“Audit reveals major red flag in nonprofit accounting records: millions in donations vanish without a trace,” is never a headline you want associated with your organization. Recognizing financial red flags early can help your nonprofit avoid situations where your nonprofit becomes the day’s news event and forensic accounting becomes necessary. By identifying potential financial risks before they escalate, your organization can prevent a crisis altogether. Drawing from insights shared on a recent webinar by nonprofit financial experts, here are some critical warning signs you need to monitor regularly.

Cash Management Warnings

  • Negative cash balances and significant downward trends in cash
  • High concentrations of cash exceeding FDIC limits
  • No savings, investments, or reserves
  • Unreconciled bank accounts

 

Regular bank account reconciliations are essential for detecting financial red flags. When these signals appear, the key question becomes “why?” – the answer determines whether it’s truly cause for concern. Another effective detection method involves both Management and the Board routinely comparing actual expenditures to budgeted amounts in your nonprofit’s financial statements and investigating significant variances. Channeling the mindset of an auditor or forensic accountant, consider these potential warning signs:

Net Asset Concerns

  • Negative unrestricted net assets or declining support
  • Nonprofits improperly using net assets with donor-imposed restrictions

 

Revenue Concerns

  • Heavy concentration in a limited number of funding sources particularly Federal grants
  • Declining trends in community support or contributions
  • Majority of funding is donor-restricted

 

Expense Concerns

  • Inconsistent or inflated program expense ratios
  • Lack of reported fundraising expenses when contributions are received

 

Debt Concerns

  • Growing payroll tax and retirement benefit liabilities
  • Lack of line of credit or maxed out line of credit
  • Inability to meet debt obligations

 

Audit & Compliance Concerns

  • Delayed audits (more than 6 months after year-end)
  • Late Form 990 filings (due 4.5 months after year-end with possible 6-month extension)
  • Frequent auditor changes or incomplete audits
  • Modified audit opinions or going concern warnings
  • Significant audit findings, adjustments, and/or reported material weaknesses or significant deficiencies in internal controls

 

Governance Concerns

  • Infrequent board meetings
  • Conflicts of interest
  • Lack of separation of duties
  • Lack of oversight

 

What To Do When You Spot Red Flags

  1. Ask questions immediately (use professional skepticism)
  2. Investigate thoroughly (review bank reconciliations, budget variances)
  3. Develop mitigation strategies (diversify funding, establish reserves, secure lines of credit, update cash forecasts)
  4. Implement regular financial review processes (that involve the Board Treasurer or members of your finance committee)

Want to learn more about protecting your nonprofit’s financial health? Watch the complete webinar for detailed examples and expert advice on addressing these critical warning signs before they put your nonprofit at risk.

Remember: The board and management team should meet regularly to review financial statements. Create an environment where challenging questions are welcomed, as they often lead to better financial decisions and sustainability.