Financial Management
last updated August 31, 2003


Accounting and Auditing

 

A new organization also requires accounting and auditing procedures and policies. Not only might such procedures be required by law, but good financial practices help enhance an organization's legitimacy and ensure the transparency of the organization. Transparency is a critical part of increasing the public's understanding of the role of NGOs and their work which, in turn, is vital to the development of a local donor base.

Accounting, simply stated, involves tracking increases and decreases in cash, and an accounting system is a set of rules followed by the staff to track these changes. As the Internet Nonprofit Center explains, the goal of an accounting system is to ensure that each financial transaction is properly entered into the accounting records (i.e., both actually recorded and recorded under the proper heading), and that financial reports are prepared accurately and on time.

As the Nonprofit Coordinating Committee of New York explains, an accounting system requires "a chart of accounts [to record financial transactions], a general ledger and a bookkeeping system to account for cash receipts and disbursements." A chart of accounts is a list of headings describing different kinds of transactions and generally includes assets, liabilities, fund balances, revenues, and expenses. The categories included in such a chart will depend on the needs of the organization. For example, transactions involving restricted funds should be recorded and balanced separately. The Alliance provides an excellent description and model of a chart of accounts in its list of frequently asked questions.

A general ledger is where transactions are recorded, and bookkeeping is the recording system. Larger organizations do not record transactions directly in the general ledger, but first in a "journal" (such as a disbursement journal, or a cash receipts journal). These transactions are later "posted to" or recorded in a general ledger. Financial statements are then generated from the general ledger. As the Alliance explains in its list of answers to frequently asked questions about financial management, smaller organizations receiving few or no restricted contributions may run all transactions through one account and use something like a checkbook for that account as a combined ledger and journal, rather than keeping both sets of books.

A NGO may be required to file a yearly financial account statement. Such a statement would generally include a balance sheet and an income statement. In some cases, larger organizations may also include a cash flow statement.

A balance sheet shows the financial position of the organization (the organization's assets and debt) at a certain date. When describing their assets, many NGOs distinguish on their balance sheets between "restricted" and "unrestricted" funds. Restricted funds are those that can be used only for specific goals that are designated by the donor of the funds. Each group of assets may be reported in a separate balance sheet or column within the general balance sheet. From Robert A. Connor, Health Care Finance and Financial Management (2000).

The income statement shows revenue (money in) and expenses (money out). A cash flow statement shows the flow of cash in and out of the organization and provides information on sources, use and timing of cash flows that is not usually available in the organization's income statement or balance sheet. From Robert A. Connor, Health Care Finance and Financial Management (2000). This statement differs from an income statement because it tracks the actual cash movement. An income statement, on the other hand, records revenue when it is earned and expenses when they are incurred—and these events may not coincide with the actual movement of cash. For example, revenue might be received before it is earned.

Auditing is a process of testing the accuracy and completeness of an organization's financial statements. An audit is not done to ensure that an organization's transactions are always recorded correctly. As the Alliance explains in its list of answers to frequently asked questions about financial management, an audit is a statement of opinion about whether the organization's financial statements, when taken as a whole, give a fair representation of its financial picture.

An audit may be required by law of every organization, or only of certain organizations. For example, an audit may be required if the organization received above a certain amount in contributions. An audit may be useful to the board in evaluating its oversight of the organization's financial transactions, or to the executive director in evaluating the NGO's financial situation. An audit may provide transparency, or reassure the public that a previous problem has been resolved. Audited financial statements may also provide additional credibility with donors. From Robert A. Connor, Health Care Finance and Financial Management (2000).

Budgeting

A budget is an "systematic plan for the expenditure of a usually fixed resource, such as money or time, during a given period." From Lath Consultants, Budgeting for Societies. A budget can help the organization sustain itself financially, prevent expenditure excess, and plan for future projects or expansion.

Although there are many types of budgets, a good budget should generally help the management of the organization reach financial objectives, give it a detailed picture of how money moves in and out of the organization, allow it to compare expenses and income, help it to forecast income and expenses, and provide it with a way to monitor the organization's progress toward its goals and to make changes as needed. From Lath Consultants, Budgeting for Societies. In designing a budget, it is important to consider previous budgetary trends of the organization and its mission and values. Finally, in designing a budget, it may be useful—both for planning as well as tax purposes—to distinguish between long- and short-term operating expenses. Thus, the overall budget may include one operating budget for equipment purchases and another operating budget for wages and supplies.

Additional Resources

The Nonprofit Management Center provides a useful overview of financial management, as well as a more in-depth discussion of all aspect of non-profit financial management. The Nonprofit Financial Center offers a downloadable sample cash flow spreadsheet and other financial management resources.

The Internet Nonprofit Center provides sample policies for financial accountability and a useful and downloadable sample budget summary. The Worldwide Initiatives for Grantmaker Support provides helpful resources for practitioners on a variety of topics. Its Codes & Standards section offers particularly useful sample best practices and draft codes of ethics and financial accountability.

The Alliance provides an excellent overview of budget preparation in its list of frequently asked questions. Juliana Grenzeback's Converting the Enemy: Budgeting During Planning offers a humorous and succinct description of ways to make budgeting a part of the organization's planning process.

Thomas Raffa and Robert J. Cocchiaro, in Managing Financial Uncertainty, in Nonprofit Quarterly, vol. 9, no. 1, 1 (2002), provide additional information about financial planning in uncertain times.