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

Budgets and cash-flow statements predict your nonprofit organization’s financial future. But you also need to review each year’s annual income and expenses in a financial statement. When your nonprofit organization is small and lean, your staff or bookkeeper can prepare its financial statements. As it grows and becomes more complex, you’ll likely hire an outside accountant to prepare and audit its financial statements.

How to prepare financial statements

If a budget is a document about the future, a financial statement tells the story of your 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.

Although good nonprofit accounting software can organize your financial information for you, preparing and 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 990-EZ or 990 financial report that your organization may be required to submit annually to the IRS. You’ll also include your financial statement in your board orientation packets and with requests for funding. Some organizations publish it in an annual report.

The value of an audit

At year’s end, your organization may be required to or 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.

For example, the auditors may tell the board that the organization didn’t consistently collect original receipts before writing checks to reimburse staff; that staff travel costs increased dramatically without that increase being approved by the board (and recorded in board minutes); or that the organization’s employees are owed so many vacation hours that the organization’s work could be jeopardized if everyone were to take his or her deserved holiday.

Although some nonprofit organizations look upon a management letter as a scolding, its point is to help organizations safeguard their financial health by strengthening their policies and recordkeeping.

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 for-profit businesses.

Do you need an audit?

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

  • Many states require nonprofits that receive contributions over a specified amount to conduct audits. This varies by state. Check with the office that regulates nonprofits in your state (usually the attorney general’s office) to see whether it has specific audit guidelines.

  • Nonprofits that directly spend $500,000 or more in federal funds in a fiscal year are required to conduct an OMB A-133 audit commonly called a Single Audit. It has a fancy name because it’s based on the Office of Management and Budget Circular A-133. It takes a particularly close look at how government funds are tracked within the organization and whether the organization complies with federal laws and regulations.

  • Some other kinds of government programs also require audits of specific grants or contracts. Other funders may also require audited statements from applicants.

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

If your organization is required to have an audit, your board should form an audit committee. The board president, board treasurer, and paid staff members may not serve on this committee, however. 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 less-expensive option is having a CPA firm provide a formalized compilation or financial review of annual statements.

Smaller nonprofits often go this route to cut down on costs but still provide some level of comfort and assurance to funders that the organization has the appropriate level of financial practices and controls in place.

Many nonprofits wonder whether they should seek pro bono audits from accounting firms or ask a board member’s firm to audit their books. A pro bono audit is a bad idea, and asking a board member for assistance is a very bad idea. An audit should be prepared independently of the organization’s staff and board. It loses its value as unbiased, outside validation when provided as a gift.

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