Independent Nonprofit Financial Audits: When You Need One
When you think about a financial audit, does your stomach start to churn? This is the immediate response that many nonprofit professionals have about the auditing process due in part to the stress we put on ourselves to be perfect. When it comes to auditing, however, keep in mind that the goal of the process is to help. This process should create a more accurate, efficient financial system for your nonprofit. Who doesn’t want that?
Sometimes these financial audits are required to remain compliant with federal or state regulations, but your organization should always try to get as much out of the experience as possible by working with your auditor to gain a deeper understanding of your nonprofit’s finances.
In this guide, we’ll review nonprofit independent audits and their purpose as a part of a nonprofit’s financial strategy. We’ll cover the following audit topics:
- The Purpose of Financial Audits
- When Financial Audits are Required
- What Financial Audits Look Like
- After the Audit
Here at Jitasa, we regularly help nonprofits find the right auditing firms, prepare for their audits, and implement recommendations post-audit. This guide is designed to help calm the natural inclination for anxiety about auditing and to help organizations make the most of the process. Ready to take the deep dive into financial auditing? Let’s get started.
The Purpose of Financial Audits
Although you might start financial audits with a groan and even an eyeroll, audits are not inherently bad or set up to punish your organization. In fact, if you approach them correctly, they can be incredibly helpful!
Audits are used to test the effectiveness and accuracy of your financial systems. During independent audits, a trained auditor from a dedicated auditing firm will review a number of your organization’s financial statements and make recommendations on how you can improve your internal control and general financial processes.
In addition to discovering new opportunities to improve your financial systems, audits can be helpful tools when it comes to developing relationships with your supporters. By informing your supporters of the audit, you increase your financial transparency and build stronger relationships based on trust.
For example, imagine you’re planning a new fundraising opportunity, like a Giving Day. If you’ve conducted a financial audit and implemented the resulting recommendations before the event, your supporters will feel assured that your organization has effective financial practices.
By contrast, if you don’t conduct the audit and miss a glaring issue, you run the risk of misinforming supporters about key financial implications of the Giving Day. This can result in discord and broken trust with your supporters who just gave to the campaign, potentially damaging relationships rather than building them.
When Financial Audits are Required
As mentioned earlier, audits are sometimes required in order for organizations to remain compliant with various guidelines. These guidelines are set by governing entities, funders, or even internally by nonprofits.
According to Jitasa’s nonprofit audit guide, here are several circumstances in which your nonprofit might be required to conduct a financial audit:
- If it’s in your bylaws. Check your bylaws before determining that you don’t need to conduct an audit. Some nonprofit governing documents require that organizations conduct one on an annual or semi-annual basis to ensure everything is up-to-scratch.
- If it’s required by your state. Some states require nonprofits to conduct an audit if they earn more than a certain amount. Usually, this amount is around $500,000, but it depends on the state. Check your state guidelines to see if you need to conduct one in your location.
- If you receive over $750,000 in federal funding. This requirement is pretty straightforward. If your nonprofit earns over $750,000 in federal funding, you’ll need to conduct a financial audit according to government guidelines.
- If grant funders require it. Check the requirements for the various grants you’ve applied for. Some of them require you to conduct a financial audit to receive their funding. If you struggle in determining the requirements for each individual grant, you might need to revisit your grant management processes and potentially reassess your software options to keep everything straight.
Even if a financial audit isn’t required for your organization, you might consider conducting one anyway. If it’s been a while since you conducted an auditor you’ve just experienced a lot of growth, audits can be helpful tools to ensure your nonprofit has proper internal controls and remains efficient.
What Financial Audits Look Like
If it’s your first time conducting a financial audit, you might be surprised to learn that it takes quite a while! The entire process can take anywhere from eight to twenty weeks to complete. Generally, the timeline will look something like this:
When you search for an auditor, you’ll want to reach out to an accounting firm for recommendations or collect referrals from other nonprofits. Then, narrow down your search by asking potential auditing forms questions about their timeline, percentage of clientele in the nonprofit sector, and fee structure.
After you’ve selected your firm to conduct the audit, you’ll need to prepare your financial documents to share with your auditor. This will help make sure that all of your financial documents are complete, allowing your auditor to get started right away. Before the auditing process begins, you’ll need to make sure:
- Every transaction is captured
- All bank accounts have been reconciled
- You’ve analyzed the adjustments for prepaid expenses
- You’ve reviewed expenses for items that should be capitalized
- You’ve taken a first pass at key financial reports
If you work with an outsourced nonprofit accounting firm, make sure to inform them about the upcoming audit and the date it will begin. They can help prepare for the audit and make sure all accounting tasks are completed.
You’ll then need to pull together the documentation necessary for your auditor to conduct the audit. Generally, auditors provide a PBC (pulled by client) — a list of documentation that you’ll need to compile for the audit. This list differs by auditing firm and organization, so be sure to look over yours carefully!
After you’ve compiled the necessary documentation, it’ll be time for the auditor to go through everything and actually conduct the audit.
After the Audit
After the audit, your organization is in charge of implementing the recommendations provided by the independent auditor. But what does this actually look like?
Immediately after the audit is complete, your organization’s executives will review the audit results and evaluate the recommendations. Afterward, it’ll be time to present the information to the board of directors.
There are two types of recommendations that you might encounter when evaluating the results from your audit:
- Internal control recommendations. Internal control recommendations identify gaps in a nonprofit’s financial processes that could lead to inaccurate or improperly recorded financial information. Your auditor’s recommendations will help lead to early detection and correction of poorly recorded data in financial statements or reports.
- Operating inefficiency recommendations. Your auditor provides an outside perspective of your organization’s financial processes. From their experience, they may recommend implementing procedures or new technologies that could help create more efficient financial processes.
Audits are best completed before your organization files your annual Form 990. This will allow you time to incorporate the recommendations and changes to your organization’s financial systems before filling out this form.
However, the auditing process is pretty lengthy. Therefore, to avoid risking the late fees and penalties associated with filing your tax return late, you might consider filing a Form 8688 extension request to give yourself some additional time. You can read more about the relationship between audits and your tax forms in Jitasa’s tax filing guide for nonprofits. It provides more information about when to start preparing to file your Form 990 to ensure your timing between the two processes aligns.
If you still cringe when you hear the word “audit,” you can relax. Auditing isn’t a punishment or any reason to stress. The auditing process can actually help your nonprofit in more ways than one!
By identifying and addressing the internal control gaps in your current financial processes through a successful audit, you’ll be able to rest assured that your future financial information is well organized and accurate. This saves the time and money you might have otherwise spent combing through paperwork to retroactively locate mistakes.
Plus, if you communicate the fact that an audit took place with your organization’s supporters, they’ll know that you take the management of their funds seriously, increasing trust and respect for your organization.
In short, while there are only certain circumstances in which financial audits are required for nonprofits, they can be incredibly helpful tools that you might consider anyway!