Whether you manage the day-to-day operations of a not-for-profit (NFP) or hold a board position, you know that strong financial transparency is critical for the organization’s success.
One of the most important responsibilities of a nonprofit board of directors is overseeing the financial governance of the organization. If your nonprofit is required to have audited financial statements, the fiduciary oversight by the board is even greater. Hiring an independent auditor and undergoing an annual audit is an important first step in complying with the board’s fiduciary responsibility. So let’s take a look at how to help your NFP be audit-ready.
What is a financial audit for nonprofits?
A financial audit is an examination of your financial statements by an independent licensed certified public accountant (CPA). An audit is the highest level of financial review available. The goal of an audit is to determine if the financial statements are presented fairly, in all material respects, in accordance with generally accepted accounting principles (GAAP) as applied to NFP entities.
Who needs an audit?
Not-for-profit audit requirements depend on your organization’s size, funding requirements, and your state. State laws regulating independent audits vary. Many times, the requirement for a nonprofit to submit audited financial statements is triggered by the nonprofit’s total revenue or total contributions. In the State of Tennessee, a charitable organization with gross revenue (excluding certain government and private foundation grants) more than $1,000,000 is required to have a financial statement audit performed by an independent CPA. An audit requirement may also be triggered by federal, state, or private grant funding, debt covenants, or board policy.
Being Audit-Ready
A common mistake that some nonprofits make lies in their audit mindset. Thinking that the audit only affects the organization a few days each year can be detrimental to a nonprofit’s success. Instead, you should implement policies and procedures to ensure that your organization is audit-ready throughout the year. Here are some helpful tips:
- Internal controls and processes: It is important that the NFP has performed its own risk assessment to identify, analyze, and mitigate risks throughout the year. Often, management and the board of directors underestimate how much auditors focus on internal controls and processes. Be sure that you’ve addressed segregation of duties, the review and approval process, and board oversight of financial reporting early on.
- Monthly closing: Implement a schedule for managing, completing, and reviewing the monthly close process (finalizing financial records every month). Ensure that all bank reconciliations are performed on a monthly basis and are completed in a timely fashion, preferably within 10 business days of month-end, and follow up on outstanding items before the next month-end close is done.
- Internal financial reporting: It is vital that management and the board have timely, accurate financial information. Management should create a checklist to help make sure that all transactions and adjustments have been recorded. The Board should have its own checklist when reviewing management-prepared financial statements. Comparative financial statements are helpful in identifying areas of concern or account balances that need follow-up. For example, an actual versus budget comparative report and a current year-to-date versus prior year-to-date financial statement can be very helpful. These documents, along with the standard NFP financial statements, should be included in the monthly financial package presented.
- Grant compliance: Review the accounting for grants to ensure that you are in compliance with grant agreements and legal requirements. Has all grant revenue that has been earned been recorded? Have we captured all grant expenses in the proper period? You should set up a formal process for tracking all grant activity. Failure to do this correctly could not only result in an audit finding, but it could jeopardize your funding source.
- Revenue recognition: One of the most common audit findings stems from inaccurate revenue recognition. To avoid issues, maintain a well-organized donor database that captures key gift details — including any donor-imposed restrictions or conditions — and reconcile it to your accounting records every month. Regular reviews make it much easier to identify and correct errors throughout the year, rather than uncovering them during the audit.
- Keep organized digital records: Throughout the year, you’ll need to reference grant agreements, contracts, donor pledges, invoices, and much more as supporting documentation. Maintaining complete and centralized records throughout the year can help ensure fiscal year-end numbers are accurate and that you are in compliance. Disorganized documentation is the leading cause of audit findings and delays.
Proactive Partnership
Your nonprofit auditor can be the organization’s biggest ally and should be a trusted partner. This proactive approach is a signal to all the stakeholders that year-round sound financial reporting is a priority, and that it is not just a once-a-year effort. Conversations that you have with your auditor throughout the year will foster smoother fieldwork and result in fewer audit surprises, helping the NFP be audit-ready.
If you have a question about an unusual transaction your NFP is entering into or a new accounting standard that applies, address this with your auditor sooner rather than later. It could make the difference between proper accounting treatment and a material misstatement.
The most successful nonprofit audits begin long before the auditors arrive. Organizations that prioritize monthly financial discipline, strong internal controls, accurate grant accounting, organized documentation, and proactive communication with their auditors typically experience smoother audits, fewer adjustments, and greater confidence from donors, grantors, board members, and other stakeholders. Audit readiness is not a year-end project; it is a year-round commitment to financial stewardship and transparency.
Audrey Nord, CPA, is an Assurance Supervisor at Smith + Howard.
