Many nonprofit organizations are under no legal obligation to have annual, or even regular, financial statement audits. But your organization might want to consider going through the process anyway. It offers numerous benefits that can pay off.

Financial audit process

So what’s involved in an audit? An independent auditor examines your nonprofit’s financial statements, accounts, transactions, records, accounting and financial procedures and processes, and internal controls. The goal is to issue an opinion on whether your financial statements present your financial position and changes in your net assets fairly, within materiality limits, in accordance with U.S. Generally Accepted Accounting Principles.

The process isn’t one-sided. It requires extensive communication and collaboration between your staff and auditors. For example, auditors often send their clients a prepared-by-client list of items your staff needs to gather pre-audit. This usually includes documentation such as:

  • Bank statements and reconciliations,
  • Investment account statements,
  • Unpaid invoices,
  • Grant and fundraising details, and
  • Payroll information.

The collection process can seem like a hassle, but it helps the audit proceed more smoothly and with fewer delays. This in turn can reduce your audit cost.

When the auditors complete their work, you’ll receive a management letter that outlines their recommendations regarding, among other things, internal controls. If you have an audit committee, it typically will meet with auditors to discuss the audit and its results. The final audit report is then presented to your nonprofit’s full board.

Audit benefits

Financial audits can be cumbersome processes that require time and other resources you might be hesitant to spare, especially when they’re not legally mandated. However, you can use the results to:

  1. Demonstrate transparency to supporters. Putting your financial statements to the test — and communicating the results — makes donors, volunteers and sponsors more confident that their contributions are being used wisely. In addition, most charity watchdogs take transparency into account when determining their ratings. Those nonprofits that can point to annual financial audits are likely to rank higher.
  2. Satisfy grant makers. Grant makers are similarly interested in an organization’s transparency. Many will consider funding only those nonprofits they consider financially responsible. An audit report and validated internal controls go a long way toward establishing the degree of your financial responsibility, in turn expanding the number of grants for which you may qualify. Moreover, if you receive a grant, the grantor could require financial audits as part of the terms.
  3. Comply with contractual requirements. Agreements you have with lenders or other parties may require full financial audits. In fact, lenders frequently request copies of audited financial statements as part of the application process. Your organization also may be subject to loan covenants that require you to maintain certain financial ratios or metrics. Audited financial statements may be necessary to prove compliance.
  4. Reduce your risk of fraud. Independent financial audits can uncover red flags that fraud may be occurring and that additional investigation is warranted. It’s important to understand, though, that financial audits aren’t designed to detect fraud, and that successful audit results aren’t a guarantee that your organization is fraud-free. An audit is more a tool of deterrence — to scare off would-be perpetrators worried that auditors might discover their scheme — than a tool of detection.
  5. Find opportunities for improvement. Independent auditors bring fresh eyes to your organization’s policies and procedures. They can help you identify mistakes, omissions, overspending, inefficiencies, and other issues holding back your organization or making it vulnerable. Different perspectives can prevent stagnation and spur progress.
Worth the cost

If annual financial audits seem cost-prohibitive, think about at least undergoing audits every other year, or whenever your organization experiences significant changes in operations (for example, shifting to remote or hybrid work). By supplementing occasional audits with other options (see “Affordable alternatives to a full financial audit,” below), your organization still can benefit.

Affordable alternatives to a full financial audit

Independent financial audits may be beyond the means of some smaller — and even some larger — nonprofit organizations. These nonprofits can, nevertheless, demonstrate financial transparency and accountability with less costly options, including:

Financial review. The scope of a review is much narrower than that of an audit — relying primarily on questioning employees and applying analytical procedures to financial data, with no testing. However, financial review provides some assurance that financial statements conform with U.S. Generally Accepted Accounting Principles (GAAP) and require no “material modifications.”

Financial compilation. A compilation has an even more limited scope. It’s simply a collection of the organization’s financial statements into a format required by GAAP or another standard reporting framework, making it easier for third parties to review them. It’s important to note that the CPA doesn’t offer any assurance that the financial statements are accurate. Explanatory footnotes required in audited or reviewed financial statements are optional in those that are compiled.

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