Audits play a critical role in ensuring the health and credibility of nonprofit organizations in a time of increased public and government scrutiny. It’s not just about financial compliance. An audit can also help your organization identify internal vulnerabilities such as weak controls, insufficient reserves or poor investment practices. At the same time, a clean audit can reassure donors, members and stakeholders that your nonprofit is well-managed and financially sound.

Internal and external

There are generally two types of audits:

Internal. These assist your board with its fiduciary responsibility. Typically, an internal audit is conducted by someone in your organization, ideally by someone independent of the functions the audit covers. The goal is to assess whether financial operations and reporting align with your internal standards, Generally Accepted Accounting Principles, and state or federal laws. Your internal auditor should also evaluate financial accuracy, operational efficiency and the strength of internal controls.  Reporting is provided directly to the board of directors.

External. This is an objective, third-party review performed by an independent CPA with no relationship to your organization. The CPA examines your financial statements, supporting documents (such as bank reconciliations, payroll records and donation classifications), and your internal control environment. Some states require nonprofits to have external audits, while it’s optional in other states.

Avoid conflicts of interest when selecting an external auditor. For example, no matter how highly qualified, a CPA who’s related to a board member won’t be deemed independent and can’t conduct your audit.

Do you need an audit committee?

You may or may not require an audit committee, but many nonprofits find them beneficial. Ideally, an audit committee will include three to five individuals with nonprofit financial expertise. Be aware that some states regulate who may serve on such a committee. Other states allow a mix of board and non-board volunteers.

Key audit committee responsibilities include:

• Selecting the external auditor,
• Maintaining transparent communication between auditors and staff,
• Ensuring robust internal controls are in place throughout the year, and
• Reviewing audit findings and recommendations.

An effective audit committee enhances accountability and strengthens governance by maintaining independence and providing financial checks and balances for your board.

Getting ready

For an effective and smooth audit, preparation is key. Start by assembling financial statements and general ledgers; board meeting minutes; budgets and bank statements; and records related to payroll, receivables/payables, grants, loans, leases and fundraising. In addition, your auditor may ask to review policies, legal documents and correspondence with banks or major donors. Before the audit begins, ask for a detailed list of documentation requirements.

Expect your auditor to ask questions regarding your financials. The auditor will be especially interested in policies in place for fraud prevention, compliance procedures and financial transaction documentation. The goal isn’t just to test financial accuracy, but also to assess how effectively your systems prevent errors and if you comply with accounting standards.

A best practice for your nonprofit is to maintain an audit-ready file throughout the year and engage proactively with your auditor. This will be especially useful when launching new programs or accepting significant donations.

Point of the audit

Audits certainly require time and effort that you may feel you can’t spare. However, an audit can uncover important issues, such as weak procedures related to error and fraud prevention or management inefficiencies, before they escalate and threaten your nonprofit’s good work. They can also strengthen your case when applying for grants or attracting major donors.

IRS Form 990 doesn’t require an audit, but it does inquire about your audit practices and board oversight. Demonstrating a strong commitment to transparency and financial stewardship not only helps ensure compliance but also builds trust with the public and your supporters.

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