Lessons for Boards from the Nonprofit Overhead Cost Project

Guide #2 from the series "Nonprofit Overhead Cost Project"

The nonpartisan Urban Institute publishes studies, reports, and books on timely topics worthy of public consideration. The views expressed are those of the authors and should not be attributed to the Urban Institute, its trustees, or its funders.

Note: This report is available in its entirety in the Portable Document Format (PDF).

Many nonprofit organizations have problems accurately tracking and reporting their overhead expenditures in financial statements. Is your organization one of them?

This guide reviews major findings from a national study and makes recommendations in four areas:

• Financial controls
• Financial reporting
• Financial staffing
• Organizational effectiveness

Nonprofit Overhead Cost Project

This guide is based on information collected by the Nonprofit Overhead Cost Project. The goal of the project is to understand how nonprofits raise, spend, measure, and report funds for fundraising and administration, and to work with practitioners, policymakers, and the accounting profession to improve standards and practice in these areas. The project is a collaboration between the Center on Philanthropy at Indiana University and the Center on Nonprofits and Philanthropy at the Urban Institute. For more information on the project, see http://www.coststudy.org.

The Nonprofit Overhead Cost Project was supported by the Atlantic Philanthropies, the Ford Foundation, the Charles Stewart Mott Foundation, The David and Lucille Packard Foundation, and the Rockefeller Brothers Fund. Project researchers who contributed to the content of this guide are Kennard Wing, Mark A. Hager, Patrick M. Rooney, and Thomas Pollak.

Financial Controls

Perhaps the most basic responsibility of nonprofit boards is to safeguard the organization's assets and ensure money is spent in intended ways. The most important way they carry out this responsibility is to ensure that adequate financial controls are in place. Most boards do not directly develop the financial controls. Instead they hire staff or consultants who are financial professionals to develop them, and ask the auditor they hire to assess the quality of these controls annually.

The adequacy of financial controls arose during nine in-depth case studies performed as one phase of the Nonprofit Overhead Cost Project. In one organization, for example, the woman who ran the thrift shop routinely took the cash home at night. It is hard to imagine a more obvious risk of loss. The management letter the auditor sent to the board at another nonprofit spoke of missing cancelled checks and invoices, a variety of transactions entered improperly in the accounting system, and physical inventory scattered throughout the organization's facilities. These practices create a fertile field for fraud or other loss. Several organizations used temporarily restricted funds to meet current cash flow needs in violation of their agreement with the donor.

Smaller organizations often had only one person who handled financial matters. This makes is hard to implement separation of duties—a basic principle of financial control—such as having different people entering invoices, cutting checks, and signing checks. A staff person who wants to commit fraud is in prime position if he or she processes the whole transaction from start to finish. Another problem at smaller organizations was that the financial person was frequently a jack-of-all-trades who handled human resources, facilities, and other administrative tasks, and had little or no financial training. Such staff are generally unaware of the importance of financial controls or how to develop them.

We recommend that nonprofit boards, particularly at smaller nonprofits, initiate a special review of financial controls in their organizations. This review is best performed by a financial professional who is an outsider to the organization. For nonprofits with auditors, we also recommend the board ask them to assess and report on the adequacy of financial controls annually. If the selection and hiring of the auditor is not currently done by the board, we recommend the board take over that responsibility.

The assessment, development, and implementation of financial controls will take scarce resources from an organization that likely cannot spare them. Given the fundamental importance of boards' responsibility to safeguard assets, however, adequate financial controls must be a board priority.

Note: This report is available in its entirety in the Portable Document Format (PDF).

The nonpartisan Urban Institute publishes studies, reports, and books on timely topics worthy of public consideration. The views expressed are those of the authors and should not be attributed to the Urban Institute, its trustees, or its funders.

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