently for nonprofits than they do for individuals. Rather than audits ensuring you pay taxes, they’re used to ensure your organization is using your funding responsibly to advance your mission.
In this guide, we’ll cover nonprofit financial audits in-depth, discussing what you need to know on the subject as well as what to expect when you conduct one. We’ll review the following topics:
- Purpose of Nonprofit Financial Audits
- When Financial Audits are Necessary
- Timeline for the Auditing Process
Audits are highly relevant to your nonprofit accounting practices. Effective accounting practices year-round are the key to a smooth audit process for your nonprofit organization.
Purpose of Nonprofit Financial Audits
As mentioned above, nonprofits don’t need to pay taxes. So why are audits necessary?
The purpose of a nonprofit audit is to make sure the organization is leveraging effective accounting processes and complying with the generally accepted accounting principles (GAAP).
- Increasing transparency with supporters. Audits require deep financial analysis and when supporters understand that this took place, they’ll also recognize that your nonprofit takes accounting practices seriously. This financial transparency is highly valuable for supporters who entrust their funds to your nonprofit.
- Ensuring accountability in finances. If you regularly conduct a financial audit for your nonprofit, you’ll be able to make sure you’re maintaining a high level of accounting controls and best practices. These become even more important as your organization continues to grow and expand your financial capacity.
- Identifying improvement opportunities. When it comes to finance, the higher the standard for your management processes, the better. Audits can help identify areas where your organization can make improvements so that you always allocate resources effectively and responsibly.
Audits have several purposes for your organization. However, they also have several purposes for other organizations as well (specifically your funders) to be sure you’re using resources effectively. That’s why you’ll need to see if you’re required by funders or by law to conduct a financial audit for your organization.
When Financial Audits are Necessary
Nonprofit financial audits may be required by some of the funders that contribute to your organization. This is used as an accountability standard to be sure your organization is using the funds they provide responsibly and as promised.
However, this isn’t the only situation in which you may need to conduct an audit. Your nonprofit might be required to conduct a financial audit if it’s required by:
- Your bylaws. Some organizations have it spelled into their bylaws that the organization must complete a financial audit every year or biannually. This allows the organization to check in on financial practices to be sure everything is running smoothly and best practices are being adhered to.
- The state. If your nonprofit accepts funding from the state, you might need to conduct a financial audit to comply with state regulations. Be sure to check the guidelines for your state to see if you need to submit an audit when you accept a certain amount of funding.
- The federal government. If your nonprofit accepts $750,000 from the federal government (or if that amount is passed from the federal government, through the state, and eventually to your organization) you’ll need to conduct a financial audit of your nonprofit.
- A grantor. Some grant funders might require your organization to conduct a financial audit as a requirement to accept the grant money. Sometimes, multiple grantors might require audits, so be sure your grant management processes are up-to-scratch.
Even if you’re not required to conduct an audit, your nonprofit might still consider doing so in order to gain the benefits listed in the last section. Discuss the options with your team and bring it to a vote about whether or not an audit should be conducted on a regular or semi-regular basis.
Timeline for the Auditing Process
The auditing process takes some time to complete. Therefore, your organization needs to allow for plenty of time to get it done.
We recommend planning ahead so that you can complete your nonprofit audit before tax season. That way, you can incorporate any changes in your processes when you fill out your annual Form 990. If you won’t have enough time, you can always file an extension on your tax forms to make this happen.
In general, the nonprofit audit timeline will look something like this:
Select an auditor.
4 to 12 weeks
When finding an auditor to conduct your organization’s examination, you’ll want to make sure they have experience working with nonprofits of your size and type. Leave around 4 to 12 weeks to find the right firm.
The following steps will help you find the right auditor for your organization:
- Cast a wide net. Research potential auditing firms by using search engines and asking for recommendations from your accountant and other similar nonprofits in your community. Write down all of the results you find before you start marking them off of your list.
- Narrow down your list. Ask questions regarding the number of the auditor’s clientele that are nonprofits, the auditing process timeline, and the fee structure. This will help you better align with an auditor that meets your needs.
- Write an RFP. Once you have a shortlist of potential providers, you can submit a request for proposal (RFP) to compare the firms. Ask for items such as a firm description, information about who will conduct the audit, what sets the firm apart, and the fee structure.
- Make your decision. After your RFP submission, you should have everything you need to make a final decision about which auditor to choose for your nonprofit.
Call the references for the firm you choose to make sure they have a positive track record from their past clients. Then, you can start preparing for the audit itself.
Prepare for your audit.
2 to 4 weeks
Your auditor will likely provide a pull-by-client (PBC) that you can use to gather the appropriate documentation you’ll need for your audit. You’ll want to make sure that you have:
- Captured every transaction, avoiding any unrecorded expenses and properly recording pledges and grants.
- Reconciled your checking, savings, investment, and all other bank accounts for your organization.
- Analyzed the adjustments made for prepaid expenses.
- Reviewed large-scale expenses and ensured they’re recorded according to your capitalization policy.
- Taken the first pass at creating your key financial reports.
It’s much easier to pull all necessary information and ensure everything is audit-ready when you have effective and regular accounting practices. Outline processes with your team ahead of time to be sure the items on this list are generally completed, regardless of whether you’re conducting an audit.
Conduct the audit.
2 to 4 weeks
For the next 2 to 4 weeks, your auditor will review the documentation you provided. Try not to stress during this time period. The auditor is not trying to catch your nonprofit in the wrong but to help you identify opportunities to improve.
Incorporate audit recommendations.
Immediately after the audit
After the audit is complete, your auditor will provide you with a report and some listed recommendations to incorporate for your organization. You’ll also receive an opinion letter that you’ll need to present to your board of directors.
After you have and present the results, you can start incorporating the suggestions of your audit. Be sure these recommendations change your processes rather than just one-time reporting. This will help ensure you’re making changes for better future financial management.
As we mentioned earlier, you should also try to incorporate these recommendations before filing your tax forms. This way, you can include any relevant information in the forms.
When individuals are audited, it often invokes dread and fear. However, your nonprofit doesn’t need to worry as much. Rather than view an audit as a negative report card, think about it as a learning opportunity for your nonprofit.
Understand exactly when you need to conduct a nonprofit financial audit so that you’re prepared when interested parties ask for one. However, remember that you don’t have to be required to conduct an audit in order to complete one. Instead, you can do it to ensure your accounting practices are well-established and to remain accountable to your funders.