Fraud presents a significant threat to fundraising dollars, causing a median loss of $76,000 each year for nonprofits. Protecting your organization’s revenue against this threat is vital to powering your mission. After all, every dollar counts when it comes to funding your programs and services.
Fortunately, the key to safeguarding your resources is within your nonprofit’s own processes. The first line of defense against fraud is internal controls.
In this guide, we’ll explore four internal controls your nonprofit should implement to prevent fraud.
1. Create a Fraud Policy
To prevent, detect, and address fraudulent activities, your entire team must be on the same page about what fraud is and how to address it. A fraud policy is a formal statement that outlines the expectations for staff, volunteers, and stakeholders regarding financial practices.
A comprehensive policy includes:
● Definitions of fraud: Clearly define what constitutes fraud, such as acts of embezzlement, forgery, misrepresentation of financial data, and any other dishonest activity that provides an unfair advantage.
● Reporting procedures: Outline the steps that staff and volunteers should follow to report suspected fraud. This could include providing channels to report the fraud, like a designated email address, and ensuring anonymity for those who report.
● Consequences: Explicitly define the consequences of fraudulent activity, both for the individual committing fraud and for the organization. This establishes the disciplinary action that is to be expected and highlights the implications of fraud on the nonprofit. For example, fraudulent activity could result in termination of employment for the fraudster and revocation of the organization’s 501(c)(3) status if private inurement occurs.
● Whistleblower protection: Include provisions that guarantee protection for individuals who report fraud. This should include protection from various types of retaliation, such as harassment, demotion, or termination.
After establishing your nonprofit’s fraud policy, inform all staff members and volunteers of the new guidelines and expectations. Implement ongoing training to refresh everyone’s memory and understanding of the procedures. Additionally, incorporate the policy into your onboarding process to familiarize new team members as soon as they join.
2. Segregate Financial Duties
Segregation of duties is an internal control principle that involves dividing financial responsibilities among various team members to increase accountability and reduce the opportunity for fraud. This practice creates a system of checks and balances, limiting any individual’s ability to engage in fraudulent activities.
For example, consider the process of cash handling and recording. Delegate each of the following tasks to a different team member:
● Cash collection
● Transaction recording
● Bank deposits
● Statement reconciliation
Segregation of duties can be implemented from the very beginning of an employee’s time at your organization, starting even as early as the interview process. To hire with this practice in mind, explore candidates’ approaches to ethical dilemmas by presenting hypothetical scenarios in their interviews. Also, align segregated duties with open roles ahead of time to ensure you select candidates who are qualified to complete segregated financial tasks.
3. Outsource Bookkeeping Tasks
Along with the segregation of financial duties, outsourcing bookkeeping tasks can reduce the risk of fraud by enlisting the oversight of an impartial third party. Not only will this provide increased objectivity, but your nonprofit will also benefit from the specialized expertise of a professional bookkeeper who is well-versed in nonprofit financials.
The bookkeeper your nonprofit works with must be knowledgeable and trustworthy to aid in preventing fraud. To ensure you work with the right one, look for the following:
● Experience in the nonprofit sector: An individual with a generic understanding of bookkeeping practices won’t do. Nonprofit finances are unique, meaning the professional you work with must have a strong understanding of bookkeeping for nonprofits to accurately record your financial information and keep your books compliant.
● References and reviews: First-hand experiences from other nonprofits can provide insight into a potential bookkeeper’s reliability and accuracy. Request references from the bookkeeper’s past clients and explore online reviews or testimonials to learn more about a candidate’s work.
● Qualifications: While not required, some bookkeepers have relevant certifications that indicate their expertise in accounting principles and nonprofit-specific issues. Consider a potential bookkeeper’s educational background and understanding of compliance requirements.
Once you’ve chosen a professional bookkeeper to work with, share your fraud policy with them and set clear expectations for communication throughout their work. Establishing a schedule for regular updates allows for ongoing dialogue about any issues that crop up, which can help your team identify and address fraudulent activity early.
4. Establish Strong Governance
While every member of your nonprofit’s team plays a role in preventing fraud, you must establish strong governance to ensure those roles are carried out properly. Nonprofit managers, board members, and other organizational leaders have a responsibility to ensure financial health, transparency, and accountability. They can do this by:
● Regularly reviewing financial statements: Frequent oversight of the organization’s financial position helps leaders detect any irregularities before they become problematic. Your leadership team should determine a recurring cadence for reviewing financial statements, such as monthly or quarterly.
● Overseeing financial planning: Nonprofit leadership should be involved in the development and approval of your organization’s annual budget. This ensures your finances align with the nonprofit’s strategic goals and holds team members accountable for adhering to the budget.
● Fostering transparent communication: Individuals in financial roles should keep board members and managers informed about financial activity through regular reporting and open dialogue. This builds trust and ensures that leaders are equipped to help safeguard the organization’s financial health.
Your nonprofit’s leadership team should complete relevant training to ensure they can detect and address fraud if necessary. By enhancing their financial literacy, your nonprofit’s leaders will be prepared to identify red flags and implement effective controls that support the organization’s commitment to financial integrity.
Implementing strong internal controls is essential to protecting your nonprofit’s resources and strengthening your ability to fulfill your mission. As a result, you won’t just reduce the risk of fraud—you’ll create an organizational culture where honesty, transparency, and accountability are core values.