The beginner's guide to nonprofit audits

The word "audit" may evoke images of IRS agents swarming your office, but the reality for most nonprofits is much less frightening. In this article, we’ll walk you through the basics of nonprofit audits, plus six insights that every organization should know about the auditing process. 

What is a nonprofit audit?

A nonprofit audit is a formal assessment of an organization’s financial health, legal compliance, and various risk factors. Several types of audits for nonprofits may be conducted to analyze an organization’s compliance with state and federal tax laws, adherence to standard accounting policies, and the accuracy of its financial statements. 

Usually carried out by a third party, such as a certified public accountant (CPA), these evaluations determine whether an organization should continue operating as it has, make specific changes to its operations, or incur penalties.

Why do nonprofits get audited?

With nearly two million nonprofits in the US alone, how do we ensure that they are operating legally, efficiently, and ethically? 

While for-profit companies are much more likely to face extensive IRS audits, nonprofits are still accountable for their financial conduct, especially due to their tax-exempt status. Because donors can write off unlimited contributions, guardrails (including audits) are set up to make sure nonprofits aren’t misusing funds or engaging in any other funny business.

3 types of nonprofit audits

Audits for nonprofits come in many forms. What kind of audit an organization will have to undergo at a given time and what the auditing process entails is based on several factors, including state laws, annual revenue, and the particular grantmaking policies of private foundations and government institutions.

Let’s explore the most common audits nonprofits will come across. 

1. Financial audits 🔬

A financial audit establishes whether an organization's financial records are up-to-date and accurate. It is usually performed as an external, independent audit by a third party, such as a CPA or a public accounting firm. 

Many states require annual nonprofit finance audits for organizations with large budgets or as part of the tax-exempt registration process in their state. Groups receiving federal funding or grants from private foundations may also need to do an annual external audit. 

Some financial audits take the form of less arduous compliance checks. The IRS audit process, for example, usually doesn’t entail a full field audit but rather a request for audited financial statements in addition to your annual Form 990 submission.

Contact your local nonprofit association for the full list of your state's nonprofit audit requirements. 

2. Compliance audits 🔍

While financial audits specifically examine a nonprofit’s financial situation, compliance audits assess its adherence to specific laws and regulations—both on a state and federal level. 

When conducting this type of evaluation, auditors check that the organization is complying with nonprofit accounting standards, regulations specific to the nonprofit sector, and broader legal requirements. CPAs and accounting firms can often provide this service for nonprofits in addition to financial audits.

3. Internal audits 🧘

Nonprofits can also decide to perform internal audits, which may be handled by the organization’s leadership, board, or special audit committee. Internal, operational audits can focus on any aspect of the organization, from financial and HR policies and practices to marketing or IT procedures—even the internal audit process itself.

The goal of internal audits is to examine how the organization is run and determine whether any of its operations should be improved, streamlined, or modified. They verify that the organization is being managed most effectively and efficiently to reach its goals while, of course, always complying with rules and regulations.

6 key things to know about nonprofit audits

Now that we’ve established the basics of nonprofit audits and the main types of audits that can be performed, it’s time to explore some deeper insights into these all-important processes.

1. Nonprofit audits align finances with mission 🤝

Just as a nonprofit funding strategy must be aligned with an organization’s mission, audits help ensure that financial practices are in keeping with its purpose, goals, and vision. 

For example, if your nonprofit often organizes fundraising events, you should be keeping track of all the financial impact that these have on your overall operations. How much did it cost to run the event? Where was the money sourced from? Did the event have a specific goal that aligns with the organization’s mission?

A comprehensive financial software stack can help you keep your finger on the pulse of all these questions. It will also make auditing much easier, as you have all the information you need stored and easily accessible.

2. Compliance understanding is crucial for smooth operations 😎

Running a nonprofit requires familiarity with specific rules and regulations regarding compliance, which can vary greatly compared to profit-based companies.

Whether you’re just starting a nonprofit or you’ve been running one for a long time, audits are helpful not only to identify potential concerns and provide solutions to inefficiencies but also as a valuable tool to help the entire team better understand crucial aspects such as financial and legal compliance.

3. Accurate expense documentation prevents audit concerns ✅

Running an efficient and productive nonprofit requires monitoring finances closely. Expenses can prove tricky to track and justify, so having the right accounting software in place is crucial. Digital tools can help simplify, streamline, and automate all major financial tasks, not to mention they are a lifesaver when it comes to cutting time and costs. 

When discussing expenses, it’s vital not to overlook one aspect: employee expenses. Whether you send your staff out on the field to conduct research or if your employees regularly attend events, workshops, or conferences, you’ll want to ensure their expenses are accounted for. 

Using employee scheduling software can give you an up-to-date, on-the-fly view of anything from shift times to employee leaves and absences, providing you with one extra tool to manage employee-related expenses better.

4. Audit findings can be used to improve systems and processes 🌟

As we mentioned earlier, operational audits look at how a nonprofit is run by examining its systems and processes in detail. Through this process, nonprofits can spot any issues, boost efficiency, improve their operations, and comply with other sector requirements.

Tools beyond the usual financial and legal software can be invaluable at this juncture. HR software can help you assess how your employees and volunteers are faring, spot signs of burnout, plan training, and set new goals. These tools can be essential to the longevity of a non-profit, as staff enthusiasm and well-being often play such a key role. 

5. Safeguard donor and public trust with transparent reporting 💛

Donations are the lifeblood of nonprofits. But what happens if there’s no clarity or transparency around how donations and funding work for a nonprofit and how that money is used? 

Conducting regular nonprofit audits, particularly financial ones, can help. These strengthen the organization's reliability, credibility, and legitimacy, boosting trust and confidence in donors, investors, and other stakeholders.

6. Identify risks impacting nonprofit sustainability 🔍

Keeping a nonprofit up and running is no easy feat. Without consistent donations and support from staff and volunteers, even organizations supporting the most noble causes can be forced to close their doors.

Conducting frequent audits, primarily financial and operational ones, can help identify any potential risk that may impact the smooth running of the organization and its sustainability in the long term. These audits should focus on spotting potential fraud, financial issues, and inefficiencies while offering suggestions for improving moving forward.

Drive efficiency and compliance through audits

Running an impactful nonprofit that makes a tangible difference in the world relies heavily on ensuring its financial, legal, and operational areas are as compliant and efficient as possible. To achieve this level of understanding, nonprofit audits should conduct regular audits. 

Through audits, nonprofit organizations can spot anything from inaccuracies in financial reporting to the risk of fraud and pinpoint specific processes and operations that might prove problematic or inefficient. 

To be as prepared for the process as possible, the right software can help you stay on top of your expenses, HR needs, donations, and more. You’ve got this!