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Cynder Sinclair: Four Tips to Help Nonprofit Boards Spot Red Flags

How often have we heard of nonprofits hitting a financial brick wall and then teetering on the edge of solvency? It happens too frequently.

When we hear these stories, we often wonder where the board was and why they didn’t steer the organization around the financial whitewater. It’s true that the board has ultimate fiscal responsibility for a nonprofit’s financial health and well-being. It’s also true, however, that forces can work to make it challenging for board members to see through the murky waters of finance reports.

Two Financial Challenges Are Inherent in All Nonprofits

First, the very structure of a nonprofit is complex — much more multifaceted than most businesses. Since board members often come from the corporate world they are not as familiar with the nonprofit business model or reporting systems. As a result, sometimes they hesitate to ask questions for fear of appearing ignorant.

Most nonprofits operate a wide variety programs with different types of revenue, cost structure, cash flow and capital. And then there are a host of multiple constituencies to reckon with: individual donors, foundations, corporate sponsors, volunteers, community leaders, board members, staff members and other supporters — many of whom have their own stipulations.

The second challenge lies in the best practice of separating board governance duties from staff operations activities. “The board should never micromanage,” says the often heard mantra. And it’s true — avoiding board interference in the day-to-day operations of a nonprofit is always advisable.

But how can a board member fulfill his/her fiduciary responsibility if s/he doesn’t delve into financial operations? Spotting financial red flags can be tricky when functioning from a board’s high 50,000-foot level. The following four strategies will help board members fulfill their duties without meddling in daily affairs.

1. Understand Nonprofit Financial Reporting

Find out if your organization uses cash or accrual accounting, or both. Cash-based accounting records revenues and expenses and will show your exact cash position at the moment. However, cash-based accounting can make you appear healthier than you really are. Accrual-based accounting records expenses as they occur but doesn’t record revenues until the service has been delivered. For example, this means you can’t book that big grant you received until the work has been completed. Before the work is completed, these funds will be shown as deferred revenue.

What about liquidity? Healthy organizations have enough working capital to cover typical expenses for three to six months. When looking at your organization’s balance sheet, compare current assets (cash in the bank plus any assets that will become cash in the next year) to current liabilities (everything that must be paid within a year). If current assets are equal to or less than current liabilities, you have a liquidity problem. Also look at total net assets on the balance sheet to see what your organization is actually worth.

Some boards pay too much attention to income statements and budgets — short-term information — and not enough attention to the long-term perspective of balance sheets. The best boards focus on ways they can help the organization increase revenue rather than just on ways of reducing spending.

2. Be clear about a board member’s fiduciary responsibilities.

In addition to a board’s legal responsibilities, the board acts in a fiduciary role by maintaining oversight of the nonprofit's finances. Board members evaluate financial policies, approve annual budgets, and review periodic financial reports to ensure the organization has the necessary resources to carry out its mission and remains accountable to its donors and the general public.

In your role as a board member, it’s important for you to know if your organization is sustainable. You can find out by looking at regular spending and revenue trends. Notice if you are consistently paying out more than you are bringing in or if you are generating more money than you are spending. Ask yourself if the organization can keep operating in the same fashion over the long term using current practices.

Board members should review a complete set of financial reports each month, with careful scrutiny by the finance committee. At a minimum, board members should see the balance sheet, a profit and loss statement, and a budget vs. actual report. Including a forecast column is also very helpful in showing an accurate view of where the organization will likely end the year.

3. Ask good questions ... continuously.

“Rather than expecting board members to instantly recognize a problem in the making, let’s encourage boards to learn to ask the questions that will lead them there. One month with a deficit isn’t a red flag, but questions must be asked when a board sees financial reports with unfavorable variances and deficits in meeting after meeting,” explains Nonprofit Quarterly. The same goes for other financial indicators such as cash flow dips or bumps up in liabilities.

Don’t be afraid of asking “dumb questions.” Others are very likely wondering the same thing but hesitate to ask in a meeting of their peers. Continuously asking questions and listening to the answers will help boards identify potential red flags while they are still yellow. Practice asking questions like these:

» Can you help me understand what this means?

» Is this a trend or pattern that we should talk about?

» Is this unexpected?

4. Work as a team with executive staff leadership.

Hopefully, your board has a finance committee that meets on a regular basis to review financial statements in depth. The chair of the finance committee works closely with the staff finance director to ensure s/he understands the reports and can present them effectively at the board meetings. Even though the reports given to the board are at a higher level than those given to the finance committee, the finance chair must understand them in their entirety.

The executive director, staff finance director, board chair, and finance committee chair work together as a team, with mutual trust and respect. Staff communicates accurate and pertinent information to committee and board members. If staff sees a troublesome trend, they alert the finance committee. A policy of “no surprises” is always best. Board members can be encouraged to ask questions of staff whenever appropriate as long as the questions are in accordance with their role.

One of a board member’s most important duties is to ensure the organization is living out its mission. Managing finances is an important part of managing the mission. Your finances may look great, but if you’re not changing lives according to your mission, good financial management is almost irrelevant.

A financial dashboard is also a very helpful tool to spotlight the organization’s most important indicators — but that’s a topic for another article.

— Dr. Cynder Sinclair is a consultant to nonprofits and founder and CEO of Nonprofit Kinect. She has been successfully leading nonprofits for 30 years and holds a doctorate in organizational management. To read her blog, click here. To read her previous articles, click here. She can be contacted at 805.689.2137 or .(JavaScript must be enabled to view this email address). The opinions expressed are her own.

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