How to Prepare Your Nonprofit’s Financial Statements and Conduct an Audit

By Stan Hutton and Frances Phillips from Nonprofit Kit For Dummies, 3rd Edition

If a budget is a document about the future, a financial statement tells the story of your nonprofit organization’s past. Nonprofit organizations keep and review their financial records throughout the year, and they prepare a financial statement at least once a year, at the end of the fiscal year. Many organizations also prepare monthly or quarterly “in progress” versions of their annual financial statements.

Interpreting financial statements is a special area of expertise. Many nonprofits seek outside professional help for this essential task. If you do choose to prepare your own financial statements, you may want to hire an accountant at year’s end to review them for accuracy.

The information in your yearly financial statement resembles (but may not be identical to) the Form 990-N, 990-EZ, or 990 financial report that your organization must submit annually to the IRS. You’ll also be including your financial statement in your board orientation packets and with requests for funding. Some organizations publish it in an “Annual Report” of activities. You can find a copy of Form 990 at the IRS website.

At the year’s end, your organization may choose to have its books audited by a certified public accountant (CPA) or firm. This service involves a formal study of the organization’s policies and systems for managing its finances, a review of its financial statements, and commentary about the accuracy of those statements.

The accountant may issue an unqualified opinion, meaning that the statements appear to be accurate. In “auditor talk” the accountant didn’t find a material misstatement — false or missing information.

If the auditors have recommendations to make about how money is managed or how finances are recorded and reported, they may issue a management letter to the board about how the organization can improve its practices.

If you hire a CPA to conduct your audit or financial review, make sure the person has knowledge about or expertise in nonprofit organizations. Nonprofits use some accounting terms and bookkeeping methods that differ from profit-making businesses.

When do you need to conduct an audit? Use the following guidelines to help you determine:

Many states require nonprofits that receive contributions over a specified amount to conduct audits. This varies by state. Check the offices that regulate nonprofits in your state to see whether they have created specific audit guidelines.
Nonprofits that directly spend more than $500,000 in federal funds in a fiscal year are required to conduct an A-133 audit. It has a fancy name because it’s based on the Office of Management and Budget Circular A-133, and it takes a particularly close look at how government funds are tracked within the organization.
Some government programs also require audits of specific grants or contracts. Other funders also may require audited statements from applicants.

Even if it isn’t required, your board may decide that it’s a good idea to have the books examined by an outside CPA. Doing so provides reassurance that financial systems are healthy and that the organization is working with accurate financial information.

If your organization is required to have an audit, your board should form a three-member audit committee. The board president, board treasurer, and paid staff members may not serve on this committee. The committee selects the audit firm, reviews a draft of the audit and any recommendations from the auditors, and, if necessary, investigates any practices that should be changed.

Although your organization can learn a great deal from an audit, the practice isn’t appropriate or necessary for every nonprofit. The process is expensive and time consuming. A rigorous but less-expensive option is having a formal financial review conducted by a CPA firm.

Many nonprofits wonder whether they should seek pro bono audits from accounting firms or ask a board member’s firm to audit their books. Although we’re big fans of contributed services, a pro bono audit is a bad idea and asking a board member for assistance is a very bad idea. It loses its value as the voice of unbiased, outside validation when provided as a gift.