How to Audit a Small Nonprofit Organization

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Published:

April 29, 2023

Last Updated:

May 3, 2023

Audits help ensure that an organization is operating in an efficient and compliant manner and they can help identify areas where improvements may be needed.

Auditing a nonprofit organization may seem like a daunting task, but it doesn't have to be. In this article, we'll explain how to audit a small nonprofit organization—from choosing an auditor to preparing and compiling key financial documents. We'll also discuss how to analyze the data collected during an audit and provide some tips for ensuring your audit is successful.

Let’s get started.

What Is a Nonprofit Audit

Question

A nonprofit audit is a review of a nonprofit organization's financial records and internal control systems.

The purpose of such an audit is to ensure that the organization is in compliance with applicable laws, regulations, and accepted accounting principles.

Since nonprofits are tax-exempt, the IRS doesn't actually require audits of them like they do for-profit businesses—but that definitely doesn't mean your organization should skip out on an audit. Many state and government agencies do require regular audits. And in some cases, grant funders will also want to see an audit of your nonprofit’s financials before giving to your organization.

However, how often these audits are necessary will depend on factors like the size of your organization and the scope of your spending. Some nonprofit organizations even specify how often they should be conducting audits in their bylaws.

An external nonprofit auditor usually conducts the audit, which might include thoroughly examining your organization's financial statements and related documentation, interviewing management personnel, and assessing internal control systems.

There are different types of audits for nonprofits, which we will cover in more detail later on in this article. However, the most common type of audit for a nonprofit organization is a financial audit.

Financial audits focus on the accuracy and completeness of an organization’s financial statements. Financial audits help determine how well an organization is abiding by accepted accounting principles and can also provide a comprehensive picture of an organization’s financial health in general.

These types of audits also provide assurance to donors and other stakeholders that their funds are being used appropriately and in accordance with the organization's mission.

Importance of Nonprofit Audits

Audit

Audits are a critical tool for nonprofit organizations for a number of reasons.

Not only can audits help ensure that the organization is being managed responsibly and in accordance with its mission, audits also provide assurance to a nonprofit’s various stakeholders, including donors, funders, volunteers, board members, and more.

Here are a few of the most common benefits of conducting an audit for your nonprofit:

  • Audits can confirm that the organization’s financial statements are accurate and that the nonprofit is in good financial health.
  • Audits can provide assurance that the organization is in compliance with applicable laws and regulations.
  • Audits can Identify critical errors or irregularities that need to be addressed and fixed.
  • Audits can instill confidence in donors and funders that their investments are being managed responsibly.
  • Audits can help catch mistakes before they spiral into larger problems.
  • Audits can help keep nonprofit staff members accountable because they expect an annual or semi-annual audit.

Not conducting an audit can be detrimental for a nonprofit organization, as they risk not meeting important regulations or requirements which can lead to fines, penalties, and other sanctions.

In general, it’s best practice for nonprofits to perform regular audits so that they can identify areas of risk or potential noncompliance, improve operations, and strengthen financial oversight. In addition, an audit is also a great way to demonstrate transparency and accountability to donors, stakeholders, and other interested parties.

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What Are the Steps in Auditing a Small Nonprofit Organization

Process

Auditing a small nonprofit organization requires planning and preparation. The entire process, from selecting a nonprofit auditor to implementing the audit's findings, can take anywhere between 8-20 weeks.

Here are some steps you can follow to audit your nonprofit organization:

1. Select an auditor

The first step to auditing a small nonprofit is to select the auditor that is right for your organization. The auditor should be independent and have the necessary qualifications for conducting such an audit.

During your search for an auditor, ask your top contenders for a request for proposal (RFP). An RFP should include the types of services they offer, fees associated with their services, and the timeline for the audit.

Additionally, it's a good idea to work with auditors who specialize in the nonprofit industry. These folks understand the intricate “ins and outs” of a 501c3 organization.

Once you review the RFPs from your varying choices, select an auditor that best meets your needs.

2. Sign an Engagement Letter

Generally, the auditor will be responsible for providing an Engagement Letter. An Engagement Letter outlines the terms of the audit, including the nonprofit audit cost and timeline.

Audits can cost anywhere from a few thousand for a small nonprofit to $20,000 for larger foundations.

3. Begin the audit prep work

Once the Engagement Letter is signed, you'll need to do some preparation before your audit can begin.

Auditors will generally send a PCB (Pull by Client) list of additional documents and information they will need to complete the audit. Items an auditor may ask you to prepare could include financial statements, bank reconciliations, payroll documents, details of any grants received, etc.

Before you provide this information to your auditor, ensure the following has been completed:

  • All bank accounts have been reconciled
  • You've reviewed any uncleared transactions
  • Ensure none of your vendors have negative or zero balances
  • Check for any outstanding payments from your members/patrons, etc.
  • Deposit any large funds
  • Double-check statements and records for coding errors
  • Review capitalization
  • Take a look that your account balances are up-to-date
  • Review all of your accounts receivable and payable

4. Conduct the audit

Once the auditor has all of the necessary documents and information, they will start to conduct the audit. This process might involve reviewing your financial statements, interviewing staff members and key stakeholders, examining internal controls, and assessing risk areas in your organization.

Auditors will provide nonprofits with a report outlining the audit results. Nonprofits should review this report carefully and make sure all discrepancies or issues highlighted by the auditor have been addressed properly.

5. Implement the findings

After you've reviewed the audit report, it's time to implement any changes or improvements that have been suggested. This could involve updating your policies and procedures, increasing internal controls, or instituting new processes.

By taking the necessary steps for auditing a small nonprofit organization, nonprofits can ensure compliance with applicable laws and regulations, reduce the risk of fraud or other financial irregularities, and improve their overall financial health.

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Areas of Focus in Auditing a Small Nonprofit Organization

Eyes

There are five types of audits for nonprofits. The type of audit your organization conducts will depend on the size and complexity of your nonprofit and its specific needs.

Here’s a quick outline of the different kinds of nonprofit audits:

1. External audit

An external audit is conducted by an independent third party. This type of audit is often used to verify the accuracy of financial statements and other documents.

2. Internal audit

Internal audits are conducted by your organization's management team. These types of audits allow the organization to take a step back and determine if there are better ways of doing things than how they're currently being done.

3. Financial audits

This type of audit focuses on the accuracy and completeness of financial statements. Financial audits are often used for tax purposes or to meet requirements for certain grants.

Auditors will review your financial statements and assess the accuracy of their reporting. They will also look for misstatements or irregularities that could indicate fraud or other issues.

4. Compliance audits

Compliance audits review your organization's adherence to regulations and requirements set by the federal, state, and local governing entities as well as your bylaws and other compliance requirements.

Auditors will review any laws and regulations applicable to the nonprofit sector, including tax-exempt status compliance and fundraising restrictions. They may also look into grant compliance or other specific requirements related to your organization.

5. Operational audits

An operational audit assesses your organization's operation systems, productivity, staffing, IT, HR, and other functions to provide insight into why your organization is hitting or missing its goals.

Auditors will also review any operational issues such as processes and procedures, employee management, inventory control, and financial reporting. They may also assess the internal audit process to ensure it is functioning properly.

Wrapping Up: The Next Steps

Audit

Auditing a small nonprofit organization is a necessary process that should not be overlooked. It can help to ensure compliance with laws and regulations, reduce the risk of fraud or other financial irregularities, and improve your overall financial health.

By taking the necessary steps to implement any improvements suggested by the audit report, nonprofits can further the success of their organization and mission.

For more nonprofit management insight and tips, be sure to check out Instrumentl’s blog.

Instrumentl team

Instrumentl team

Instrumentl is the all-in-one grant management tool for nonprofits and consultants who want to find and win more grants without the stress of juggling grant work through disparate tools and sticky notes.

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