Reducing Nonprofit Risk Through Strong Internal Controls

In recent headlines, we've witnessed alarming cases of fraud within nonprofit organizations. A Minnesota woman siphoned over $300,000 from her animal rescue charity, a Florida man faced multiple felony charges for exploiting charities for personal gain, and a New York man received an 18-month prison sentence for defrauding his trade association employer. Shockingly, nonprofit organizations have approximately a 9% chance of falling victim to fraud, as reported by the Association of Certified Fraud Examiners. That's nearly one in every ten organizations.

The good news is that strong internal controls can significantly reduce your nonprofit's risk. You might be tempted to think that internal controls aren't necessary, especially if your nonprofit prides itself on being a harmonious community of leaders, staff, volunteers, and clients. However, it's crucial to understand that controls and trust can indeed coexist.

Are Your Controls Effective?

Internal controls encompass policies and procedures governing various aspects, from handling cash to signing checks and ensuring IT network security. While most nonprofits have a basic set of internal controls, dishonest individuals, including employees, can exploit gaps when controls are insufficient or inadequately enforced.

So, why might nonprofits skimp on controls or enforcement? One common reason is that they may be so immersed in their programs that they overlook allocating sufficient budget and resources to fraud prevention. Furthermore, executives and board members may underestimate their organization's vulnerability to fraud, often placing fraud prevention low on their priority list, especially when they lack experience in financial oversight, which is typically found in for-profit counterparts.

Which Controls Are Critical?

Employee theft in nonprofit organizations often manifests in forms such as check tampering, expense reimbursement fraud, and billing schemes. However, one highly effective method of preventing such fraud is the proper segregation of duties. For example, assigning account reconciliation and fund depositing to different staff members can significantly reduce the risk of malfeasance. Strong management oversight and confidential fraud hotlines accessible to all stakeholders have also proven effective in curbing employee theft.

While trust is vital, it's equally important to verify what your team tells you. Conduct background checks on prospective hires and volunteers responsible for handling finances. Provide thorough orientation to new board members to ensure they understand their fiduciary role and the potential consequences of fraud.

Lastly, address fraud incidents seriously. Many nonprofits choose to quietly dismiss wrongdoers and sweep their actions under the rug. However, this approach can lead to rumors that tarnish the organization's reputation more than addressing the issue openly. It's wiser to file a police report, seek legal counsel, and inform major stakeholders about the incident.

Do You Trust Too Much?

Trust can be both a nonprofit's greatest strength and its Achilles' heel when it comes to fraud. While it's admirable to regard your team and stakeholders as a close-knit family, establishing boundaries and safeguards is essential. Reach out to us for assistance in identifying any control gaps your organization may have and guidance on implementing them effectively.

In conclusion, nonprofit organizations can thrive in an environment of trust and strong internal controls. By prioritizing and implementing these controls, nonprofits can significantly reduce their risk of falling victim to fraud, protect their reputation, and maintain the trust of donors and stakeholders.

How HoganTaylor Can Help

The HoganTaylor Nonprofit team of business advisors and CPAs is comprised of former CFOs, controllers, and industry experts with extensive experience providing the guidance organizations need to lean forward again in their leadership. If you have any questions about this content, or if you would like more information about HoganTaylor’s Nonprofit practice, please contact Jack Murray, CPA, Nonprofit Practice Lead.

INFORMATIONAL PURPOSE ONLY. This content is for informational purposes only. This content does not constitute professional advice and should not be relied upon by you or any third party, including to operate or promote your business, secure financing or capital in any form, obtain any regulatory or governmental approvals, or otherwise be used in connection with procuring services or other benefits from any entity. Before making any decision or taking any action, you should consult with professional advisors.