With cost-of-living concerns, interest rates and federal funding cuts continuing to be prominent in the headlines, many nonprofit leaders are understandably focused on external economic pressures. Yet some of the most serious threats to an organization’s financial stability don’t come from the broader economy — they originate within the organization itself. Executives and board members alike should stay alert to the following internal red flags that may signal deeper financial or governance issues.
Budget variances without clear reasons
After your board of directors approves a budget, it should be monitored for variances. Although some variances are to be expected, your staff should be able to provide reasonable explanations — such as funding changes or macroeconomic factors — for significant discrepancies. Where necessary, work to mitigate negative variances by, for example, cutting expenses.
Additionally, beware of overspending in one program funded by another, dipping into operational reserves or engaging in unplanned borrowing. These, plus the need to draw from your nonprofit’s endowment for funding, may mark the beginning of a financially unsustainable cycle.
Decreased donor confidence and giving
Let’s say your nonprofit has been receiving fewer and smaller donations lately. Then you start hearing from long-standing supporters that they’re losing confidence in your organization. Investigate immediately. Ask supporters what they’re seeing or hearing that prompts their concerns.
Also note when development staff approaches major donors outside of the usual fundraising cycle. This could mean your nonprofit is scrambling for cash.
Incomplete or noncompliant financial reporting
If your financial statements are untimely and inconsistent or aren’t prepared using U.S. Generally Accepted Accounting Principles, you could be heading for trouble. Poor financial statements can lead to poor decision-making and undermine your nonprofit’s reputation. They can also make it difficult to secure funding.
Insist on professionally prepared statements as well as annual audits. Members of your organization’s audit committee should communicate directly with auditors before and during the process. All board members should have the opportunity to review and question the audit report.
Unchecked executive authority
Even the most experienced and knowledgeable nonprofit executive director shouldn’t have absolute power. Your board needs to step in if an executive ignores expense limits or violates other rules of good fiscal management. The board should also question any executive who attempts to select a new auditor or make strategic decisions without board input.
How to respond
Nonprofits rarely encounter financial trouble overnight. Problems usually develop gradually, with early indicators that are easy to overlook or explain away. By paying close attention to budget discipline, donor trends, financial reporting and leadership accountability, boards and executives can identify risks early and take corrective action.
If any of these red flags sound familiar, now is the time to act. We can help you engage your board, strengthen your internal controls and review any financial and governance warning signs before they become deeper issues.
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