Board members: Stay alert for these 4 financial red flags

Your board members are undoubtedly well aware of your nonprofit’s financial problems during the COVID-19 pandemic. But as 2021 unwinds, the board should keep its eyes on potential problem spots, ask questions and direct remedies as needed.

These four areas can present clues that the organization is headed for trouble.

  1. Financial statement flaws. Late, inconsistent financial statements — or statements that aren’t prepared using Generally Accepted Accounting Principles (GAAP) — can lead to poor decision making and undermine a nonprofit’s reputation. They also can make it difficult to obtain funding or financing. Statements also can be unreliable if they’re not prepared at least quarterly, or preferably monthly, and in accordance with GAAP or another comprehensive basis of accounting. Financial statements that aren’t prepared timely or have accounting errors also can signal understaffing, poor internal controls and efforts to conceal mismanagement or fraud. Time-wise, the board generally should receive the nonprofit’s financial statements within 30 days of the close of a period.

Some issues are applicable to larger nonprofits. For example, the board or audit committee should insist on annual financial statement audits and expect they’ll be able to select the audit firm. And members of the audit committee, or another designated group, should communicate directly with auditors before and during the process. All board members should have the opportunity to review and question the audit report and any related management recommendation letter and receive satisfactory answers.

  1. Budget problems. Certain budget-related issues hint at rocky times to come. All nonprofits should prepare a budget and larger organizations should draft budgets for each program or department. Ideally, board members will see that management-proposed budgets are in line with board-developed and approved strategies. A nonprofit with no budget is a flashing red light, even in uncertain times. The lack of an operating budget suggests an undisciplined approach to fiscal matters. Because of the pandemic’s financial effects, some nonprofits may need to re-think annual budgets that were prepared in more certain times and focus on a shorter term.

Once a budget has been okayed, the board should compare it to actual results for unexplained variances. Some discrepancies are bound to happen, but staff must explain significant differences. There may be a reasonable explanation, such as program expansion, funding changes or economic factors beyond the organization’s control. Where necessary, the board should direct management to modify activities to mitigate negative variances. Instituting cost-saving measures may be in order.

Board members also should beware of overspending in one program via funding by another. Watch out, too, for dips into the organization’s rainy day fund (its reserves), the raiding of an endowment or unplanned borrowing. Such moves might signal a financially unsustainable cycle.

  1. Donor worries. If the board starts to hear from long-standing, passionate supporters who’re harboring doubts about the organization’s finances, that’s a very bad sign. What are they seeing or hearing that prompts their concerns?

The board also should note when development staff begin reaching out to historically major donors outside of the usual fundraising cycle. These contacts could mean the organization is scrambling for cash and hoping its most dependable donors can fill the gaps.  However, during the pandemic, there may be funds restricted for purposes or timeframes that aren’t currently feasible. If need be, the board should direct staff to contact donors to request an adjustment in contribution terms.

  1. Power plays. It’s understandable that board members who have full-time jobs and other responsibilities might cede some of them to a trusted executive director (ED). However, that may be risky, even in a crisis when an ED naturally needs to step up.

So, what are the signs of an ED who wields too much power? The board should think about changes if the ED 1) insists on choosing the organization’s auditor, 2) adds board members who are friends or 3) makes strategic decisions without board input and guidance. Also, an ED shouldn’t be allowed to ignore expense limits; going outside of budget or policy guidelines should require board approval.