Financial oversight is one of the primary roles of your nonprofit board of directors.
Every nonprofit is required to have a board of directors. According to the National Council of Nonprofits, the board has a responsibility to “steer the organization towards a sustainable future by adopting sound, ethical, and legal governance and financial management policies.”
But, in practice, the terms fiduciary duty or financial oversight are a bit ambiguous. And they create a lot of confusion for people new to the nonprofit sector. So rather than trying to define it, let’s look at some guidelines for what financial oversight looks like in real-life.
What is Financial Oversight?
Financial oversight refers to a broad range of responsibilities. A few of the primary components include:
- Policy development
- Financial sustainability
But before we dig into what those look like, let’s talk about why fiduciary responsibility is such a big deal in nonprofits. And why the board of directors plays the primary role in providing financial oversight.
Nonprofits are fundamentally different from other businesses
You hear the term financial oversight in the nonprofit world and less in the for-profit world, largely due to the structure of a nonprofit. Unlike a for-profit company, a nonprofit organization doesn’t have an “owner.” Instead, it is funded by and belongs to the public.
But the term “nonprofit” itself can be misleading. I’d suggest you stop thinking of a nonprofit as “a business that doesn’t make a profit.” And instead, think of it as a business where the ‘profit’ must be directly reinvested to support its stated mission.
The owners of a private for-profit business can choose to distribute profits to themselves or spend as they choose. But the leader of a nonprofit cannot make distributions to themself because all expenses must be consistent with furthering the organization’s stated mission.
In return, for reinvesting your profits to further a charitable mission, the IRS allows you to operate free of income taxes.
But without proper financial oversight, you could inadvertently spend funds in ways that don’t directly impact your mission. And if you do that, you may risk losing that tax-free benefit or even find yourself in legal trouble.
Public responsibility brings a higher standard of fiduciary responsibility
In for-profit businesses owned by specific people, it’s clear who carries the risk and liability of operations. In most cases, a failure of financial oversight affects just the owners (and maybe their employees or vendors), but not the general public. In the case of a large public company, they have highly involved boards of directors to provide an additional layer of financial oversight.
But when public funds are at risk (in the form of donations and grants) an accountability system must be employed to ensure funds are used appropriately. The board of directors is the core element of this accountability system. And this is why all nonprofits are required to have a board starting from the moment of incorporation.
The board is charged from your inception with a fiduciary responsibility to ensure your organization lives up to the promises you made when you accepted public donations.
What Does Financial Oversight Look Like?
The idea of financial oversight can be overwhelming for founders, directors, and even board members who don’t have a financial background.
To help you start to grasp it, here are some best practices that a board should be performing to ensure effective financial oversight:
- Policy development. Your board should help to establish and monitor management policies, such as:
- Financial policies (investments, capitalization of fixed assets, operating reserves, financial key performance indicators (KPIs), segregation of duties, etc.) and
- Operational policies, such as conflict of interest and whistleblower policies.
- Financial sustainability. Your board should be involved in reviewing and approving the annual operating budget. It should also review financial statements at every board meeting and challenge management on numbers that don’t make sense.
- Compliance. Your board should review and approve the annual tax return (IRS Form 990). If your nonprofit requires an audit, the board should engage directly with the audit firm. Finally, the board should be aware of significant compliance requirements the nonprofit is subject to and ensure a system of accountability is in place.
Too often, we see financial oversight delegated to the Board Treasurer or the finance committee. However, your board cannot simply delegate financial oversight to the Finance Committee or a single board member.
Regardless of which committee you belong to, every board member has a fiduciary responsibility to the organization. Your lack of a financial background does not relieve you of the obligation to oversee the financial performance of the nonprofit. Instead, it’s your responsibility to educate yourself on the basics of financial management and oversight.
At a minimum, each board member should be able to do these things:
- Review annual tax return before filing
- Review annual audit
- Review periodic financial statements at each board meeting
PRO TIP: If you or one of your board members can’t understand nonprofit finances, don’t feel defeated. It’s very common. And it’s not that hard to get up to speed. Look for some resources, like our free masterclass for making sense of nonprofit financial statements, and get up to speed!
The Role of the Finance Committee in oversight
While all board members need to do their part, the finance committee does play a leading role in critical financial policies and decisions. For example, the finance committee will generally take the lead with things like:
- Reviewing the annual budget in detail, asking questions, and doing a preliminary approval of the budget before bringing it to the rest of the board
- Reviewing annual tax return for accuracy before bringing it to the rest of the board
- Spearheading communication with the audit firm and reviewing the audit prior to bringing it to the rest of the board
- Developing key financial policies for endowments, investments, capitalization, operating reserves, internal controls, etc.
- Reviewing financial statements in detail each month (financial reports reviewed at the finance committee level are generally more detailed than the reports going to the board level. The finance committee should understand the primary sources of revenue and expenses. The committee should also develop KPIs in line with the organization’s goals. KPIs may include: operating reserve %, days of cash on hand, accounts receivable collection period, aging of accounts payable listings, restricted vs. unrestricted net assets, etc. )
- Holding regular meetings to discuss finances and ensure that the organization is sustainable (finance committees typically meet monthly or every second month)
Simply put, good financial oversight looks something like this:
Every board member has a general understanding of the organization’s sources and uses of funds. In addition, they understand the overall financial position and sustainability.
Each board member is familiar with the critical compliance issues the organization faces and the policies created to ensure adherence to compliance standards.
The sign of effective financial oversight is the presence of fruitful conversations about the financial performance at your board meetings. All board members should participate, regardless of their background or committee assignments.
Need help managing your nonprofit’s finances?
The first step to better financial oversight is getting your board more comfortable understanding the organization’s financials. For example, understanding basic terminology, the underlying financial assumptions used for budgeting, and the organization’s primary sources and uses of funds.
If you or your board is struggling with any of these things, we’d like to help. That’s why we created our free online masterclass for nonprofit founders, directors, and board members to give you a crash course on nonprofit finances.
Check it out for free: https://www.thecharitycfo.com/university/