6 Specific Financial Pitfalls that all Nonprofits Should Avoid

Whenever I hear Nonprofit, I think of men and women with angelic faces, wearing white clothes and big smiles (with an imaginary halo over their heads), doing humanitarian work with no need or want for any reward in return. Especially monetary rewards.

Well, sorry to burst the bubble, but the myths are untrue.

Even though Nonprofits don’t put their focus on turning a profit, it still doesn’t mean they have no use for money, or they don’t handle huge amounts of money at times. Also, the conception that volunteers and staff members of Nonprofit firms are entirely reliable and honest, can be no further from the truth.  Nonprofits account for 10.1% of all frauds (ACFE 2016 RTTN), because they ignore these 6 specific pitfalls that make them particularly susceptible.

The Shortage of Everything

Except major, globally organized Nonprofits, most nonprofits function akin to small businesses. They’re small setups, with usually a dearth of volunteers or resources or infrastructure, and oftentimes all three.  In the United stated alone, about 75% of nonprofits of the registered ~1million, have annual expenses of less than 500,000. This simply means, they do not spend enough on the resources or infrastructure necessary to mitigate the risk of fraud in their accounting and finances. Smaller nonprofits often lack the funding to even have extra resources to facilitate segregation of duties. Although this is a tough nut to crack, it’s one of the most fundamental pitfalls that nonprofits tend to overlook. The lack of funds becomes a scapegoat excuse for bad management or financial decisions and lookouts.

One person to rule them all

As is the case in several nonprofits, especially the smaller ones, there is very little financial leeway for something as fundamental as segregation of duties. In most cases, it’s the founder or executive director who is the sole decision maker for everything from checks to vendors to resources. This lack of segregation of duties is a catalyst for fraudulent activities in nonprofits. According to ACFE’s 2016 Report, Tenure and level of authority, most often than not, correlate with the magnitude of the fraudulent activity. According to the report, the scale of the fraudulent activity increases several fold, in line with the tenure and level of authority of personnel who commits the fraud. .

The curious case of All-volunteer boards

As opposed to the risk of having one person control all management or financial decision in an nonprofit organization, most nonprofits hire a volunteer board of directors, who are financially literate. Although all board members need to know how to read and understand financial statements in order to help take sound financial decisions, and avoid fraud, in most cases, these members lack the experience to do this. In other cases, the priorities of the nonprofit organization are more aligned towards fundraising and may completely overlook the need to look at fraudulent activities; In such cases, the roles defined for these board members are limited and do not include financial oversight as a necessary responsibility.

The Confidentiality Report

Another important risk factor in nonprofit organizations is that all financial data is completely out in the open for even volunteers to see. In many nonprofit organizations, in a motion to encourage segregation of duties, volunteers are asked to step up to work on several different task that may have high visibility to the financials. Volunteers may get involved in high risk financial tasks such as collecting donations, rental fees, and other payments. In cases where nonprofit organizations neither have the time or the resources to have the volunteers vetted thoroughly, the risk of potential fraudsters or repeat offenders is increased.

The ugly truth

In the donor – an organization’s partnership with a smaller nonprofit, the transaction is fairly straightforward. But this opens the door to a lot of risk. When a donation is made, a donor

simply receives a letter of thanks and acknowledgement. And since smaller nonprofit organizations encourage cash donations more than any other digital financial platform, there is no way to actually track the money. With no paper trail, it becomes increasingly easy to divert or siphon off huge sums of money.

Reputation like Glass

For most nonprofit organizations, it’s the factor of trust that keeps the donations coming. At no level can a nonprofit organization allow bad reputation and expect to live beyond it. This is especially true for smaller nonprofits. In a ACFE study, released in 2016, it is hypothesised that about 40% of fraud cases committed in nonprofit related cases, were never reported to the authorities, for the fear of negative publicity for the afflicted organization. For many small nonprofits, such negative reputation could spell disaster, and could potentially sink the organization. This factor impacts two different things that, at the end of the day, simply spur more opportunities for fraud than anything else: The board of directors, or executive members of the organization refuse to report any kind of fraudulent activity; Fraudsters, whether they be first time offenders or repeat offenders, find it easy to commit a crime and leave with zero consequences. This becomes such an easy circumstance for any criminal or individual with a maleficent predisposition to indulge in. And because of the fact that most volunteers are recruited with little to no background verification, there is no way to know who is who.

Above all, the most basic problem is the myth of goodness that hangs over the nonprofit world– it blinds the eyes of decision makers and authorities to the fraudulent activities that may be happening at these firms. So stop thinking of all nonprofit organizations in a fairy tale dream worlds, and start looking at the hard numbers.

A brilliant option to avoid these pitfalls is to let a robust financial accounting software built for nonprofit organizations to handle the nuances of your business, so you can avoid fraud, and may be start  growing that halo over your head.

Sounds good?