Is your board staring at financial red flags without knowing it? Although some warning signs — such as those experienced when the pandemic first hit — are obvious, others are easy to overlook. Here are several signs of trouble that board members need to be aware of and prepared to act on.
3 Potential Financial Red Flags
Unexplained Variances and Other Budget Issues
Certain budget-related issues may hint at rocky financial times to come. Having no budget is a flashing red light and suggests an undisciplined approach to fiscal matters. But assuming management has submitted a budget, your board should ensure it’s in line with board-developed and approved strategies.
Once a budget has been okayed, your board needs to compare it to actual results for unexplained variances. Some discrepancies are bound to happen, but staff should explain significant differences. There may be a reasonable explanation, such as program expansion, funding changes or macroeconomic factors. But your board should be wary of overspending in one program that’s funded by another. Dips into your not-for-profit’s reserves, unplanned borrowing or raiding of an endowment might also mark the beginning of a financially unsustainable cycle.
Late or Poorly Prepared Financial Statements
Untimely, inconsistent financial statements — or statements that aren’t prepared using U.S. Generally Accepted Accounting Principles (GAAP) or another accounting basis — can lead to poor decision-making and undermine your not-for-profit’s reputation. They also could signal understaffing, lax internal controls and efforts to conceal mismanagement or fraud.
Ideally, your board should receive financial statements within 30 days of the close of a period. Larger organizations are generally expected to engage experts to perform annual audits, with the whole board or audit committee selecting the auditing firm.
Changes in Stakeholder Behavior
Not all financial red flags are found in a not-for-profit’s numbers. For example, if long-standing, passionate supporters express doubts about your organization’s finances, board members need to take them seriously. Your board also should note if development staff begin reaching out to historically major donors outside of the usual fundraising cycle.
An overreaching executive director is further cause for concern. For instance, an executive might insist on choosing an auditor or make strategic or spending decisions without board input and guidance. Such power grabs could signal dishonesty or financial instability.
Not-for-profit boards must act as fiduciaries, which means taking a proactive stance and acting on warning signs before they blow up into financial crises. If you or your board are concerned about certain financial red flags, contact us for help.
To learn more about how PKF Texas serves not-for-profit organizations, visit www.pkftexas.com/NotForProfit.