Lessons learned: the importance of nonprofit internal controls in your accounting system

Developing and maintaining adequate internal controls is essential for your nonprofit’s long-term mission success.

Sufficient internal controls set up clear standards and procedures for efficient operations. Internal controls also help organizations mitigate risk, maintain compliance, prevent fraud, and assure donors of proper financial stewardship.

Fortunately, a cloud-based accounting system can provide essential nonprofit internal controls to help you run your organization with confidence and financial integrity.

This blog post will define nonprofit accounting internal controls and explain six reasons most nonprofits need to improve internal controls.

We will also reveal why using a cloud-based nonprofit accounting solution, such as Sage Intacct, helps organizations tighten internal controls and provide a list of nine internal control functionalities that accounting software should provide.  

Here’s what we’ll cover

What are internal controls?

Nonprofit accounting internal controls consist of the processes and procedures established to ensure the accuracy, reliability, and integrity of a nonprofit’s financial reporting and operations.

These controls help safeguard the organization’s assets, ensure compliance, and prevent and detect errors or fraud.

The best internal controls are preventative controls that deter or prevent errors and fraud from occurring. Segregation of duties and approval workflows are two examples of preventative controls.

However, it is also important to implement detective controls that catch errors or discrepancies soon after they occur so someone can correct them.

Examples of detective controls include reports and reconciliations. Detective controls also instill confidence that preventative controls are working.

There are many types of internal controls, and they generally fall into the following categories:

• Completeness controls ensure that all relevant transactions are captured and processed.
• Existence controls ensure transactions captured are genuine.
• Accuracy controls ensure the correct recording of transactions.
• Valuation controls focus on assets (depreciation) and inventory and the carrying value of transactions (foreign currency).
• Presentation controls ensure financial statements correctly disclose balances.
• Cut-off controls ensure transactions get recorded in the correct accounting period.
• Fraud controls help organizations prevent and detect fraud.

Six reasons nonprofits need to improve internal controls

Effective internal controls in a nonprofit organization ensure:

• accurate and reliable financial reporting necessary for decision-making and external reporting
• promote compliance with regulations and standards
• prevent fraud
• utilize resources efficiently
• build donor and stakeholder trust.

Internal controls develop checks and balances over your operational processes that positively contribute to organizational health and sustainability, allowing you to carry out your mission effectively.

Here are six reasons why the majority of nonprofits need to strengthen and improve their internal controls:

1. Financial integrity

Internal controls help ensure that financial transactions are recorded accurately and financial statements are correct.

This accuracy is essential for internal decision-making, as well as for external reporting to stakeholders, including donors, grantors, and regulatory agencies.

2. Fraud prevention

The most common types of accounting fraud in nonprofits include falsified expenses, embezzlement, and payroll fraud.

Internal controls reduce the risk of fraud and theft by implementing checks and balances that institute multiple layers of financial oversight.

For example, separating duties so one person does not have control over all aspects of a financial transaction helps prevent misuse of funds.

At the same time, approval processes reduce the risk of unauthorized transactions, and regular reconciliations help nonprofits catch fraud early.

3. Compliance

Nonprofits often have to adhere to specific regulatory requirements and standards.

Internal controls strengthen compliance with laws and regulations, including those related to tax-exempt status and grant requirements.

This helps avoid legal issues, fines, and penalties while maintaining good standing with regulatory bodies.

4. Operational efficiency

Controls can streamline operations by setting clear procedures and standards.

With greater standardization comes operational efficiency and improved utilization of resources.

Good internal controls can help ensure funds are allocated and spent in alignment with the organization’s mission and objectives for enhanced operational effectiveness.

5. Donor confidence

Donors and funders want assurance that nonprofits properly manage contributions.

Transparent and well-controlled financial practices build credibility and trust with donors, funders, and other stakeholders.

Internal controls provide assurance and help encourage greater financial support.

6. Risk management

Controls help identify and mitigate risks before they can escalate and impact the organization’s mission and reputation.

Nine internal controls built into leading cloud nonprofit accounting solutions

Critical elements of internal controls include segregation of duties, authorization and approval processes, regular reconciliations, and thorough documentation.

Cloud-based accounting systems offer some crucial advantages for establishing nonprofit internal controls.

First and foremost, a good cloud accounting solution should include built-in internal controls needed by nonprofit organizations.

Additionally, leading cloud providers typically offer robust data security around access control, automated data backups, and disaster recovery.

Cloud-based systems enable real-time access in multiple locations, empowering employees to update transaction information more quickly and giving the accounting team better and faster visibility into what is happening.

Essential internal control features to look for in your cloud accounting software include:

1. Login security

As a most basic internal control, cloud nonprofit accounting software must include a secure login process to protect against unauthorized access.

For example, Sage Intacct includes controls like password expirations, password rules, session timeouts, single sign-on, and IP address restrictions to maintain login security.

2. Multi-factor authentication

Credential theft is the top category of compromised data in global small and medium-sized business (SMB) breaches (Verizon 2021 Data Breach Investigations Report).

Weak passwords and employee mistakes can jeopardize financial security.

Nonprofit accounting software should require users to verify their identity through multiple methods prior to accessing the system.

3. User permissions

Restricting access based on roles will limit specific tasks and sensitive data to authorized individuals only.

Sage Intacct provides nonprofits with user access restrictions that can be defined by role for individual users or defined by department or entity.

4. Audit trails and audit log

Detailed logs of all transactions and changes made within the system provide a clear history for tracking and review.

Track the when, what, and who of every transaction entered, and any subsequent modifications.

In addition to audit trails and an audit log, Sage Intacct allows organizations to give auditors read-only access to locate important data within the system during an audit.

5. Collaborative documentation

Within most nonprofit finance and accounting teams, there is much communication around transactions, approvals, and reporting.

Unfortunately, that communication generally takes place via email, outside the accounting system.

Maintaining these conversations within the system is preferable for internal controls and auditing.

Sage Intacct Collaborate documents all these conversations, raising awareness of issues and solutions for the whole team.

6. Segregation of duties

Implementing controls to ensure that critical functions, such as authorizing transactions and recording them, are handled by different individuals to prevent fraud.

Sage Intacct includes built-in accounts payable transaction approval workflows to ensure segregation of duties.

7. Workflow controls

Cloud-based nonprofit accounting software should include built-in workflows to help organizations establish strong internal controls over critical processes that impact the accuracy of financial statements.

Controls include ensuring completeness of transaction records and making sure the correct paperwork and approvals take place before orders and payments.

Three of the most important workflows to automate include: Procure to Pay, Order to Cash, and Record to Report.

8. Automated reconciliation

The more often nonprofits can reconcile their books, the higher the likelihood of catching mistakes or discrepancies early.

A reconciliation control uses two or more sources of information to validate the completeness, accuracy, and validity of one or both sources of information.

Sage Intacct Bank Feeds securely connect to over 10,000 banks to deliver daily accurate cash insights and automated transaction matching to help nonprofits get closer to a continuous close.

9. Centralized grant records

A lack of internal controls or insufficient recordkeeping can put grants and donations at risk.

Sage Intacct centralizes grant records and reports, tracks funding details, and monitors spending and budget as grants are used.

Sage Intacct Nonprofit Revenue Recognition improves management of conditional grants by automating revenue recognition when milestones are reached.

Final thoughts

Maintaining financial integrity is crucial for nonprofits. Internal controls play a critical role in ensuring accurate recordkeeping and reliable financial statements, which is vital for donor trust and proper fund usage.

These controls also prevent fraud, reducing the risk of theft through checks and balances such as separating duties.

Finally, they help nonprofits comply with specific laws and regulations related to tax-exempt status and grant requirements.

Cloud accounting software has nonprofit internal controls built into the system, with features including secure logins, role-based access, approval processes, and audit trails.

These features make it easier to demonstrate compliance to regulatory agencies and good stewardship to funders.

Learn more about how to establish excellent internal controls when you download the Benefits of Cloud-Based Nonprofit Accounting Software e-book .

About the author

Nancy Master

Nancy Master is a senior nonprofit industry marketing manager at Sage Intacct and is passionate about helping nonprofits achieve mission success.

With more than 15 years of experience in software marketing, Nancy has close to 20 years of experience working with a human services nonprofit organization.