| Volume 10, Issue 3 | |||
| Main Feature | |||
MAIN FEATURE
Understanding the Financial Responsibilities Of Nonprofit Boards
On the surface, the Enron debacle would not appear to have any lessons for the nonprofit sector. Certainly a publicly-traded for-profit business has very different goals and objectives than a charitable or other nonprofit organization. However, a closer look shows that nonprofit organizations can, indeed, learn much from the Enron situation.
Much of the controversy surrounding Enron involves the governance and financial oversight role played by the company's board of directors and audit committee. With a publicly-traded company, the board represents the ownership, the stockholders, in its oversight role. The "ownership" of a nonprofit organization may be defined differently, since it has no stockholders, but as the recent controversy involving the American Red Cross illustrates, there is certainly an interested "ownership" in most charities and other nonprofit groups.
Boards of nonprofit organizations have numerous responsibilities in serving their governance role. Among these roles are determining an organization's mission and establishing policies in support of that mission, ensuring effective long-term planning, protecting and managing organizational resources, monitoring of programs and activities, enhancing the organization's public image, and assessing organizational performance. Intertwined among several of these responsibilities is the role of financial oversight.
Given the diversity and complexity of these responsibilities, as well as the size of some boards, it usually makes sense for boards of directors to delegate the details of certain of these responsibilities to committees comprised of board members. Typical committee size is between three and five members, although larger committees can sometimes work just as well. The primary purpose of board committees is to tackle the details of an issue or area that would otherwise be too cumbersome or time-consuming for the entire board to deal with in the appropriate level of detail. The committee then makes recommendations for actions that are voted on by the full board.
Many nonprofit boards attempt to handle all board responsibilities with the entire board of directors. This is simply not possible in most instances. There just isn't enough time during regular board meetings to engage in the types of detailed discussions that are necessary to fulfill the board's responsibilities in each area. Delegating responsibilities to committees provides for board-level involvement at an appropriate level of detail.
The exact committee structure can vary greatly from one nonprofit to another. However, some of the typical committees of nonprofit organizations include an executive committee, a finance committee, an audit committee, one or more program committees, and a development or fund-raising committee. Other committees frequently encountered address personnel, nominations, investments, building or facilities, strategic planning committees, and public or government affairs.
With Enron, much of the controversy involves whether the audit committee did an adequate job of financial oversight. With nonprofit organizations, a similar role must be fulfilled by a board-level committee. Whether these responsibilities are carried out by an "audit committee" or by another committee is not important. What is important is that formal responsibility for financial oversight be assigned to a committee, not the full board, so that this function can be addressed in sufficient detail.
But just what are the responsibilities of an audit committee? BoardSource, formerly the National Center for Nonprofit Boards, identifies four broad categories of responsibilities of an organization's audit committee:
- Financial reporting
- Internal controls
- Standards of conduct
- Financial management
Financial reporting responsibilities are those most closely associated with the annual audit. The audit committee should select an external CPA firm, understand and approve the audited financial statements, ensure compliance with donor and grantor reporting requirements, and ensure that all tax and information reporting requirements are complied with.
In the area of internal controls, an audit committee should have an adequate understanding of internal controls to ensure that those controls are adequate to protect the assets of the organization. The audit committee should communicate with the external auditors at least annually in order to address any concerns about controls and to understand auditor recommendations for improvements in internal controls.
Ethics, employee behavior, and standards of conduct are other areas in which the audit committee can serve a key role. Written codes of conduct, conflict-of-interest policies, and fraud policies do not necessarily prevent any inappropriate behavior. But, board-level involvement in the development and monitoring of these policies establishes behavioral expectations and a strong control environment.
The audit committee should have authority to investigate any reports of inappropriate or illegal behavior, fraud, or violations of codes of conduct. This authority should extend to investigations of employees and board members alike.
Audit committees may also be involved in other aspects of financial management. The level of involvement varies based on the number of other committees with financial responsibilities (i.e. budgeting, investments, etc.). No committee should ever "manage" an organization. Boards and committees must limit their role to a monitoring and oversight function and leave the day-to-day management to the hired managers. However, it is critical that each of the financial responsibilities described here is adequately monitored by a committee.