Imagine you’re reconciling your nonprofit’s accounts one day, and you find a significant discrepancy. At first glance, it seems like a probable mistake. But after doing some more digging, you recognize that it’s more likely a member of your team intentionally committed fraud. How could you have missed this, and how will you address it?

This scenario illustrates the importance of internal controls, which are processes that uphold financial integrity. Implementing strong internal controls limits fraud, identifies financial reporting errors, protects assets, and maintains trust with stakeholders. Explore how to establish internal controls to keep your nonprofit running smoothly and successfully.

Set a foundation for your internal controls with financial policies and procedures that guide your team. YPTC’s nonprofit financial management guide recommends creating the following policies, among others:

• Expense reimbursement policy. Determine how you’ll reimburse employees, volunteers, board members, and other stakeholders who incur expenses on your organization’s behalf. This policy should include the types of expenses you’ll reimburse, the process for submitting reimbursement requests, the required documentation, and the method and timeline for processing and issuing reimbursements. That way, everyone knows exactly how the process works, and your team can properly review and approve reimbursement requests.
• Conflict of interest policy. Define what situations constitute a conflict of interest and how your organization will review, evaluate, record, and act upon these conflicts. This policy allows you to maintain trust while ensuring stakeholders’ outside financial interests or relationships don’t unfairly impact your nonprofit’s operations.
• Gift acceptance policy. Establish rules for accepting gifts so donors know exactly what they can and should contribute. Highlight stipulations for in-kind donations to prevent donors from contributing unusable items, such as expired, broken, damaged, or hazardous goods. Your policy should cover the types of gifts you can and can’t accept, the circumstances or conditions under which you’ll accept different gifts, and the process of recording gifts.

Additionally, develop fiscal policies and procedures that cover areas like tax compliance and audits, budgeting and financial planning, financial reporting, cash management, grants and contract management, and more.

One hallmark of internal controls is spreading financial responsibilities across multiple staff members so no one person has complete control over your organization’s finances. Segregate duties by following these steps:

• Identify key financial processes. Pinpoint the main financial processes involved in your operations. These may include cash handling, payroll processing, budget preparation, financial reporting, compiling financial statements, and reconciling accounts.
• Define the roles and responsibilities involved in these processes. Break down these processes into their respective roles and responsibilities. For example, the cash receipts process involves collecting donations, maintaining donor records, entering donations into your donor software, preparing bank deposits, submitting bank deposits, and entering donations into your accounting software.
• Establish checks and balances. Ensure individuals don’t have too much power over responsibilities that could lead to misappropriation of funds. For instance, the team members involved in the cash receipts process should not also be responsible for reconciling accounts.

Communicate each team member’s exact responsibilities and explain why separating them is crucial in maintaining accurate financial records, increasing accountability, and preventing fraud.

Your organization likely has physical assets that are important to protect as well. Make sure you’ve accounted for these items and safeguard them against theft by:

• Maintaining an asset register. Listing your assets with important details like their descriptions, purchase dates, locations, and estimated values allows you to keep track of the items your nonprofit owns. Update this list regularly as you acquire new assets. Remember to include small items like laptop computers and cell phones in addition to larger items like furniture and equipment.
• Scheduling physical asset checks. Conduct regular physical asset checks to ensure everything is in place and in good condition. Determine who will conduct these checks, and consider performing unscheduled checks as well to further prevent theft and mismanagement.
• Storing cash and checks securely. Keep cash and checks secure in safes or locked cash boxes. Restrict access to the specific individuals involved in cash handling.

Foster a culture of trust and accountability to ensure staff members feel comfortable and encouraged to speak up about issues related to physical assets. Make it easy for them to report damages or losses so you can rectify these issues as soon as possible.

Even with strong internal controls in place, risks will still arise. Assessing these potential risks will strengthen your internal controls and help you mitigate the negative impact of vulnerabilities. This process involves:

• Assembling a risk assessment team. Create a team of stakeholders, like finance staff, program managers, and board members, to oversee the risk assessment process.
• Identifying potential risks. Have team members discuss risks that could arise in regular operations and review past incidents of fraud, errors, or compliance issues you’ve encountered.
• Categorizing and evaluating risks. Divide risks into categories, such as financial, operational, compliance, and reputational, and evaluate their likelihood of occurrence and potential impacts so you can prioritize them appropriately.
• Analyzing whether your controls are sufficient. Review your current internal controls alongside the risks they help mitigate. Identify gaps you could close to better address potential risks. For instance, you may further segregate duties or develop a more intensive authorization process to protect against fraud and asset mismanagement.

Navigating potential risks and challenges regularly ensures you iterate on your internal controls to promote financial integrity to the best of your organization’s ability.

Prioritizing internal controls is essential for protecting your assets and maintaining trust with donors, sponsors, grantors, board members, staff, and other stakeholders.

To fortify your internal controls, consider outsourcing some of your financial operations to a nonprofit accountant or bookkeeper to unlock their financial expertise.