An office clerk “borrowing” money from the office petty cash is a classic example of why internal controls are necessary. How easy would it be for an office clerk to “borrow” a few dollars for her morning coffee? What internal controls are in place so that this cannot happen? One answer to this illustration is is to have someone who does not handle petty cash conduct random and monthly audits of the petty cash box and keep records of the cash and receipt amounts. If a large amount of petty cash is kept, it would be an added safeguard to audit petty cash with another person just in case the cash comes up short.
A wise person once said that locks just keep honest people honest. The same is true for internal controls.
A publication by the Virginia Society of Certified Public Accountants explains that good internal controls are essential to:
- Prevent loss through errors, misappropriation of funds, or theft
- Prevent an “honest” employee from making a mistake that can ruin his or her life
- Document the responsibility of the board as it safeguards the assets of the NPO
- Assure that all transactions are properly authorized and recorded
While seemingly time consuming, the simple act of having two people present during the petty cash audit protects both employees and assets – a distinct advantage of using adequate internal controls.
Internal Controls Defined
The National Council of Nonprofits defines internal controls as financial management practices systematically used to prevent misuse and misappropriation of assets, such as occurs through theft or embezzlement. Internal controls protect not just assets but reputations as well. It is critical for nonprofit organizations to maintain the highest integrity and ethical standards in orderto attract and retain funders.
The objective of internal controls is to put “checks and balances” in place to protect the assets of the organization.
What Can Go Wrong
Any discussion of the most important internal controls for nonprofits Should be prefaced by answering the question, , “Just consider what can go wrong.”
I scoured the internet to find examples of what can go wrong with weak or non-existent internal controls. The following stories are true and could happen to you.
Scenario: Cash – MIA (Missing In Action)
Suppose checks are merely kept in the bottom drawer of a file cabinet. An enterprising employee might take a few checks from the bottom of the stack, forge a signature, and cash them, stealing thousands of dollars before being caught.
Internal Control Solution: Secure the checks with keys held by two different financial managers. Ensure that bank reconciliations are performed by staff with no access to deposits or withdrawals. Bank reconciliation should be prepared on a monthly basis, at minimum.
Scenario: Employee Alert
A clever payroll employee adds overtime hours to pay himself or herself at time and-a-half.
Internal Control Solution: Timecards should be signed by managers. A second person compares the payroll totals to signed timecards.
Scenario: Sad but True Fundraiser Fiasco
During a fundraiser, a volunteer handled all aspects of the cash ticket sales, including depositing funds and reconciling the bank statement. Occasionally short on cash, she would borrow funds and then pay them back….until she didn’t pay them back. This well-meaning volunteer “borrowed” around $10,000. The event intended to be financed by the fundraiser had to be cancelled.
Internal Control Solution: Anytime cash is involved, the responsibilities should be divided among several people. At least two people should be present when cash is counted. Separate people should make the deposits and reconcile bank statements.
Internal controls should be clearly documented in a procedural manual and authorized by the board or governing authority of the organization. Discovery of theft or embezzlement and the resulting investigation is hard on the organization internally, and the external damage to the organization’s reputation can cause loss of funding. Additionally, bonding insurance premiums could skyrocket, especially if it could have been prevented by using good internal controls.
Establishing internal controls protects the organization and the board members, officers, and staff. For more comprehensive reading, Abila has created “Internal Controls for Nonprofits: Best Practice Principles, Policies, and Procedures.”
Welter Consulting bridges people and technology together for effective solutions for nonprofit organizations. We offer software and services that can help you with your accounting needs. Please contact Welter Consulting at 206-605-3113 for more information.