Nonprofit Risk Management Center Vol. 22, No. 2, Summer 2013
2013 Risk SUMMIT
August 25 – 27, 2013 Revere Hotel – Boston, MA We invite you to attend the 2013 Risk SUMMIT at the Revere Hotel in Boston. During this three day event, you will enjoy provocative and enlightening risk management workshops, a vendor expo, and the chic ambience of the Revere Hotel. The Revere is a modern, eccentric hotel in the Back Bay neighborhood, only a block from scenic Boston Common and a short walk from the historic South End neighborhood. Back Bay is home to countless 19th century Victorian homes and the beautiful Boston Public Library. The Revere is within walking distance of prime Boston sights including: Paul Revere’s house, Trinity Church, Fenway Park, New England Aquarium, the Boston Public Gardens, and the local shopping hotspot of Newbury Street. To register for the SUMMIT, visit www.nonprofitrisk.org/summit.
The Financial Risk Issue Financial Sustainability: The New Frontier By Melanie Herman and Jessica Say
Ensuring that adequate funds are available to support the mission of a nonprofit may be the ultimate challenge facing today’s nonprofit sector leaders. The clarion call to “diversify” an agency’s funding sources is often heard, but ultimately hard to achieve. Uncertainty about the ability of a nonprofit to finance
an ambitious menu of services remains a top concern among staff and board leaders alike.
Are We Healthy, or Just Hanging On?
Do the leaders of your nonprofit worry about whether next month’s expenses continued on page 2
A publication of the Nonprofit Risk Management Center ©2013 Nonprofit Risk Management Center 15 N. King Street, Suite 203 • Leesburg, VA 20176 • Phone: (202) 785-3891 • Fax: (703) 443-1990 • www.nonprofitrisk.org
2 ❙ Risk Management Essentials • Summer 2013 Financial Sustainability: The New Frontier continued from page 1
Vol. 22 • No. 2 • Summer 2013 Published three times annually by the Nonprofit Risk Management Center 15 N. King Street, Suite 203 Leesburg, VA 20176 Phone: (202) 785-3891 Fax: (703) 443-1990 Web site: www.nonprofitrisk.org.
Nonprofit Risk Management Center Staff Directory (All staff can be reached at 202.785.3891) Melanie Lockwood Herman ■ Executive Director Melanie@nonprofitrisk.org Erin Gloeckner ■ Project Manager Erin@nonprofitrisk.org Kay Nakamura ■ Director of Client Solutions Kay@nonprofitrisk.org Alexandra Ricketts ■ Project Manager Alexandra@nonprofitrisk.org Jessica Say ■ Project Manager Jessica@nonprofitrisk.org
2013 Board of Directors President Michael A. Schraer Chubb & Son Warren, NJ
Robert O’Leary Philadelphia Insurance Companies Boston, MA
Treasurer Lisa Prinz Harleysville Insurance Harleysville, PA
Kim Y. St. Bernard Girl Scouts of the USA New York, NY
Secretary Carolyn Hayes-Gulston National Multiple Sclerosis Society New York, NY Peter Andrew Council Services Plus, Inc. Albany, NY David S. Kyllo Riverport Insurance Company Minneapolis, MN
Trish Shanahan First Nonprofit Foundation Savannah, GA Bill Tapp College of Direct Support Knoxville, TN Jeffrey D. Weslow Housing Authority Insurance Group Cheshire, CT
will be paid, on time and in full? Is your Executive Director hesitant to support the expansion of programs due to concern about the sustainability of current funding streams? Do members of the board admit to being risk averse about growth? Although a savvy outside finance expert might be able to quickly pinpoint signs that a nonprofit is surviving, rather than thriving, those signs may be less clear to insiders. To make it a bit easier to evaluate fiscal health, let’s contrast surviving and thriving nonprofits. A financially stable, thriving nonprofit is likely to be: ■■ Investing financial and staff
resources to improve existing programs and services; ■■ Exploring opportunities to build
on programmatic success, such as scaling up high-demand programs; ■■ Open to new partnerships that
could bring the mission to life faster or more efficiently; and ■■ Competitive with other
organizations providing similar services or working with similar consumers or clients. In contrast, a nonprofit that is barely surviving may be seen: ■■ Taking every available shortcut and
cutting corners to trim short-term expenses; ■■ Allowing the workforce to shrink
by leaving vacant positions unfilled; ■■ Freezing cost of living and merit
pay increases over multiple year periods; and ■■ Putting pressure on program
and project managers to “do more with less.”
Components of Financial Sustainability
Reflecting on the fiscal health and contrasting ills of the many nonprofits we advise, several key topics came to mind as possible puzzle piece components of financial sustainability. In the paragraphs that follow we explore what we view as the five building blocks or key foundational components of financial sustainability: ■■ Community engagement ■■ Dependency awareness and analysis ■■ Fiscal oversight by the Board ■■ Timely and effective financial
reporting ■■ Programmatic rigor
1. Community Engagement A key component of financial stability is community engagement. Engaging with the community you serve is necessary to identifying the evolving service needs and wants of current and prospective clients, consumers and service recipients. There many different ways to gather information about the needs and wants of your clientele: reviewing published data and reports, conducting surveys, and sponsoring focus groups, are just a few. Conducting a community needs assessment and building and sustaining meaningful relationships with the people and organizations you serve go hand in hand to support long-term fiscal health. Here are some questions to consider when performing your community assessment: ❏❏ What are the current and projected
needs for your services in your community? ❏❏ Who are your potential members/
clients/service recipients? What methods are best to reach and continued on next page
Risk Management Essentials • Summer 2013 ❙ 3 Financial Sustainability: The New Frontier continued from page 2
engage these individuals or organizations? ❏❏ Who are your current and possible
future competitors? What services do your competitors offer and how is your organization or service mix different? How might you differentiate your nonprofit going forward? ❏❏ How is your nonprofit perceived
by current and prospective clients? What is your basis for assessing your reputation?
2. Dependency Awareness and Analysis Understanding your dependency on key sources of revenue is fundamental to strengthening financial sustainability. With rare exceptions, organizations that rely on a single funding stream are often at greatest risk of poor fiscal health or vulnerable to a fiscal crisis caused by the withdrawal of a funding source. Yet an organization with multiple streams of revenue can also be at risk of poor fiscal health. For example, during the recent economic recession one client reported that corporate donations, fees for services, and product sales to nonprofit clients were all negatively impacted. And so despite having several streams of revenue, no stream was exempted from the negative consequences of the recession. Here are some questions to consider to increase awareness of your organization’s degree of financial dependency: ❏❏ What are the core programs and
services of your nonprofit? ❏❏ How is each core program or
service funded? ❏❏ What are the realistic prospects that
the funding stream for each core program or service will continue
without major cuts for the next 2 years, 3 years, and 5 years? ❏❏ What programs or services are at
greatest risk of a funding cut or the elimination of funding altogether? ❏❏ What programs or services are the
least likely to be de-funded or face significant funding cuts? ❏❏ Has the nonprofit received notice
from any funders that funding will decline or be terminated in the years to come? ❏❏ Is 40% or more of your organization’s
revenue derived from one source or stream of funding? What would happen if this source of funding was no longer available for the next fiscal year? What is the current back-up plan to replace this funding source over time, or in the event of an emergency? To what degree are the programs and services funded by this source essential to your core mission and reputation?
3. Fiscal Oversight by the Board
Another fundamental component of fiscal stability is true fiscal oversight by the nonprofit board. A board that cedes responsibility for finance issues to the staff puts the nonprofit at undue risk. The perspectives and participation of both staff and volunteer leaders are needed to ensure that the nonprofit adopts sound financial strategies that advance the organization’s mission, and ensure good fiscal health. Yet effective fiscal oversight isn’t simply an assignment handed out at a board meeting; it is a responsibility that grows out of a strong and trusting relationship between the board of directors and CEO. Leaders must respect one another, offer mutual support, share a passion for the nonprofit’s mission, and find ways (both large and small) to collaborate continued on page 4
A board that cedes responsibility for finance issues to the staff puts the nonprofit at undue risk.
4 ❙ Risk Management Essentials • Summer 2013 Financial Sustainability: The New Frontier continued from page 3
The fiscal health of a nonprofit cannot be assured in the absence of accurate, timely reports comparing financial goals and forecasts to actual results. Financial reporting should be viewed as a component of financial sustainability, rather than as
a routine task on the CFO’s “to do” list.
for the greater good of the organization. A strong, collaborative relationship marked by mutual trust and respect is key to empowering the board to discharge its responsibility for fiscal oversight. To evaluate whether your board has embraced its responsibility for fiscal oversight, ask: ❏❏ Does every member of the board
demonstrate fluency and comfort with the nonprofit’s financial statements? ❏❏ Does the board actively participate
in training/orientation on fiscal issues, such as a board education session on “how to read nonprofit financial statements”? ❏❏ Does the makeup of the Finance
and Audit Committees change periodically, so that most board members have a chance to serve on one committee during their term in office? ❏❏ Does the Finance Committee report
to the full board on a regular basis, and engage the board in a dialog about indicators of fiscal health? ❏❏ Do the Board Chair and Treasurer
model the importance of engaging the full board in fiscal oversight? The following are possible questions to help engage the board in a discussion about sustainability, as part of its larger responsibility for fiscal oversight: ❏❏ How do we envision the
organization’s mission evolving in the next 3, 5 and 10 years? ❏❏ How do we describe our current
model/framework (or “business model”) for funding the mission? ❏❏ What trends in our segment of the
nonprofit sector potentially impair the current financial or business model for funding our mission or
put the model in jeopardy in the next 3, 5 or 10 years? ❏❏ Are the financial/funding goals we
adopted as part of the most recent strategic plan still realistic given internal and external changes and developments? ❏❏ What do we know now that we
didn’t know the last time around that should inform our approach to funding the mission?
4. Timely and Effective Financial Reporting The fiscal health of a nonprofit cannot be assured in the absence of accurate, timely reports comparing financial goals and forecasts to actual results. Financial reporting should be viewed as a component of financial sustainability, rather than as a routine task on the CFO’s “to do” list. A recent trend in financial reporting is the use of fiscal dashboards. Dashboards offer a visual interpretation of financial results. The components of a dashboard depend on the issues of critical to importance to the nonprofit. For example, a nonprofit engaged in an ambitious growth plan may want to provide periodic updates on its progress during finance presentations to the board. A graphic comparing results to the growth goals is a tool for helping the board see the progress made to date and the work yet to be accomplished. The leaders of a nonprofit’s Finance Committee and staff finance team should collaborate in deciding which items will be included in committee and full board presentations. Some of the common items found in finance presentations include: ❏❏ Narrative overview of fiscal status
prepared by the CFO, CEO or board Treasurer continued on next page
Risk Management Essentials • Summer 2013 ❙ 5 Financial Sustainability: The New Frontier continued from page 4
government contracts or leveraging existing revenue streams. Only after the opportunity to replace a former funding source has been exhausted, are leaders willing to consider scaling back or discontinuing existing programs or services. We use the term programmatic rigor to refer to the willingness to: ❏❏ evaluate the sustainability of a
nonprofit’s services on a program by program basis, ❏❏ consider the relationship of each
program to the organization’s mission, and ❏❏ evaluate each program’s fiscal
❏❏ Statement of Financial Position
(balance sheet), Statement of Activities, and Statement of Cash Flows ❏❏ Proposed changes to key financial
policies, such as the Investment Policy, Operating Reserves Policy, Travel/Reimbursement Policy, Contracting Authority policy, or the position description for the Finance Committee ❏❏ Fiscal Dashboard showing results or
illustrating trends in various areas, such as: progress towards growth goals, year-to-year fluctuations in revenue from various funding streams or channels, growth of unrestricted net assets, ratios comparing the nonprofit to a defined benchmark, and more. For more information on fiscal dashboards, see “Set the Story Straight with a Financial Dashboard.”
5. Programmatic Rigor While it’s true that not every program or service in your nonprofit will generate net income, it is important that staff and board leaders have a clear understanding of which programs are mission-critical, and under what circumstances beloved programs may be subject to change or elimination. It is preferable to undertake this discussion without the added stress or noise of a funding crisis. While your leadership team may agree that all programs have value, articulating the financial expectations for each program and service area is essential to ensuring not only the fiscal health of individual programs or areas of service, but of the organization as a whole. When a nonprofit experiences a downturn in one or more revenue streams, the immediate focus is often on finding new donors, seeking new
sturdiness—before a funding crisis occurs. Financial sustainability is a familiar goal in high-performing nonprofits. The risks of ignoring the topic are potentially severe, and include the need to eliminate programs and services with little notice to clientele who depend on your nonprofit. Yet like weight-loss, there is no inexpensive and simple remedy that suits every organization. Differences in mission, structure, culture and staffing necessitate a custom approach to ensuring financial sustainability. As you explore this important topic with your board or senior management, consider breaking it down into component parts, perhaps using the topics addressed in this article and suggested discussion questions as tools. Melanie Herman is Executive Director and Jessica Say is Project Manager at the Nonprofit Risk Management Center. They welcome your feedback and questions about any of the topics addressed in this article at Jessica@ nonprofitrisk.org, Melanie@nonprofitrisk. org or (202) 785-3891.
6 ❙ Risk Management Essentials • Summer 2013
Set the Story Straight with a Financial Dashboard By Erin Gloeckner
Take yourself back to college math class; perhaps you studied statistics or calculus. You may have been one of the lucky few who aced every exam, but more likely, you had trouble staying awake during lectures. Numbers can be boring, confusing, and overwhelming when you’re not a math whiz. Still, nonprofit leaders require financial awareness and diligence to sustain their organizations’ missions and operations. While you might prefer to pass finance to the CFO and never crunch numbers again, finance is truly a shared responsibility. Take part in writing and telling your nonprofit’s financial story to generate momentum toward fiscal health.
Calculation Cornucopia: Too Much Math is a Bad Thing Many nonprofits remain in a weak position with regard to fiscal literacy and engagement because they present financial data as a dull, mathematical
maze. What are the contextual issues that lead to the sharing of cold calculations rather than a compelling financial story? ■■ Lack of fiscal accountability –
When responsibility for financial management and fiscal oversight are left on the doorstep of the CFO or finance department, the members of the staff leadership team may starting believing they are off the hook. And worse, board members may become disinterested in fiscal oversight. Statements such as “finance isn’t in my job description” or “we’ve got a finance team, so I don’t need to worry about money,” are cause for concern. Lack of shared accountability for financial planning, financial management and fiscal oversight heighten the risk of financial catastrophe. ■■ Silos between programs or
departments – Many of our nonprofit clients experience continued on next page
Risk Management Essentials • Summer 2013 ❙ 7 Set the Story Straight with a Financial Dashboard continued from page 6
avoidable conflict caused by the fundraising and spending patterns in the organization. Each program covets the money raised or earned from its mission-related work, and programs or departments that generate less than they spend or no resources at all may be viewed as leeches. The lack of a shared vision for spending can lead to unhealthy competition between programs within an organization. Warring operations result in workplace tension, program instability, and selfish budgeting. ■■ Poor fiscal oversight by the board
– It’s plain and simple: if financial presentations are not engaging, board members may lose interest in providing fiscal oversight. Similarly, if financials are confusing or board members lack finance experience, fiscal stewardship may take a backseat at the board meeting.
Tell a Compelling Financial Story
As you may have heard, ‘dashboard’ is the new buzzword in the nonprofit finance arena. A financial dashboard is a tool for inspiring greater fiscal awareness and enthusiastic participation in fiscal oversight. Awareness and participation are essential to identify and address sort-term and long-term financial challenges. A typical dashboard consists of a set of “dials,” images or charts that depict various financial results. For example, one chart may illustrate the organization’s progress in reaching a specific goal (e.g., a fundraising target for the fiscal year), while a second chart could illustrate Working Capital and Debt to Asset Ratios. Yet another image could illustrate how many months of cash a nonprofit has in reserve. The number of images in the dashboard and what they show is limited by your
imagination! While a dashboard can be an effective tool, it must be created thoughtfully and with an audience in mind. Develop your dashboard with these strategies as a backdrop: ■■ Define the target audience –
Before you select metrics or data to include in a dashboard, it is imperative to understand your audience. A dashboard for the finance committee of the board may be very different from one created for a group of staff members. Consider how a dashboard’s purpose may vary depending on the audience. What are you trying to accomplish with your dashboard? Possible goals include, but aren’t limited to: ❏❏ Increase general awareness of
specific aspects of fiscal health ❏❏ Illustrate potentially mission-
threatening trends on the revenue or expense side of the budget ❏❏ Provide context for goal setting ❏❏ Communicate progress and
success ❏❏ Provide a common platform for
interpreting financial data No matter the purpose, remember that your audience will not listen to a financial story that isn’t entertaining. Brainstorm about your audience’s interests and the metrics they care about measuring. And remember to design your dashboard with your audience’s financial expertise, or lack thereof, in mind. ■■ Customize your dashboard –
There is no formula or perfect template for dashboard design. The best dashboards present information in a manner that suits the culture of the organization. Some dashboards look through a strategic, wide-angle lens while continued on page 8
Financial Storytelling at its Finest To learn more about fiscal dashboards and financial storytelling, join us at the 2013 Risk SUMMIT for the workshop, “Financial Storytelling: Captivating Stakeholders with Financial Results.” The 2013 Risk SUMMIT will convene at the Revere Hotel in Boston during August 25–27. For more information, please visit: www.nonprofitrisk.org/ summit.
8 ❙ Risk Management Essentials • Summer 2013 Set the Story Straight with a Financial Dashboard continued from page 7
others focus on the operational metrics of a specific program. Dashboards may present real-time data, snapshot data to capture a single moment, or historical data to help forecast future results. Your dashboard may encourage discussion by highlighting results that are inconsistent with projections, or prompt discussion about the validity of various measures of fiscal well-being. ■■ Discriminate between data – Data
can be illuminating, confusing, helpful or not. An effective dashboard includes information that helps leaders understand the financial status, health and challenges of the organization. Ask yourself which data will promote thoughtful discussion about the fiscal goals and results of the nonprofit. Aim to share metrics with the following qualities: ❏❏ Actionable – Share metrics that
relate to measurable goals. Goalbased metrics are especially important when responsibility for goals has been assigned to specific staff members or teams. ❏❏ Shared interpretation – The
most powerful metrics have shared meaning among those that use them. Rather than highlighting numbers or ratios that only the CFO comprehends, focus on telling a story that will be readily understood by those with financial backgrounds, as well as those without. ❏❏ Transparent – Select metrics
whose sources are credible and easy to understand. If the source of the data on a diagram or chart isn’t readily apparent, include a footnote to explain where the
comparison or information came from. ❏❏ Compelling – People love
numbers that link back to the mission of a nonprofit. Consider choosing metrics that tie back to specific goals in your strategic plan. Use your fiscal dashboard to remind leaders what bigpicture strategies your teams are focused on and report the progress that has been made. Fiscal dashboards can be an important tool in telling your nonprofit’s financial story, but they leave much to tell. Consider implementing these practices at your nonprofit to continue developing the story: ❏❏ Instill a culture of shared fiscal
accountability – Make it known that although the CFO drives financial management, all staff members share responsibility for pieces of the finance puzzle. Many nonprofits require program directors to develop individual budgets, or allow certain operations to fundraise and spend independently. If this is the case at your nonprofit, require leaders to attend quarterly financial meetings led by the CFO or finance director. Sitting face to face offers an opportunity to develop a shared financial vision and discuss ways to improve budgeting and financial reporting. Encourage staff to view funds as a large pot that sustains the nonprofit as a whole, rather than distinct sums that belong to specific programs.
❏❏ Cut programs that repeatedly
bleed funds – Many of us cannot bring ourselves to make the necessary decision to cut a failing program. Even when a program has hemorrhaged money for years, continued on next page
Risk Management Essentials • Summer 2013 ❙ 9 Set the Story Straight with a Financial Dashboard continued from page 8
our heartstrings want to protect it from the guillotine. To practice true financial stewardship, nonprofit leaders must view the organization as a whole, not in parts. One failing program could put undue pressure on or limit the chances for success and growth in other areas. Today’s nonprofit leaders must have the courage to recognize when a program’s instability becomes unbearable, or when the historical need for that program dissipates. ❏❏ Share your dashboard publicly –
Most fiscal dashboards are internal resources presented to staff and board leaders to measure progress toward goals. A new trend among progressive nonprofits is to share fiscal dashboards with the general public, including donors and the media. Dashboard-sharing has its perils, including the danger of
inviting public scrutiny for which you are unprepared, or the risk of sharing information the nonprofit has every right to keep to itself, but the benefits may be greater. Consider the possible benefit of being able to show an example of bringing your promise of transparency to life. Making your fiscal dashboard public could also inspire greater ownership of fiscal goals and outcomes among staff who realize that the whole world may be watching. Erin Gloeckner is Project Manager at the Nonprofit Risk Management Center. She welcomes your feedback and questions about any of the topics addressed in this article at Erin@nonprofitrisk.org or (202) 785-3891.
10 â?™ Risk Management Essentials â€˘ Summer 2013
A Violation of Trust: Fraud Risk in Nonprofit Organizations By Jonathan T. Marks, CPA, CFF, CITP, CFE, and Pete A. Ugo, CPA
The risk of fraud is a serious concern for all types of enterprises, but fraud can be particularly damaging to a nonprofit organization, for which a damaged reputation can have devastating consequences.
The Costs of Fraud in Nonprofit Organizations
According to the most recent global fraud study by the Association of Certified Fraud Examiners (ACFE), the typical organization loses an estimated 5 percent of its annual revenue to fraud. While fraud in nonprofit organizations resulted, on average, in a smaller net loss than fraud in commercial enterprises, the nonprofits in the study reported a median loss of $100,000â€”an 11 percent increase from the previous study and a significant loss to any charitable organization. Beyond the immediate financial
loss, however, an even greater potential cost of fraud to nonprofit organizations is the reputational damage that can occur. Because most nonprofits depend on support from donors, grantors, or other public sources, their reputations are among their most valued assets. In addition, fraud in nonprofit settings often garners unrelenting negative media attention.
Vulnerability to Fraud
Nonprofits can be particularly attractive targets for fraudsters. Executives who are passionate about their agencies and their missions are naturally trusting of others who share their interest- or who pretend to. Moreover, board members and executives who are dedicated and talented in their particular fields may not be well versed in financial issues and internal controls. continued on next page
Risk Management Essentials • Summer 2013 ❙ 11 A Violation of Trust: Fraud Risk in Nonprofit Organizations continued from page 10
In addition, nonprofits of all sizes may have only limited resources available to address internal controls. This makes them vulnerable to an employee who could recognize this lack of controls and use it as an opportunity to commit fraud. As the Center for Audit Quality has noted, “fraud cannot occur unless an opportunity is present. Opportunity has two aspects: the inherent susceptibility of the [organization’s] accounting to manipulation, and the conditions within the [organization] that may allow a fraud to occur.” In addition, the opportunity for fraud is also affected by an organization’s culture, a factor that is often overlooked. The very nature of some nonprofits also makes them tempting targets. Many nonprofits distribute grants, scholarships, awards, or other types of financial aid to outside agencies or individual recipients. This opens yet another door for potential abuse or misappropriation and requires even more oversight to make sure funds are not being misappropriated. In addition, nonprofits tend to have large amounts of cash and checks coming in from various sources, making them vulnerable to skimming (when an employee accepts payment from an outside party but does not record the sale and instead pockets the money) or cash larceny (when an employee steals cash and checks from daily receipts before they are deposited in the bank). Struggling agencies also frequently experience relatively high staff turnover, making training and adequate segregation of duties more difficult. Finally, many nonprofits depend heavily on volunteers and other community members, which can further complicate efforts to establish or maintain internal controls. It is important to remember that internal controls provide only reasonable—not absolute—assurance
that the objectives of an organization will be met. As a result, no organization, even one with the strongest internal controls, is immune to fraud.
How Fraud Occurs and Why
While nonprofit organizations present particular temptations to fraudsters, the actual fraud schemes they might face are common to all types of organizations. Fraud schemes in nonprofits can include check fraud, embezzlement, ghost employees, expense fraud, misappropriation of funds for personal use, fictitious vendor schemes, kickbacks from unscrupulous vendors, and outright theft of cash or assets—to name a few. One area in which nonprofit organizations seem particularly vulnerable is billing schemes, in which an employee fraudulently submits invoices to obtain payments he or she is not entitled to receive. According to the most recent ACFE survey, billing schemes were among the most common fraud methods in the cases studied for the 2012 report. Billing schemes often involve the creation of a shell company. In such a fraud, a dishonest employee sets up a fake identity that bills for good or services the organization does not receive. In some instances, goods or services may be delivered but are marked up excessively, with the proceeds diverted to the employee. Other scams include pay-andreturn schemes that cause overpayments to legitimate vendors. When an overpayment is returned, it is embezzled by the employee. Another favorite is simply ordering personal merchandise that is inappropriately charged to the organization. Common warning signals or red flags of potential billing fraud include but are not limited to: ■■ Invoices for unspecified or poorly
■■ Unfamiliar vendors ■■ Vendors that have only a post-
office-box address ■■ Vendors with company names
consisting only of initials (many such companies are legitimate, of course, but fraudsters commonly use this naming convention) ■■ Sudden increases in purchases from
one vendor ■■ Vendor billings issued more often
than once a month ■■ Vendor addresses that match
employee addresses ■■ Large billings that are broken into
multiple smaller invoices that will not attract attention ■■ Internal control deficiencies such
as allowing a person who processes payments to approve new vendors These warnings or red flags can be organized into four general categories:
Data ■■ Transactions conducted at unusual
times of day, on weekends or holidays, or during a season when such transactions normally do not occur ■■ Transactions that occur more frequently than expected – or not frequently enough ■■ Accounts with many large, round numbers or transactions that are unusually large or small ■■ Transactions with questionable
parties, including related parties or unrecognized vendors
Documents ■■ Missing or altered documents ■■ Evidence of backdated documents ■■ Missing or unavailable originals ■■ Documents that conflict with one
another ■■ Questionable or missing signatures continued on page 12
12 ❙ Risk Management Essentials • Summer 2013 A Violation of Trust: Fraud Risk in Nonprofit Organizations continued from page 11
Lack of Controls ■■ Unwillingness to remediate gaps ■■ Poor “tone from the top” ■■ Inconsistent or nonexistent
monitoring controls ■■ Inadequate segregation of duties ■■ Lax rules regarding transaction authorization ■■ Failure to reconcile accounts in a
Behavior ■■ Financial difficulties or generally
living beyond one’s means ■■ Divorce, family problems, or ■■ ■■
■■ ■■ ■■
addiction problems Past employment-related or legal problems An unusually close association with vendors or recipients of grants or services Control issues and a general unwillingness to share duties Refusal to take vacations Irritability or defensiveness
■■ Complaints about inadequate pay ■■ Complaints about lack of autonomy
or authority It is also worth noting that fraud is not about obstruction; rather, it is about deception, deflection, and persuasion. When fraudsters or white-collar criminals are profiled, they often are found to be anxious, secretive, moody, hot-tempered, friendly, outgoing, and passionate. They often are good salespeople and will say what people want to hear in order to build rapport and gain trust. Moreover, often there are other warning signs or red flags hidden in plain sight—such as living beyond one’s means, having financial difficulties, maintaining an unusually close association with vendors, or exhibiting excessive control issues, which generally will not be identified by traditional
internal controls. It is important to maintain a healthy level of skepticism and always remember that trust is a professional hazard; if you do not verify information, you could become a victim.
As with all risk issues, the ultimate responsibility for identifying gaps and developing fraud controls rests with management. To meet this responsibility, management should avoid complacency and not assume that if fraud occurs “the auditors will catch it.” Although having an annual audit is a good anti-fraud control, by the time an audit uncovers a fraud scheme, it is usually too late to prevent the financial and reputational damage that will follow. Most board members and executives of nonprofits do not think as fraudsters do, which is a good thing. Unfortunately, this can make it difficult for them to develop controls that help reduce their organizations’ exposure to fraud risk. A critical step in the process of developing an effective fraud risk management program is assessing the board’s own skills and capabilities and deciding where professional help is most needed. The board is ultimately responsible for oversight of the organization’s risk management efforts, which senior management is then charged with carrying out.
Here are some important principles to keep in mind as you work to refine the anti-fraud control policies at your nonprofit: ❏❏ Form an effective and empowered
audit committee or equivalent. One of the most important attributes of the audit committee is complete independence from management. In addition, the committee should be authorized
continued on next page
Risk Management Essentials • Summer 2013 ❙ 13 A Violation of Trust: Fraud Risk in Nonprofit Organizations continued from page 12
to hire outside counsel and other advisers to assist it in discharging its responsibilities. Although your circumstances may warrant a larger committee, a committee of three to five members is generally workable and optimal for most nonprofits. At least one audit committee member should be a financial expert, but individuals with nonfinancial skills and expertise are also needed to provide additional perspective. ❏❏ Establish and enforce a system of
effective controls. Combinations of internal and cultural controls form the core of an anti-fraud program. Internal controls limit opportunities to hide the fraud trail and can discourage all but the most arrogant fraudsters. Common tools include security and access controls, such as dual authority or monetary authorization limits, as well as audits, inspections, and transaction monitoring. The recent ACFE survey pointed out that the presence of anti-fraud controls is notably correlated with significant decreases in the cost and duration of occupational fraud schemes.
❏❏ Establish the right tone from the
top. Mere mechanical compliance with internal controls can still leave the organization vulnerable, which is why the attitude and actions of management are so important. Actively and visibly promoting a culture of integrity and ethics will embolden honest employees to put a stop to fraud. Most organizations find that a strong ethical environment encourages selfpolicing, thereby increasing the level of oversight far beyond what internal control methods alone provide.
❏❏ Provide a clear process for
reporting suspicious behavior. Over the years in which the ACFE
has been conducting its global fraud studies, the most effective means of detecting fraud has always been tips. In the most recent study, tips were responsible for uncovering nearly three times as many frauds as any other form of detection such as management reviews, surprise inspections, audits, or surveillance devices. While some nonprofits use a third-party hotline service for reporting suspicions about fraud, creating a culture where employees know that the nonprofit’s reputation and mission depend on their willingness to report suspicions of fraud is less costly and may be equally effective. ❏❏ Develop a response plan in
case deterrence fails. In spite of everyone’s best efforts, fraud still can occur. In many cases, the initial reaction of executives or board members is to confront the suspected fraudster outright or, if there is doubt, to begin collecting paper or electronic evidence. All too often, these are exactly the wrong things to do and could compromise an organization’s ability to prosecute. Confronting a suspected fraudster without adequate evidence is not only awkward and legally dangerous; it can also alert the suspect to cover his or her tracks. On the other hand, surreptitiously examining computer links and email archives could compromise the evidence and imperil the integrity of a formal investigation, making conviction and recovery more difficult. To avoid these various unintended consequences, nonprofit organizations should develop appropriate strategies in advance to deal with specific types of fraud or other misconduct. The protocol for
dealing with an employee suspected of cheating on an expense report is different from that for an executive involved in a conflict of interest. ❏❏ Confront the issue openly and
directly. Perhaps the most common impulse when fraud is detected is to dismiss the offender, limit the damage, and hope the story can be kept quiet. This too is likely to fail. Eventually, word of the fraud gets out and the associated rumors are likely to be exaggerated, causing even more reputational damage than would have been done if the board had simply been forthright.
A Combination of Deterrence and Detection
As important as it is to respond quickly to fraud, avoiding the situation in the first place is the best plan of all. Although it is unrealistic to expect to completely eliminate the risk of fraud, the governing board and executives in a nonprofit organization can take effective steps to minimize the risk. By establishing an environment in which ethical behavior is expected, closing gaps in internal controls, and developing a proactive fraud identification and response program, nonprofits can significantly reduce the financial and reputational risks associated with fraud. This article was excerpted from an article published by Crowe Horwath in August 2012. Jonathan Marks is a partner and leader of Fraud, Ethics, and Anti-Corruption Services with Crowe Horwath LLP in the New York office. He can be reached at 212.572.5576 or firstname.lastname@example.org. Pete Ugo is a partner with Crowe in the Indianapolis office. He can be reached at 317.208.2509 or email@example.com.
14 ❙ Risk Management Essentials • Summer 2013
IN is OUT, and OUT is IN Outsourcing the Finance or Accounting Function in a Nonprofit By Alex Ricketts
Outsourcing financial tasks has become a popular trend in the nonprofit sector. Common reasons nonprofit leaders outsource some or all of their financial management responsibilities include: ■■ to gain access to expertise the
nonprofit doesn’t require on a full-time basis, ■■ to reduce the cost of financial
management activity, and ■■ to enable the efficient ramping
up or scaling back of financial management based on the ebbs and flows of fiscal activity at the organization. In addition to the benefits listed above, retaining an independent, qualified finance or accounting firm may enable a nonprofit to mitigate certain downside risks that arise in financial management, such as: ■■ fraud made possible by the practice
of allowing one staff member to control some or all financial functions from start to finish, ■■ undesirable fiscal surprises or
instability due to the lack of fiscal literacy on the board and the board’s inability to spot red flags in periodic financial statements, ■■ untimely financial reporting or
filing because the nonprofit staff must focus on other pressing business, and ■■ allegations of noncompliance with
the terms of grants or contracts due to sloppy financial reporting.
Fiscal outsourcing can be helpful to a nonprofit that finds itself ill-equipped to manage these and other financial risks alone. But before outsourcing, nonprofit leaders must first prepare to mitigate risks that may arise from outsourcing.
Outsourcing Due Diligence
Before turning over access to any aspect of the financial management function to a third-party, it’s important to take the time to choose a vendor whose expertise, business model and pricing suit your needs. According to Ed Mulherin, CEO and Founder of eCratchit, a Bostonbased accounting firm that offers “virtual” financial services, the key to successful fiscal outsourcing is finding the right match. “Collaborating with the right firm is essential for a healthy partnership,” Mulherin said. “Partnering with an inexperienced firm or one that is unfamiliar with your organization is the greatest potential downside risk.” Planning for a successful partnership begins by understanding your needs. Ask: What specific fiscal tasks should we outsource? What are the pros and cons of outsourcing a few specific financial tasks or activities, versus the entire finance function? Knowing the answers to these questions will help guide you in the search for a firm and enable you to reduce the risk of a costly match. Mulherin also urges nonprofits to seek out firms that carry professional liability insurance. Once you identify potential partners, interview them as if you were hiring an
employee. Some of the questions you might ask include: ❏❏ Have you worked with nonprofits
before? ❏❏ What sizes and types of nonprofits
do you currently serve? ❏❏ What is the range of services you
provide? What specific services do you recommend for a nonprofit similar in size or structure to ours? ❏❏ How long will the transition take,
and what is involved? ❏❏ Is there a startup fee to access your
firm’s services? ❏❏ How often will we be billed
for services, and how is billing structured (e.g., monthly invoice based on number of hours devoted to the account, or flat weekly fee debited from the nonprofit’s bank account)? ❏❏ How often will you provide
financial statements or other reports, and can these reports be customized to meet our needs at no additional cost? ❏❏ What is your availability to meet
with our finance committee, audit committee, and/or board, and are these meetings included in your fee? ❏❏ What training, if any, will our
staff need in order to work in partnership with your firm? (e.g., training on accessing our accounts virtually) ❏❏ What challenges do you anticipate
(e.g., based on our internal resources, current accounting continued on next page
Risk Management Essentials • Summer 2013 ❙ 15 IN is OUT, and OUT is IN Outsourcing the Finance or Accounting Funtion in a Nonprofit continued from page 14
software, etc.) and how do you propose to address them?
fiscal health of the organization. Outsourcing finance tasks doesn’t
❏❏ Can you provide current and
mean forgetting about your legal
former client references?
responsibility for fiscal oversight.
The answers to these questions will be invaluable as you narrow down your options. You may discover, for example, that a well-respected firm isn’t in position to assign a go-to account manager; instead, you’ll be working with a different representative every time you call. Or you may learn that the affordable flat fee for services is a baseline only, and weekly or monthly bills are likely to include unpredictable costs, such as fees for work by senior accountants, or fees for custom reports.
Caution is Required ❏❏ Use a Written Service Agreement:
In order to reduce the risk of confusion and disappointment, a well-structured service agreement is crucial. “A service agreement with a detailed scope of work is essential,” Mulherin advised. “The segregation of duties is one of the greatest potential benefits of outsourcing, so it’s important to formally establish the exact services that will be provided by the firm.” ❏❏ Have Realistic Expectations:
Though your nonprofit will have access to greater fiscal expertise, do not assume that your outside partner is perfect. The risk of human error and even fraud remains. Although professional liability insurance provides some peace of mind by potentially financing some losses, it remains the nonprofit’s duty to guard the
❏❏ Ensure Accessibility: In order
to discharge the responsibility for fiscal oversight, make certain you will be able to access your accounts and reports without delay. Ask: Will we be able to verify information provided by the firm by accessing our accounts directly? Does the firm have 24/7 support? Will the firm immediately notify us when a problem arises? Will the firm provide us with several communication options? What is the firm’s commitment to respond promptly to our questions and concerns? These questions should be asked and answered prior to signing a service agreement. ❏❏ Formulate an Exit Strategy: To
avoid the perils of a long-term commitment to an unhealthy partnership, formulate a way out long before you need it. Mulherin suggests that nonprofit leaders create ‘at-will service agreements’ with their outsourced partners. If things don’t work out or the firm’s services are no longer needed, the relationship may be terminated, without penalty, by the nonprofit. Include in any exit strategy your expectations for support and assistance during a transition period. ❏❏ Be Selective: Think carefully
about which financial functions you should outsource. Mulherin
suggests that the easiest activities to outsource are transactional tasks: bill payments, financial report production, and management of bank accounts and payroll. You may want to outsource some of these tasks before you hand everything over to the firm. Outsourcing transactional tasks for a time also provides an opportunity to get to know the firm and evaluate the firm’s proficiency at managing finance tasks. ❏❏ Don’t Lose Touch: It is essential
that nonprofit leaders routinely review the performance of an outside accounting firm. Beware of losing interest and neglecting financial duties after outsourcing. You will still need to be fiscally literate and savvy to discharge your responsibility for fiscal oversight. Discus with your provider what protocols make sense for communication, such as regularly scheduled check-in calls or as-needed email exchanges and conversations. As fiscal outsourcing becomes more common in the nonprofit sector, it may be tempting to jump on the bandwagon. Like any other trend, however, it is important to first identify, understand and manage the downside risks associated with any new approach before you can reap all of the benefits. Alex Ricketts is a Project Manager at the Nonprofit Risk Management Center. She welcomes your feedback and questions about any of the topics addressed in this article at firstname.lastname@example.org or (202) 785-3891.
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This Issue Financial Sustainability: The New Frontier............................................. 1 Set the Story Straight with a Financial Dashboard................................6 A Violation of Trust: Fraud Risk in Nonprofit Organizations............... 10 IN is OUT, and OUT is IN: Outsourcing the Finance or Accounting Function in a Nonprofit.................................... 14 The Risk Management Marketplace...................................................... 16 Products/Publications from the Nonprofit Risk Management Center.......19
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