Financial risk

Not-for-profit entities are confronted by risks that can threaten their viability. These may be external (e.g. loss of their main funder) or internal (e.g. fraud). Internal controls are organisational checks to reduce the likelihood of errors and fraud. They should be developed to protect staff members who handle cash, financial and other assets of the entity.

Internal controls

Internal controls are checks and balances in the financial system. They provide security for the treasurer, comfort to the board and good practice for managing the organisation’s finances.

It is important that internal controls are clearly documented and well understood.

Internal controls prevent errors from occurring – for example

• matching invoices to cheque payments ensures that payments are valid
• ensuring receipts are prepared for every donation, grant or other income means that total money received can be obtained from the receipt book.

These controls make sure that payments and receipts are dealt with correctly.

Internal controls detect errors that may have occurred – for example

• regular reconciliation of the entity’s bank accounts.

If for example a cheque has been entered incorrectly in the records, a bank reconciliation will highlight this.

When errors do occur, it is also important that they are corrected

Segregation of duties

Possibly the most important internal control is segregating duties (for example – one person orders goods or services and another approves the payment). This involves

• Adequate security around banking of cash – have two people count and document the cash received before banking it.
• Two signatories on each payment – for example, the chairperson and the treasurer.
• Preparation and recording of the financial report and full presentation to the meeting where the information is minuted and formally approved.

In a small not-for-profit entity it is often difficult to segregate duties. When this occurs, it is important to ensure that the treasurer reports financial transactions to the managing committee (preferably before the committee meeting). The managing committee should minute and approve all payments.

The managing committee should ensure that they see a fully reconciled bank balance that provides full information about each transaction at least monthly.

It is important that the controls are set at a level which provides the right balance between security and practicality.

Controls to be considered:

Payments: 

• Record all invoices against an appropriate expenditure item to aid accurate reporting. Make sure that invoices are authorised by a person other than the one making the payment.
• Pay bills by cheques or internet transactions only if an invoice has been received.  In most cases suppliers will provide a copy invoice to assist with record keeping. In the event that there is no supporting invoice it is important to have the particular transaction recorded separately at a meeting and written authority to make the payment should come from the Chairperson.  If the amount is significant you will not be able to claim GST on that payment (refer to GST on tax pages). You should also note that a statement is not sufficient by itself to act as a GST invoice.
• An important internal control is to have two signatories on each payment. This ensures that the payment is being made to the appropriate supplier. It can be tempting to have pre-signed blank cheques available to the treasurer for times when there are not two authorised people available. This is not good practice as it opens up the opportunity for theft, fraud and other misuse of cheques.
• Internet banking can be a speedier way to make payments – particularly when the signatories are not readily accessible. However, it is important that the system requires two authorising codes before payment is made. Authorising passwords should not be shared.

Receipts: 

• Cash and cheques received should be recorded in a receipt book and recorded against an appropriate income item.
• Receipts should be numbered and the date of banking noted.

Cash:  

• Bank cash as soon as possible.
• For security reasons it is not a good idea to accumulate cash at home – nor is it wise to bank cash into an account, other than the entity for which it is intended.
• Do not use cash to pay invoices as this makes an audit trail difficult to follow.
• Cash should be counted by more than one person as soon as possible after collection so that it can be receipted and banked without delay.

Reporting: 

• The treasurer should prepare and present reports at least monthly to the Board
• The report should reconcile all transactions to the main bank balance and take account of the purpose for payment or receipt. 
• This report should be formally adopted and included in the minutes of the meeting as part of the formal record keeping. 
• These reports can supply ready information to the person in charge of applying for grants.

Payroll: 

• Payroll can be a significant element in a not-for-profit entity.
• It is critical for internal controls, tax and employee security that good systems are in place to manage payroll transactions. 

Whatever payroll system is used (manual or electronic) the following controls should be in place:

• Employee agreements which record the amount and type of work that is being paid for should be signed by both employee and employer.
• Where appropriate timesheets should be completed by the employee and approved by the manager of that person. 
• The person preparing the financial transaction is normally the treasurer – not the person approving the timesheet.  Payroll transactions should be prepared and recorded and reconciled to individual timesheets prior to any payment.  
• Prior to payment, ensure that each payroll payment has been approved (and keep the documents on file)
• Withholding payments or honorariums generally require Resident Withholding Tax (link to tax) to be deducted and are part of the payroll transactions. 
• PAYE and Resident Withholding Tax (both link to tax) payments should be calculated and approved and paid in a timely manner to avoid penalties and potential audit complications.

An information sheet on employment topics can be ordered from the North Shore Community and Social Services site