How to Prepare for Your First Audit
The first audit can be a source of anxiety for any nonprofit leader. The good news is that all it takes is a bit of looking ahead. It’s all about preparation - and we’re here to help you.
The first audit can be a source of anxiety for any nonprofit leader.
Many executive directors spend most of their time and focus on programming and fundraising, leaving little time for the nitty-gritty of the organization’s finances and operations. And many operations professionals run into trouble when a nonprofit grows more quickly than anticipated, necessitating on-the-fly tweaks to their systems. Beyond that, there’s the natural apprehension about an external CPA firm coming in, poking around your sensitive financial information, then determining whether your systems work for them, let alone whether they work for you!
The good news is that all it takes is a bit of looking ahead. It’s all about preparation – ideally months or even years before the auditors show up in your lobby.
While scary, audits and auditors are often extremely helpful! They can tell you whether you have the right operational systems in place, serve as a check on your bookkeeping/accounting solutions, and uncover fraud – or the potential for it.
Start at the start
Literally – from the very beginning of your organization, you should set it up with the assumption that it will be audited. That way, you’ll save your future self lost sleep as you scramble to get things right when audit time comes. To that end, make a habit of keeping detailed records of all your transactions, and allocate non-insignificant time and effort to ensuring those records are properly maintained and cataloged.
Just as important as record maintenance is establishing internal protocols that will set you up for success if and when an audit comes along. This will look different for each organization’s unique structure and activities, but as a basic foundation, it’s a good idea to:
Always require invoices from external vendors
Establish, clearly and in writing, financial controls to dictate who can access your organization’s funds, how often, and for what purposes. Clarify exactly which transactions require double or triple approvals, as well as who is authorized to take out cash at all.
Location, location, location
If you’re running a nonprofit, you’ll need to look up the audit revenue threshold that will tell you whether you have an independent audit requirement. You should also determine whether any of your donors – private foundations or government funders – have audit requirements. Some nonprofits even submit to audits voluntarily, just to shore up donors’ trust.
Finally, and this may be obvious, but we’d be remiss not to mention the importance of staying on top of the relevant regulatory bodies that set the auditing standards for your industry. For nonprofits, that’s usually government agencies at the local, state, and federal level.
Rule of thumb: Beware informal relationships and transactions
At Pocketbook Strategies, we find that what trips organizations up most often is work done with friends and acquaintances in an unofficial capacity. It’s only natural, and even laudable, to work with people you know, but this often leads to unrecorded expenditures and, consequently, money that seems to have simply disappeared.
We’re not saying you’re forbidden from hiring a friend or contact for a temporary project – like bringing on a graphic designer you know for a year-end report, for example. But we are saying you should make sure you’re tracking the invoices and reimbursements for that work just like you would any other external partner.
Save up for audit season
As any auditor will tell you, audits take work, so the fees can be hefty. Generally, the larger the organizational revenue and the more urban the location of the CPA firm, the more expensive the audit. So it’s a good idea to create a nest egg and add a bit of cash to it on a regular basis.
There are some less-pricey options for nonprofits, known as “reviews” and “compilations” of your organization's financial statements. But those aren’t as comprehensive as audits, so whomever you’re reporting to will likely not accept them as a substitute.
In your everyday operations: Manage those expenses
You may not see receipts as absolutely essential to your organization’s health, but they are. Keep careful track of them in an expense management system that’s stored in strong, protected software. As your organization grows, your finances will become more varied and complex, and the importance of thorough, detailed records will grow accordingly.
A general rule to keep in mind is that, once your organization is fairly large, auditors will want documentation for most expenses over $1,500. Similarly, they’ll closely scrutinize any and all funds being routed to key executives and people with direct access to organizational funds, intending to tease out any misbehavior at the top levels. So you’ll want to make sure to triple-check expenses that fall in those categories, before you pay them out.
Remember, audits are a good thing
They indicate that you take financial management seriously. That means a lot to two very important groups of people: your board and your funders.
Board members often have very little exposure to your day-to-day operations, so they’ll appreciate the confirmation of prudent financial practices. Your funders will feel much more confident cutting checks when they have third-party verification that you have systems in place to manage their donations responsibly. Take it from us – if you haven’t been audited, you’ll have a much harder time landing bigger, multi-year funding from private foundations.
And it’s not just external stakeholders. The basic purpose of an audit is to ensure no fraud is taking place, which is always a good thing for nonprofit directors to verify. An audit can also point your management team to any minor hiccups in your finances that, if left in place, could snowball into major problems down the road.
For your finance team, an audit adds highly skilled professionals – generally CPAs – to the group of people supervising your operations, which will help you ensure those operations stay above board as the organization grows. Audits are accompanied by what’s called a management letter, in which the auditing firm outlines detailed feedback about how your financial management can be improved or streamlined, which your team can refer to as needed.
The bottom line is that audits are often inevitable, and they offer immense benefits, so you might as well prepare as early as possible.