Nonprofit Best Practices: Internal Management of Financials

The internal management of a nonprofit’s financial information is an important part of maximizing resources and efficiencies. There are various internal reports which are useful for all levels of management and departments, while providing an overview and understanding of operational reporting on programmatic, administrative and fundraising information.

Internal analysis and reporting can be augmented through the use of technology and financial metrics. There are a variety of technology dashboards and other software that can support your organization’s mission and available resources. In addition, these tech solutions can also provide the appropriate and effective internal controls your organization can utilize.

The process of gathering and analyzing this internal information proved especially important during the pandemic, as most nonprofits needed to pivot how they did business. Some processes and procedures that demanded immediate change were:

• Operational
• Segregation of duties/internal controls
• Internal financial reporting

For some, the disruption in operations allowed management and boards to think beyond the day-to-day, propelling them to analyze their operations and conduct appropriate upgrades. Some of those upgrades included more strategic budgeting practices, new accounting systems and utilizing cloud-based solutions to stay connected while moving to a more remote work environment.

Internal Financial Reporting

One thing that will never change for accounting within nonprofits, no matter what is going on in the world, is the importance of reporting financials to management and to the board of directors. Nonprofits should develop a written process for internal financial reporting, as well as a timeline for how soon after month-end the books will be closed.

Individuals from each of the various departments within the organization should follow their established budget, then when they report on their actual-to-budget, they’ll be able to show how well they’re meeting their goals. They should also provide this information to those who are responsible for the budget to allow all involved to monitor spending, adjust as needed and to facilitate a smoother operation overall. 

In an employee-run organization, the board of directors should be involved in approving the annual budget prior to the start of the fiscal year, as they are ultimately responsible for its oversight. The budget process is developed internally months before the start of the new fiscal year.

Another important role the nonprofit board holds is reviewing its Form 990 annually, since it’s a vital and highly-visible public document that shows the overall financial strength and program accomplishments.

The overall health of your nonprofit organization is reflected in the budgeting and financial reporting process. Healthy organizations tend to align their budgets with their missions and strategies and are able to effectively report and monitor results on a continuous basis.

Allocating Expenses for Financial Statements

An important aspect of solid financial reporting is the process of accurately allocating expenses. The allocation of functional expenses for financial statement purposes is one of the most common pain points of a nonprofit organization. However, allocating expenses on a functional basis allows stakeholders to see costs by individual programs, as well as administrative and fundraising costs that support the organization. It also helps in budgeting in the future, understanding total program costs and where funding shortfalls may occur.

Within nonprofit financial statement reporting, there are three classes of functional expenses:

• Program expenses, which there can be multiple programs
• Management and general expenses
• Fundraising expenses

If expenses are directly related to only one category, then the direct cost method can be used and recorded within that one expense classification for that expense line item. If an expense is not attributable to only "one" expenses classification, or should be spread to more than one program, then the indirect cost allocation should be used to record the expense. 

In addition to maintaining proper functional expenses for the organization, those that receive grant funding may also have to track specific costs associated with that specific grant. Many accounting systems will track grants, or tracking could be built through the addition of an app or dashboard. 

A best practice for nonprofits is to address the allocation of expenses as they are incurred instead of doing a study at the end of a fiscal year so that financial records are accurate throughout the entire year. 

Methods of Allocation

Each organization will need to develop a reasonable and consistent method of allocating expenses. There are various methods that can be used for the indirect cost allocation method, depending on the type of expense. 

There is a bit of a science to proper allocation of expense, which in turn provides proper and accurate internal financial reports for management. Determining the ideal allocation methodology for cost allocations can include:

1. Payroll costs – Expenses that are directly related to the number of employees in a department or classification of expense can be allocated based on the payroll in that department or classification.
2. Time or effort – A time study should be done to allocate an executive’s payroll across the appropriate programs or functional expense classification. If this time study is routine and does not change throughout the year, then it could be used for a standard allocation of expense.
3. Square footage – Often, utilities and maintenance are allocated to programs or expense classifications based off square footage used.

Using Key Performance Indicators (KPIs) to Track Performance

Beyond the management of financials, it is equally as important for organizations to track and report on performance, both financial and non-financial. It can be challenging to create useful performance measures for an organization. It can seem easier and more convenient to grab the simple data and come up with standard measures, but sometimes those measures may not be what truly counts to your organization. You can count numbers all day, but if they aren't driving your daily decisions and actions, then they probably aren't crucial to your mission and overall vision. That’s why establishing what your key performance indicators (KPIs) are is so important.

KPIs are a quantifiable measure used to evaluate the success of an organization, employee, or similar, in meeting objectives for performance. They are an important tool to use because they can influence management and employee behavior as well as the overall culture of your organization. They really help align your operations to your mission and strategies. 

First, focus your budgets on your mission and strategies. In order for your KPIs to align with your mission and strategies, review your mission statement in detail and then break out the key areas within it and write them down. Repeat the process with your vision and strategic plans.

From there, you will define goals for each of those areas that you identified. Without these goals, it will be impossible to determine a useful KPI that aligns with your mission and strategies. Next, choose a few KPIs for each goal. You can identify both financial and non-financial KPIs and decide which metrics are the right ones which will be unique to your nonprofit organization and mission.

It’s best to try to minimize the number of KPIs you track in order to keep it manageable—especially when first starting out with the process. Three to five KPIs for each area is a good practice. Keep that in mind that if circumstances change within your organization change. Your KPIs may no longer be relevant.

Ultimately, it’s important to understand that KPIs are only telling part of the story—as it’s only a partial measurement of your overall nonprofit performance. When you look at each area of KPIs, any set of these are incomplete without the others, without the full picture of what's going on in your organization. Be sure to watch for links between your indicators and the impact they have on each other. KPIs may also "indicate" there could be some operational issues developing that need attention.

Nonprofit Specific KPIs

Financial KPIs pull data directly from your financial statements, and non-financial KPIs use activity-based data from outside of your financials. These nonprofit specific KPIs could be used in your reporting, if they are an accurate measure of your goals. These KPI examples are not a complete list but should spark ideas for your unique measures. When establishing your nonprofit’s KPIs, be sure to incorporate mission-focused KPIs.

Financial:

• Donation Growth Rate
• Net Fundraising & Public Support
• Fundraising ROI
• Grants Secured
• Administrative and/or Program Efficiency
• Defensive Interval Ratio
• Liquid Unrestricted Net Assets
• Quick Ratio
• Debt Ratio

Non-Financial:

• Donor Growth
• Donor Retention Rate
• Website Page Views
• Landing Page Conversion Rate
• Number of Patrons Served
• Program Attendance
• Net Promoter Score
• Pre and Post Scores
• Volunteer Satisfaction & Retention

Identifying and tracking your nonprofit’s unique KPIs is invaluable when conducting financial reporting. Over time and repetition, this process will become more streamlined and will lead to greater success for your nonprofit.