The success of a nonprofit organization is dependent on its workforce and the governing body and structure it assembles to accomplish its mission.
Achieving organizational alignment is critical to the success of the organization; the various elements of the organizational structure need to operate efficiently and effectively. The passage of the Sarbanes‐Oxley Act in 2002 has revolutionized governance and internal controls in the business world, and its effects are rapidly being integrated by many nonprofits into their processes. Nonprofit organizations provide unique challenges in this area. In the story that unfolded after the Washington, DC, United Way scandal and forced resignation of the chief executive officer (CEO)/executive director (ED), a task force was convened with the charge to “help formulate a code of ethics and a set of financial and other business procedures that reflect best practices among not‐for‐profit organizations.”1 Key attributes for nonprofits surfaced: ethics, governance, transparency, and the constant building of trust. An important enabler of each of these is your organization's financial structure. Recently, Grant Thornton diagnosed nonprofit governance practices and highlighted a culture of ethics as a primary driver of organizational success and sustainability.2 In this chapter we build an understanding of governance and the board, accountability and how it may be fostered, organizational structure with a special focus on the chief financial officer (CFO), and ethics.
(a) ELEMENTS OF THE FINANCIAL STRUCTURE. In order to be useful, the financial structure of both nonprofit and for‐profit organizations must reflect the nature and needs of the organization. It consists of these components, some of which are accounting issues and others of which we cover in other sections of this volume:
Organizational structure is established to support (see the next section)
Financial component of the organizational structure
Chart of accounts created to record financial transactions
Financial plan
Fundraising plan
Cash‐flow plan
Systems to support the processing of financial transactions and internal controls
Financial reporting system
Distribution system for financial reports
System for producing all financial and management reports
System for reviewing financial results
Communication of roles, responsibilities, and accountabilities related to the financial activity
System for evaluating and adjusting the system to coincide with organizational goals and objectives
External reporting and relations
(i) Importance of Financial Structure. Financial resources allow organizations to accomplish their missions and achieve their goals. They are needed to raise funds, hire and reward people, acquire property and equipment, and cover many types of expenses incurred in pursuit of the organization's mission.
Resources can be maximized by planning, recording, and reporting the financial activities, financial position, and cash flows in a manner that is meaningful and useful to the organization. Technical expertise as well as managerial and communication skills are required to design a financial system which serves all the organization's constituents.
(ii) Development of Financial Structure. The board of directors of a nonprofit organization is responsible for ensuring that its financial structure is appropriate and meets the organization's needs. Generally, the board treasurer or chief financial officer (CFO) develops a proposed structure and presents it to the board for review and approval. After this occurs, the financial structure is periodically reviewed to ensure its continued ability to meet the internal and external requirements of the organization. It is the responsibility of the board to ensure that these periodic reviews are conducted.
(iii) Financial Structure Soundness. A financial structure is sound when it serves the needs of all internal and external constituents of the organization, including primarily the following:
Board of directors
Program directors
Fund managers
Staff
Volunteers
Grant agencies
Donors
Internal Revenue Service
Banks and Bondholders
Auditors
Investment service providers
Suppliers
Independent contractors
Academic institutions and consultants that study and advise nonprofit organizations
(b) INTERNAL CONTROLS. Internal control is defined as “a process effected by [a nonprofit's] board of directors, management, and other personnel, designed to provide reasonable assurance regarding the achievement of objectives relating to operations, reporting, and compliance.”3 It is essential for the financial structure of the nonprofit organization to be safeguarded by a system of internal controls, which requires the delegation of roles and responsibilities in such a way that no one person has control over more than one function. This segregation of duties is a central tenet of internal controls. Internal control as a system goes beyond fraud prevention, however. Pertinent to financial managers is the risk assessment component. The Committee of Sponsoring Organizations of the Treadway Commission (jointly sponsored and funded by three professional accountants' associations, an auditor association, and Financial Executives International) explains:4
Businesses and nonprofits are now broadening their score to view internal control within the parameters of enterprise risk management (ERM). ERM's perspectives include “strategy‐setting, governance, communicating with stakeholders, and measuring performance. Its principles apply at all levels of the organization and across all functions.”5 We return to this important topic in Chapters 5, 10, and 14.
(c) FINANCIAL POLICY. Every nonprofit organization that raises and expends financial resources should have written financial policies readily available to those who carry out roles and responsibilities on behalf of the organization and its mission. These policies are determined by the board of directors or its designee and are statements of the nonprofit organization's requirements in the financial areas of managing cash, investing, fundraising, budgeting, expending funds, arranging for and discharging debt, and reporting financial results. Related policies should also include, at a minimum, document retention, whistleblower, and conflict of interest policies. We detail the types and nature of these policies in Chapter 5.
(d) FINANCIAL PROCEDURES. The financial structure of the nonprofit organization should be supported by written financial procedures (sometimes called standard operating procedures) that provide detailed descriptions of how financial transactions are to be processed to ensure compliance with the organization's financial policy. Examples are documented procedures for handling cash, making deposits, managing funds, and developing budgets.
Financial procedures provide information on what is required to process various types of financial transactions successfully within the financial structure and system of the specific nonprofit organization. They contribute to the ongoing integrity of financial data and reports and ensure the correct processing of financial transactions with existing and/or new staff, volunteers, boards, committees, and other constituents. They provide detailed information in order to orient new staff members and assure that knowledge transfer takes place in the event of staff turnover. We shall deal with these in later chapters.
4.2 ORGANIZATIONAL STRUCTURE AND GOVERNANCE
One person should be placed in charge of the financial health and integrity of a nonprofit organization. However, financial responsibility is ultimately shared by everyone in the organization with decision‐making responsibilities: the board of directors/trustees, councils and committees, ED/CEO, CFO, and other managerial and program staff. This is what we referred to in Chapter 3 as financial leadership, where knowledge and responsibilities are distributed throughout the organization. According to IRS laws governing nonprofit organizations, any of the above‐mentioned persons can be held liable for financial errors as long as there is sufficient evidence to presume that they should have known about the errors and could have acted to avoid them. It is therefore important to have a clear definition of responsibilities for different roles in the organization, with an accompanying set of checks and balances (part of the organization's internal controls) and detailed written policies and procedures. The topics of this chapter – organizational structure and governance, the finance function, financial and accountability structures, and ethics – will help to ensure an organizational focus on accountability, ethical conduct, and trust building, while enabling the nonprofit to carry out its financial management in an effective and efficient manner.
Vulnerability to fraud is an issue that motivates the importance of governance, structure, accountability, and ethics. Nonprofits are especially vulnerable to employee‐perpetrated fraud because of these six characteristics:
An environment of trust, implying that the guard may be down
Large degrees of control by a founder, CEO/ED, or substantial donor
Failure to include individuals with financial oversight expertise on the board of directors/trustees
Nonreciprocal transactions (contributions) that are easier to steal than other forms of income because when fraudulent they are more difficult to detect
Failure to devote sufficient resources to financial management
Program and financial reports, particularly with respect to government grants, may determine job security and possibly even compensation6
We shall develop fraud issues more completely in Chapter 10, but note that items 2, 3, and 5 each bear on governance and organizational structure issues. Governance is the set of responsibilities that ensures accountability, achieves legitimacy with all key internal and external constituencies, and establishes the mission as well as sustains the organizational well‐being necessary to pursue that mission.7 We provide a brief glossary of governance terminology in Exhibit 4.1. The central players in governance are the members of the board.
(a) BOARD OF TRUSTEES/DIRECTORS. The board of trustees/directors of a nonprofit organization determines the mission and sets the parameters under which the organization operates. The board's major areas of responsibility are
Determine the organization's mission and establish policies for its operation, ensuring that its charter and bylaws are written and being followed (see Appendix 4A for more on bylaws)
Develop the organization's overall program on an annual basis and engage in long‐range and strategic planning to establish its future course
Establish financial policies and procedures, and set budgets and financial controls
Provide adequate resources for the activities of the organization through oversight of the revenue portfolio, direct financial contributions, and a commitment to fundraising
Select, evaluate, establish compensation for, and if necessary, terminate the CEO
Develop and maintain a communication link to the community, promoting the work of the organization
The board of trustees/directors must keep the nonprofit organization focused on its mission. Board members do not ordinarily participate in day‐to‐day operational decisions – although the board's level of participation has changed slightly since 2002 when Sarbanes‐Oxley (SOX) was enacted – but they approve operating budgets and may assess the productivity of the operational managers. Increasingly, nonprofit organizations are voluntarily adopting the provisions of SOX.8 Ordinarily, board members receive no compensation (except for private foundation board members), whereas operational managers are usually on the payroll of the organization.
Yesterday's board practices and today's best practices in a Sarbanes‐Oxley world are quite different. Orientation regarding financial documents and the strategic plan, importance of the financial viability of the organization, ability to read and analyze financial statements, the unethical nature of conflicts of interest, and the increased importance of an audit or financial review conducted by a CPA firm are key differences. Consult Exhibit 4.2 for more on these differences and how they can usher in an improved culture in your organization. Today's regulatory environment, in which fines and penalties for self‐dealing appear to be increasing and the IRS is honing in on certain other violations by private foundations, as well as excess benefit transactions by public charities, makes these issues even more pressing. Compliance with ethical standards is now an implied requirement on the Form 990 where questions about conflict of interest policies as well as whistle‐blower protections are attested to. What was a series of best practices has now become enshrined in publicly‐available reports. We recommend that your organization's ED/CEO, board executive committee, and board finance committee self‐evaluate your board's practices using Exhibit 4.2 once every three years. Then, a summary report should be presented while in executive session to the full board.9
Source:Exhibit 6.1, pages 90–91, of Peggy M. Jackson and Toni E. Fogarty, Sarbanes Oxley for Nonprofits: A Guide for Building Competitive Advantage (Hoboken, NJ: Wiley, 2005). Used by permission.
Exhibit 4.2 Best Board Practices in a Sarbanes‐Oxley Environment
Since the board of trustees/directors can be held responsible for the operations of the nonprofit, it is vital for each member to fully understand the oversight role and for the organization to protect all members through the purchase of board liability insurance. We discuss liability management in greater detail in Chapter 10 and insurance more fully in Chapter 14.
(i) Choosing Trustees/Directors. It is critical for nonprofit organizations to choose trustees who have the experience, skills, and knowledge base needed for the board to carry out its fiduciary and programmatic responsibilities. The board, as a whole, must work well together and demonstrate strengths in these areas:
Vision
Strategic thinking and planning
Program high‐level decisions
Oversight of but not intrusion into day‐to‐day operations
Organizational development
Fundraising
Financial management
Accounting and auditing
Human resources management
Legal and risk management issues related to nonprofits, contracts, human resources
Conflict‐of‐interest avoidance
Public relations
Community representation
Organizational dynamics and development
(ii) Board Financial Responsibility and Liability. Accountability is an important concept for members of nonprofit boards of trustees to understand, and they should be well informed about the full extent of the liability, both personal and organizational, resulting from their service. Since accountability laws vary from state to state, legal advice should be sought by all boards of trustees to ensure that they have the correct information for their organization in their particular state. Nine general guidelines follow.
The standards established for the conduct of trustees (board of directors members) of nonprofit organizations are found in corporate law rather than trust law and are therefore less strict than those governing other types of trustees. Because nonprofit boards do not have the wide range of delegation powers and outside resources found on corporate boards, they are required to exhibit “prudent man” behavior in carrying out their responsibilities and are only liable for gross negligence.
Trustees are not likely to be held liable for business or financial decisions, provided they are made through informed judgments. However, they can be found liable if they never attend meetings, approve financial or business transactions with no background information, or engage in illegal financial or business activity.
Liability claims can be filed against trustees who place their personal financial interest above that of the nonprofit corporation, use corporate property for personal gain, take advantage of a financial opportunity at the expense of the nonprofit corporation, or self‐deal without appropriate disclosure.
Trustees are liable for ensuring that the corporation is carrying out its mission, as documented by federal and state law. Trustees are accountable for ensuring that donors' funds are used for the purposes of the organization, as prescribed by the donors.
Liability for ensuring that their nonprofit organizations comply with the rules and regulations set by federal, state, and local governments that have jurisdiction over them rests with the board of trustees. These organizations must file tax returns with the IRS and applicable state agencies. Fulfilling legal requirements as an employer, including the payment of payroll taxes for the organization's employees, is the ultimate responsibility of the board of trustees.
The financial health of a nonprofit organization also rests with its board of trustees, but it can best be achieved when all stakeholders are assigned some segment of responsibility and accountability. The trustees fulfill this obligation within the context of their broader set of responsibilities, noted earlier in this chapter.
Trustees should avoid these types of activities:
Engage in the day‐to‐day operations of the organization.
Hire staff other than the ED/CEO.
Make detailed programmatic or financial decisions without staff consultation.
The financial plan of an organization must be properly aligned with the organizational structure and program needs in order to be meaningful and useful. Since all organizations require resources to operate, it is critical for the financial development, implementation, monitoring, and reporting activities to involve the program stakeholders.
In the process of addressing its financial responsibilities to the nonprofit organization, the board should pursue these tasks:
Create a vision.
Raise funds.
Communicate.
Set policy and include the rationale.
Assign responsibility.
Establish a budget.
Project cash flow.
Monitor and amend the budget.
Review financial statements.
Report results.
Watch the trends.
Develop long‐range plans.
Evaluate results.
Ensure internal control.
Develop and monitor key performance indicators.
The board's financial responsibilities should be taken seriously. New York's assistant attorney general notes that the “duty of care requires that trustees, directors and offices… be attentive to the organization's activities and finances and actively oversee the way in which its assets are managed…This includes…insuring that funds are properly managed, asking questions, and exercising sound judgment.”10 Board members have a fiduciary responsibility for the organization's finances. This means that board members remain objective, responsible, honest, trustworthy, and efficient. Board members need not be experts in financial management but it is essential that they be “financial inquisitors.”11 They are required by law to exercise financial leadership.
(b) OFFICERS OF THE NONPROFIT ORGANIZATION. State laws vary, but they generally require a nonprofit organization's board of trustees to have at least three officers: a chair (or president), a treasurer (or chief financial officer), and a secretary. Some organizations include additional officers. The number of officers and their titles, powers, and duties are spelled out in the bylaws (see Appendix 4A for an example), along with the timetable and process by which officers are elected.
The selection of the right individuals to serve on the board of a nonprofit organization is a critical task. Only the most qualified persons should be considered for officer positions, with no one appointed on an honorary basis.
(i) President/Chair of the Board. The president/chair of a nonprofit board should be a person of authority who is respected by the other board members, the organization, the staff, and the community and who has the time and other resources needed to complete the required work. Ordinarily, the president has previously served in several other board positions and is familiar with and informed about the mission and operation of the organization.
(ii) Treasurer/Chief Financial Officer. The treasurer must be a person with financial experience related to the operation of nonprofit organizations. Accountants and business professionals are generally preferred for these jobs; however, many lack experience with nonprofits and may not be sensitive to the special needs and characteristics of financial management in this sector. It is most advantageous for these organizations to find a treasurer with nonprofit experience. Also, many accountants are lacking in training in cash and treasury management topics, due to a deficiency in most accounting curricula in colleges and universities. This shortcoming may be partially corrected as new accounting graduates take more finance courses to reach the revised 150‐hour CPA educational requirement, although the majority of collegiate finance programs nationwide do not teach cash and treasury management topics (courses may be labeled “working capital management” or “short‐term financial management”). In any case, ongoing education in nonprofit governance (financial and otherwise) should be included in any governance development initiatives.
In smaller organizations, the treasurer also serves as the CFO. (The role and responsibilities of the CFO are discussed more in section i, “Finance Function.”) Quite often, as organizations grow, they split the board treasurer role from the CFO role. A qualified and dedicated CFO is a great asset to the organization and indispensable to the proficient financial management advocated in this book. As an example of this arrangement, notice in our example in Appendix 4A that “The vice president–finance shall serve as chief staff officer of the executive committee and chief financial officer of the foundation, and act as the foundation's secretary and treasurer.”
(iii) Secretary. The secretary must be well organized and able to record information accurately since this position is usually responsible for maintaining all records of the nonprofit, including the preparation of board meeting agendas and minutes. Since minutes serve as the official record of board deliberations and decisions, they must reflect the actual motions, who made and seconded them, and how they were voted. Board minutes are considered to be legal documents and are generally reviewed by independent CPAs during financial audits.
The secretary should draft the board meeting minutes and distribute them to board members in advance of the next meeting for review and correction, as necessary. After all corrections are noted, the board votes to accept the minutes and make them part of the corporate record. Their importance cannot be overstated because, when the minutes are approved, the board's action is official and binding.
(c) BOARD COMMITTEES. When a nonprofit organization reaches a certain size, its operation becomes more complex and its board may experience difficulty in meeting all of its responsibilities. When this occurs, the board may decide to pursue its work in smaller groups or committees, permitting a more detailed analysis of specific functions or areas, such as executive, finance, staff, development (or fundraising), investment management, property management, and planning. The role of these committees is to delve into the issues in their respective areas in a detailed way and to bring the results of these activities to the full board for discussion. The board may require a recommendation for action from the committee, based on its in‐depth review.
Advantages of a committee structure are the division of workload and the promotion of a more informal discussion of the pros and cons of matters before the board. It also allows an organization to bring experts into the deliberation process without appointing them to the board.
In general, such committees should be chaired by a trustee or board member and have a majority of board members serving in combination with outside resource people and staff members, who are assets to the process.
The committees listed next are common in nonprofit organizations. The actual number of committees depends on the size of the organization.
Executive Committee. Mandated to strengthen the efficiency and effectiveness of the governing board
Trustee Committee. Reviews recommendations from the nominating committee and makes final recommendations to the board for new trustees
Development Committee. Develops sound policies and tasks that support successful fundraising and related programs
Nominating Committee. Identifies potential trustees for the board of directors and may also focus on getting people involved in the nonprofit organization (see also Trustee Committee)
Planning Committee. Develops long‐range strategic plans for the organization
Building and Grounds Committee. Makes policy for the physical plant and addresses issues, such as deferred maintenance
Marketing/Public Relations. Determines policy for how the organization will be marketed and presented to the public
Program Committee(s). Assumes general responsibility for one or more major events that may involve mobilizing volunteers to plan and work the event
Personnel/Human Resource Management Committee. Sets human resource management policies
In schools, colleges, and universities, two additional committees are common:
Student Affairs Committee. Deals with issues related to the welfare of students
Academic Affairs Committee. Ensures that an institution's actions and policies reflect its priorities, mission, and character
We have reserved the three committees deserving most of our attention for last: the finance committee, the audit committee, and the investment committee.
(i) Finance Committee. This committee determines how the board should oversee the fiscal operations of the institution most effectively. The finance committee is responsible for providing a detailed review of financial statements and audit reports, internal as well as external, and reporting the results to the board of directors. The committee also makes recommendations to the board on policy matters such as target liquidity, debt, and other issues related to the financial management functions of the organization. A competent, dedicated, and high‐performing finance committee is key to the board meeting its fiduciary responsibilities. Finance committee members should be well versed in nonprofit financial matters and the financial affairs and standing of the organization.
(ii) Audit Committee. The audit committee is responsible for overseeing audit functions of the nonprofit organization. A well‐managed audit committee, which some argue should not be a board committee at all in order to ensure total independence, oversees regular audits of financial activities and adherence to laws and regulations and monitors the organization's conflict of interest policies. The wave of the future for nonprofits is now on the horizon in the form of Securities and Exchange Commission (SEC) rules for business audit committees. Pursuant to the charge given by Sarbanes‐Oxley to develop improved audit committee rules, SEC rules include stipulations that the audit committee
Must have “direct responsibility for the appointment, compensation, retention, and oversight of the work of the company's independent auditor…”
May have the company pay for any experts or advisers that it determines are necessary
“Is also responsible for establishing procedures for the receipt, retention and treatment of complaints regarding accounting, internal accounting controls, or auditing matters, as well as for establishing appropriate procedures to handle any anonymous employee complaints about questionable accounting or auditing issues”
Be made up of truly independent members, meaning that no member may directly or indirectly (including through any family member) accept any compensatory fee related to consulting or advisory services12
Organizations such as the Red Cross have adopted Sarbanes‐Oxley guidelines, even though they are not mandated for nonprofits (with the exception of whistleblower protection and document destruction). KPMG, a “big four” accounting firm, prescribes five “Basic Principles for Audit Committees,” which are worthy of quoting:
Recognize that the dynamics of each organization and its board are unique – one size does not fit all.
The board must ensure that its audit committee comprises the “right” individuals to provide independent and objective oversight.
The board and audit committee must continually assess whether the “tone at the top” embodies insistence on integrity and accuracy in financial reporting.
The audit committee must demand and continually reinforce the ultimate accountability of the external auditor to the audit committee as the board's representatives of external stakeholders.
Audit committees must implement a process that supports their understanding and monitoring of the
Specific role of the audit committee in relation to the specific roles of the other participants in the financial reporting process (oversight)
Critical financial reporting risks
Effectiveness of financial reporting controls
Independence, accountability, and effectiveness of the external auditor
Related to the fourth point, the external auditor should report to the board through the audit committee.
(iii) Investment Committee. Financial management and leadership constitute a series of sub‐disciplines and investment management is a specialized discipline requiring specialized knowledge and skills. The investment committee should be created with this is mind. It develops strategies and guidelines to support the board's short‐term and long‐term investment programs. The investment committee is responsible for reviewing and managing all the organization's investments, developing or revising and gaining full board approval of the investment policy statement, ensuring full compliance with policies and guidelines applying to nonprofit organizations, and reporting its findings to the board.
An outstanding source of board information, with broad coverage of nonprofit organizational types, is BoardSource:
BoardSource
Address: 750 9th Street NW, Suite 650 Washington, DC 20001‐4793
Three more important and useful printed resources geared to educational institutions are (1) “The Role of the Board Professional,” on the roles and responsibilities of board members and committees, (2) “The Board's Role in Financial Oversight,” and (3) “The Finance Committee.” Each of these is available from:
Association of Governing Boards of Universities and Colleges (AGB)
1133 20th Street N.W., Suite 300 Washington, DC 20036
Exhibit 4.3 profiles a quick check on board effectiveness that you should use to evaluate your board's governance periodically – at a minimum every two years. Items 4 and 6 are financial effectiveness gauges. Item 4 may be measured by the degree of achievement of the appropriate liquidity target as well as the establishment of and board concurrence on a cash flow plan of 12 to 18 months that shows no impairment of that liquidity target. Item 6 suggests some comparison of benefits to costs for the various programs and services delivered, not merely balancing or running a slight surplus in the budget. Additionally, one might compare costs element increases, year over year, to the inflation rate for that year (as measured by the CPI: specifically, gather the number for the Consumer Price Index for All Urban Consumers [CPI‐U] for the US City Average for All Items, 1982–84=100; select the first check box at http://data.bls.gov/cgi-bin/surveymost?cu, then select “Retrieve Data.”).
Source: Mel Gill, Robert J. Flynn, and Elke Reissing, “The Governance Self‐Assessment Checklist,” Nonprofit Management & Leadership 15 (Spring 2005): 271–294. Based on the 32 organizations the authors studied, the mean overall score was 4.06, out of a possible maximum score of 5.00, with a standard deviation of 0.3. The authors also administer a proprietary instrument that has 144 different questions; the 15 items included here correlate highly with those 144 items, and represent the items in the board literature that are especially linked to effective board governance. Used by permission.
Exhibit 4.3 The Governance Effectiveness Quick Check
(d) EXECUTIVE DIRECTOR/CHIEF EXECUTIVE OFFICER. The character of every nonprofit organization is largely determined by its executive director/chief executive officer, who speaks for the organization publicly and hires the staff who deal with the organization's constituents on a daily basis. Because this position is crucial to the nonprofit, the selection process should follow the next guidelines:
Board members should agree on the kind of person they are seeking, the special qualifications desired, and their expectations of the executive director prior to the actual selection.
The board must outline everything that needs to be accomplished by the ED/CEO in managing the day‐to‐day operations of the nonprofit organization by responding to these four questions:
What tasks are being performed now, and are they necessary?
What tasks are not being performed now that should be?
What new activities are being added that will require additional work?
What specific tasks are required to accomplish the new work?
The ED/CEO is charged with reviewing and understanding the financial operations of the nonprofit organization as part of his or her overall responsibility for day‐to‐day operations.
The ED/CEO should appoint individuals who are responsible for various components of financial management, such as internal control, reviewing the financial statements, and monitoring all of the financial details in the organization to ensure their accuracy and integrity. She or he should ask questions until satisfied that answers make sense and are in sync with the mission and related activities of the organization. Individuals with these responsibilities will be held accountable.
(e) STAFF. The ED/CEO is responsible for hiring the staff. Before doing so, he or she must determine the tasks to be performed and distribute them among the salaried employees, volunteers, independent contractors, and outside service providers. The best workforce mix is one that achieves the organization's mission in the most effective and efficient way. Usually a number of configurations will achieve the goal, and each has its own set of advantages and disadvantages.
In addition to financial support functions for the board, assistance from the financial function is needed to support the staff program managers and operational directors in their financial responsibilities. We consider separately the program/fund managers, marketing director, development director, and strategic/long‐range planning staff.
(i) Program Managers. Program managers are responsible for the financial management functions of their programs including budgeting and expending resources and raising funds for their programmatic activities as well as the delivery of the program as a whole within the organization.
The treasurer/CFO helps program managers by providing the financial and nonfinancial information needed to develop and maintain their programs. The treasurer is also responsible for sharing interrelated program information that can be used to benefit the entire organization.
Financial operations and expertise play an integral role in a number of other critical functions within the organization. Some of these contributions and interrelationships are discussed later.
(ii) Marketing Director. The financial and marketing functions of an organization are separate and distinct. According to one leading scholar in marketing, a marketing professional uses research and understanding of the client to develop an offering to meet the client's needs in a way that the client would value, communicates this to the client, and offers it to the client at the proper time and place. Proficiency in doing this means the marketing staffer has a keen understanding of the service and the organization delivering the service. Applied to donor marketing, marketing involves knowing the various ways in which gifts can be made and selecting the best alternative for each potential donor. The main marketing function of the CFO in this context is to assist in the crafting of a convincing case statement on the best vehicle for making a gift.
In an organization that has a separately identified marketing director, this marketing director is concerned with making the services of the nonprofit organization attractive to the client, developing client awareness, distributing information to stimulate new clients and contributions, and designing programs to attract new constituencies. The financial function is responsible for ensuing money flows.
The financial function serves the marketing director by providing information and services needed to determine a final marketing budget. Finance also assists in pricing programs, products, services, and contract offers to be presented in the marketplace, in developing effective fundraising strategies, and in helping to construct valid fundraising effectiveness analyses after the fact.14
(iii) Development Director. Most nonprofit organizations also have a development function which includes one or more of these types of fundraising: annual campaigns, grant writing for corporate and government grants, special events, capital campaigns, planned giving, endowment campaigns (if separate from annual or capital campaigns) and donor relations. Organizational alignment and efficiency depends on a good working relationship between the development director and the finance director. This sounds good, but in practice it requires a lot of communication and learning across both disciplines.
Development and finance have different views on gift recognition, pledges, income projections, and expectations about performance. Finance directors naturally have a more compliance‐based approach to these matters where development directors operate more on relationship development. These behavioral concerns can be overcome through tightly coordinated activities, a close working relationship where assumptions are explicated, and where trust is established.15
(iv) Strategic Management/Long‐Range Planning. Planning for the future is critical to the success of a nonprofit organization. We profiled the growing role of the finance function in assisting in the strategic thinking and planning process in Chapter 3, and we cover long‐range planning in Chapter 9. CFOs are typically called on to be internal business consultants because of their ability to analyze situations and to perform numerical and financial analyses. By providing accurate information that is useful, the finance staff becomes more highly valued by other organizational units. For an example from the business world, Intel's CFO asks participants from outside finance to evaluate the contribution the finance area has made in strategic decisions after those decisions have been made; if that contribution is equal to 25 percent or greater, that is considered “on target.” Arbitrary? Unquestionably. A good first step toward ensuring finance's strategic contribution? Absolutely.
Businesses now expect their CFOs to (1) understand the markets their companies work within, (2) take part in general management, (3) help construct business strategy, and (4) work hand‐in‐hand with operating personnel.16 These attributes apply equally to educational and healthcare organizations, and if we restrict the markets in (1) to “labor markets” and “donor markets,” all four attributes may be applied to any nonprofit CFO. A key finance educator role for any CFO includes helping all employees understand that tying up funds has a cost, and that the lost interest revenue or added interest expense reduces the organization's net revenue. Just as importantly, using these funds impairs the organization's liquidity position. Explaining how other staffers' decisions affect cash flow is an ongoing task for finance staff.
Every organization needs to be financed before it can accomplish its mission, and nonprofits are no exception. Programs have short‐, mid‐, and long‐range financial needs to be used for salaries, benefits, supplies, travel, space, furniture, buildings, and other resources. Nonprofit organizations raise the money to support their activities through strategic, financial, and programmatic planning.
(f) VOLUNTEERS. Volunteers are a source of uncompensated labor that can be extremely useful to the nonprofit organization. The process of recruiting, training, and retaining volunteers is complex, and volunteer interaction with paid staff must be handled with care. Many nonprofits would be unable to function without volunteers, who want meaningful responsibility. Smaller organizations often rely on a volunteer treasurer to serve as the organization's CFO. A volunteer may also do the bookkeeping/accounting work in the nonprofit. Unpaid interns (or interns paid by a third party) from a local college or university may gain valuable work‐related experience while providing the organization with assistance on financial data entry, reports, and receipting and other record keeping. Providing ways to reward and recognize volunteers is one of the significant challenges of the nonprofit organization calling for a professional approach to volunteer management.
(g) INDEPENDENT CONTRACTORS. Independent contractors are often retained to perform work for the nonprofit organization because they have special expertise that is not available in existing staff, provide that expertise at a cost lower than hiring additional long‐term staff to fill a short‐ to medium‐term need, enable organizations to focus on core activities, and increase organizational flexibility.
Outsourcing to independent contractors initially began as a strategy used solely by large corporations, but the practice has become widespread among organizations of all types and sizes. Services commonly outsourced include payroll, taxes, employee benefits, claims administration, investment services, graphic services, organizational restructuring, and organizational development. Accounts payable, remittance processing, and new donor development are areas in which outsourcing is growing. There are organizations that actually take this to the level of using outsourced CFOs, sometimes labeled “rent‐a‐CFO.”
(h) CONSTITUENTS. Constituents are responsible for requiring and reviewing financial reports and asking the right questions. They also have a fundraising role which includes making contributions of time and money as well as using their networks to provide additional support of all kinds to the organization. Some define their constituency as any stakeholder of the organization. It is very common for private school or college faculty, staff, and administrators to join board members in giving to annual or capital campaigns.
(i) FINANCE FUNCTION.
(i) Chief Financial Officer. In larger organizations, the CFO is typically responsible for selection of those assigned responsibility for the day‐to‐day financial operations. In midsize organizations, the finance chief may carry the title of controller, with a large accounting and reporting focus. In smaller organizations, the CFO may have the title of business director or finance director, and must perform many of the finance‐related functions rather than delegating them and also perform some responsibilities not normally considered to be part of the finance function. In the smallest organizations, there may only be a bookkeeper or accountant, possibly only part‐time (or outsourced or volunteer), and the board treasurer must wear the CFO hat.
Adding a CFO as your organization grows involves adding a significant, fixed expense. Before doing so, your organization will likely move down a path involving these phases, according to Thomas McLaughlin:17
Do‐it‐yourself, in which you are the ED/CEO and the bookkeeper as well. (We note here that as many as one‐half of nonprofits in the United States are all‐volunteer organizations;18 the difficulty of getting a separate person to volunteer to handle the financial affairs and bookkeeping implies that the founder and/or ED/CEO of the organization will have these responsibilities.)
Do‐it‐yourself with a bookkeeper. This individual will help you set up a “real accounting system” and is best contracted for as an independent contractor, not an employee, and works part‐time in this bookkeeper role.
Part‐time accountant working a few hours each month. Your organization might have several employees working for it at this point and perhaps gaining a few grants.
Retain an audit firm.
Hire a chief accountant.
Hire a chief financial officer (CFO). This person should be committed to your organization's mission, possess a high skill/competency level, as well as be adept at communicating financial data. This person will also be able to help you and your other managers discern the financial implications of major decisions. This person may have worked his/her way up from part‐time accountant to chief accountant to CFO (see #3 and #5 above).
Senior vice president of finance. Tends to be found in an established organization, joined by other members of a strong executive team, and piloting a complex funding system (business model).
The migration through these phases cannot be pinpointed to a certain number of months or years, but is more closely based on the growth of the organization and the complexities of managing financial matters. Once you get a CFO or senior vice president of finance, you will want that individual to possess these attributes, ideally:
training and experience in financial management (including basic elements of treasury management), generally accepted accounting principles, and internal control systems;
knowledge about the organization's mission and programs and their relationship to financial requirements and components; and
technical expertise and procedures for developing budgets and preparing financial statements.
We next detail the CFO's role and activities, noting the differences in small and large organizations.
The role of the CFO in nonprofits is to:
Make and enable others to generate prudent and appropriate decisions regarding program and asset investments.
Safeguard financial and other assets.
Arrange for financing and provide helpful evaluation for fundraising efforts in support of the mission.
Optimize the level and uses of cash and other forms of liquidity.
Help ensure that funds providers' wishes are honored.
Report financial results.
The CFO is traditionally responsible for these activities related to that role:
Maintaining financial records
Preparing timely, meaningful, and accurate financial statements
Budgeting
Safeguarding organizational assets
Providing effective internal controls
Complying with external reporting requirements
Anticipating financial needs through development of cash budgets, capital budgets, and long‐range financial plans
Reacting to operational changes that affect finances
Maintaining appropriate communications with the ED/CEO and board of trustees/directors19
In the small‐ to medium‐size organization, these roles are often expanded; for example, in a private school or college they may include such activities as:
Fundraising
Management of physical plant
Building planning and renovation/expansion project management
Information technology (including cyber security)
Food service management
Theater management
Human Resource Management (HRM)
All these functions, and more, have impacts on the finances of the institution and are required to meet the institution's volunteers' expectations and its mission. Much depends on the size of the nonprofit organization and on the skills of the individual in the position. There is no single best way to distribute functions to finance staff members. These assignments should be constantly evaluated and changed when it makes sense to do so. In large organizations, many of the responsibilities are delegated to a controller or accountant.
The role of a CFO in today's nonprofit corporations is in a constant state of flux. Over the past two decades we have seen these developments for this position:
Operational expertise is one of the primary criteria in the selection process.
Skills in interpersonal communication, influencing others, and related areas have become as important as technical skills.
Principles and values are used to define appropriate standards of behavior and the finance function in the organization.
While numerical integrity and the corporate audit process remain a priority, there is an increased emphasis on employee empowerment and softer controls (although this has been offset somewhat by Sarbanes‐Oxley initiatives) as long as employees understand that a level of control is needed and does not constitute a negative reflection on their integrity or capabilities.
Empowerment has implicit boundaries and demands greater responsibility and accountability.
Finance people transcend their functional identities within the organization by serving as key participants in teams engaged in addressing multifaceted organizational problems. This is a key management strategy as finance people bring analytical skills and organizational knowledge that are sometimes lacking in program or development staff.
Remaining competitive in today's global market requires internal and external information sharing and the development of systems to empower people with the information they need.
While cultural change is most effective when it begins at the top of the organization, the finance function may serve as a catalyst because it interacts with every other function. The finance function may also initiate cultural change in organizations experiencing financial difficulty.
Finance people play an integral role in organizational decision making and focus their efforts on finding creative solutions to issues and problems.
Organizations depend on finance people to clarify the business impacts during every step of the planning and budgeting process and to act as advocates rather than merely naysayers. While finance people have compliance responsibilities, they also have knowledge that is useful in many other situations in a nonprofit organization. Their early involvement in the decision‐making process prevents unnecessary surprises.
Beyond providing financial reports, the CFO should present to the ED/CEO and board a balanced picture of what is happening, where the problems lie, and what actions need to be taken. The person in this position is also responsible for working with program heads in order to represent their interests and explain the story behind the numbers. It is not a stretch to call the CFO a “financial educator.” This calls for enhanced communication and relational skills.
The finance function (in larger organizations) is largely decentralized and matrix managed (e.g., use of multidisciplinary project teams with a finance representative along with individuals such as a program director and someone from the fund development office).20
Over the coming years, Tom McLaughlin expects these developments:
More equality in ED/CEO and treasurer/CFO roles because of the growing insistence by government forces (especially IRS and state attorneys general) to have accurate and reliable IRS informational tax returns (Form 990); there seems to be a bit less distance between CEO and CFO types, quite often
A respectful distance that grows between the ED/CEO and treasurer/CFO as the ED/CEO requires assurance of financial report integrity and accuracy and as the finance person adheres more and more to professional (such as CPA or CTP) behavioral norms; however, when there is a sudden departure of an ED/CEO, the CFO often temporarily steps into that role, implying there has been a tacit acknowledgement of the CFO's unspoken “number two” role
More technology focus for the CFO (and staff treasurer, if there is one) because of growing insistence and possible ensuing legislation regarding electronic financial control standards and the need for the finance director to document effectiveness and accuracy of electronic financial information flows; there appears to be an emerging assumption that technological proficiency and involvement constitutes an increasingly important role for the CFO
More emphasis on long‐range strategic input and analysis (documented in Chapter 3 of this book)21
Financial managers find their position increasingly important and more complex in today's nonprofit environment. Several developments explain why:
Increased role for the CFO in strategic initiative evaluations
Reduced governmental grant or aid provision, necessitating alternative revenue development and/or cost reduction
Increased competition for donor dollars and “donor fatigue,” accompanied by increased demands for accountability regarding efficiency and effectiveness
Increased availability of new financial instruments, enabling risk management to better contribute to fiscal stability
Enhanced information technology and increased opportunities for automation, such as electronic information and cash management systems, with a proper emphasis on using these developments to make better decisions on a timely basis – with many nonprofits housing (locating) the information technology (IT) function in the finance office
Related to the IT revolution, the increased harnessing of information to create and maintain competitive advantage and further mission accomplishment for the nonprofit
Increased ability of CFOs to document proper control over information flows
Notice the common thread running through each of these forces – information: information about the impact of proposed strategic initiatives on the organization; information about the decline of traditional revenue sources and the availability of alternative revenue sources; information about cost‐reduction opportunities; information provided to present and potential donors; information‐producing and processing technologies; information provided to program directors and senior management; information security; and the harnessing of information to expand the organization's programs, flexibility, and resourcefulness. Information gathering and dissemination must be coordinated, and the financial and accountability structures enable the nonprofit to do just that. In other words, these structures are not only for cash‐flow management but for information‐flow management as well. Using IT tools, particularly the newer cloud‐based software services, enables one to meet both objectives simultaneously.
Information management is also a cornerstone of a turnaround strategy in struggling organizations. Business turnarounds have CFOs engage in these practices, which can be adapted to the nonprofit situation:
Shift the information mode. Involve operating managers in financial analysis and reporting so that they will acknowledge financial problems usually brought to their attention by the CFO and so that they have a better feel for the implications of the financial information (financial leadership).
Improve the reporting system. Making small, hardly noticeable changes to the information system may conserve financial resources at this critical time, while providing faster and more accurate operating and financial data.
Communicate with candor. Since employees, donors, clients, and suppliers will learn the truth sooner or later anyway, gain support of the stakeholders by publicly working through the difficulties, enhancing your chances of success as you gain support of critical constituencies.
Form a “tiger team” in larger organizations. This small, motivated group of middle managers can make suggestions and help implement them; it should focus on major plans and permanent solutions, not quick fixes.
Be creative in tapping sources of cash. Tax refunds, restructuring of bank debt, asset‐based financing (e.g., selling receivables), negotiating with suppliers, aligning with sympathetic donors or customers, and selling off idle assets are all sources of cash in tight times.
Enlist employees' aid. In difficult times, employees may be enlisted to accept work rule changes, temporary compensation reductions or deferrals, or benefit reductions.
Protect earned income and grant and fundraising sources. It is tempting to engage in across‐the‐board spending reductions, but this may be tantamount to a high‐tech company eliminating its research and development budget: Maintain or even increase your investment in revenue‐augmenting activities.
Eliminate or automate administrative functions. Assuming you have already done everything possible to reduce overhead expenses, look for administrative functions that may be trimmed or eliminated: using outside fundraising counsel and out‐sourcing payroll are two examples. A key question is whether volunteer resources are already doing some of these tasks, or whether they are required.22
Recapping this section, the financial manager may have any of a number of formal titles. In smaller organizations, the person holding the title “finance director” or “director of finance” often holds a part‐time position, sometimes voluntary. That individual is often also the CEO/ED. In larger organizations, the finance director or treasurer may make many of the financial policy decisions, with executive director guidance and agreement and board committee or entire board approval.
(ii) Treasurer's Office and Controller's Office. In larger organizations, separation of controllership and treasury functions is possible and desirable. The structure might result in the organizational chart in Exhibit 4.4.
Exhibit 4.4 Controller's Function Versus Treasurer's Function
Some of these areas, such as capital budgeting or IT, can be found in either the controller's office or treasurer's office, depending on the organization's preferences. There are two noteworthy differences in the focuses of the two offices: (1) the controller's office assumes responsibility for most of the bookkeeping, reporting, and compliance issues; and (2) the treasurer's office handles most of the areas requiring management decisions, such as when and how much money must be raised (this timing and amount determination may be delegated to and surely is executed by the development office); how to best manage cash inflows, mobilization, disbursement, and forecasts; how to invest pension funds and manage those funds (or who will do the investing, if outsourced); whether to self‐insure risks, which bank(s) to use and how to compensate the bank(s); which capital projects to accept; whether to hedge foreign exchange exposure; and whether a fundraising event provides enough additional revenue to repeat it, even when taxes must be paid on the net revenue. Our useful oversimplification is then:
Controller's focus: Get the financial numbers right and conserve the organization's resources.
Treasurer's focus: Plan, increase, and manage financial resources
Many organizations deviate from the just‐described organizational structure in two significant ways:
The organization may try to combine the controller and treasury functions into one office.
The organization may divorce fundraising from the finance function altogether.
Apparently, organizations view fundraising vis‐à‐vis finance in the same way a business would view marketing and finance. However, finance may aid and help evaluate the fundraising function, which is typically housed in a “development office.”
Why not consolidate the controller's and treasurer's offices? In smaller organizations (up to $1 million in annual revenues), it is necessary to combine the controller's office and treasurer's office. However, larger organizations that merge their activities often end up with a “second‐best” setup that does not allow the organization to work at its full capacity. There are eight reasons why combining the offices, while commonplace, puts larger organizations at a disadvantage:
The control focus ends up dominating, leading to ever‐stronger financial reporting and internal control (e.g., use of internal auditors), and more detailed financial reports.
The “reports in search of a user” phenomenon may surface; conciseness is sacrificed for level of detail, with no improvement in usefulness. Very few of the reports are true management accounting outputs, such as break‐even analyses. Operating personnel may receive larger and more frequent requests for data and explanations to feed the exception reporting (variance analysis) process. On the positive side, management may gain a better idea of corrective actions to take, and there may be more protection against employee fraud.
The treasury function invariably suffers, as financial management tasks are important but less urgent than getting the monthly, quarterly, and annual statements compiled, and keeping up with recurring grant reporting, payroll, and payables tasks.
Capital projects that place ruinous financial burdens on the organization are approved.
Planning is sacrificed in favor of overemphasis on financial reporting and auditing. The problem area is not so much budget development, except to the extent (1) budgets are not linked to carefully developed long‐range strategies and plans, and (2) the budget development and approval cycle is too long. What suffers is long‐range financial planning (see Chapter 9).
Short‐term financial management (treasury management) areas suffer from benign neglect: Cash management procedures are outdated and inefficient, bank relationships are never reevaluated and rebid (costing anywhere from $1,000 to $200,000+ in unnecessary fees annually), idle funds are left in noninterest‐bearing accounts or accounts paying well‐below‐market interest rates.
Risk management is overlooked due to inadequate time and expertise: Interest rate and exchange rate exposures go unhedged, and the organization overpays for or has inadequate insurance coverage.
Financial investments are made in inferior or inappropriate vehicles: Some organizations invest in overly conservative vehicles, short‐changing employees due to underfunded and/or inadequate pension fund coverage for its employees. Other organizations have invested in extremely risky mortgage‐backed securities because they did not have the in‐house expertise to evaluate these investments and have not retained outside counsel.
Why do so many nonprofits suffer from these easily avoidable predicaments? One of the main reasons for the consolidation of controller and treasury functions is the selection of accountants for the CFO position. This strengthens the bookkeeping and financial reporting aspects and possibly regulatory compliance. The emphasis in academic accounting programs at colleges and universities in the United States is financial reporting. However, due to separation of accounting and finance in the academic world, accounting students get very little financial management training—many accountants have had only one finance course, and it was geared to business financial management. The result? The graduates of these types of programs rarely get any training in the financial aspects of cash management, banking selection and relationship management, receivables management, investments, borrowing, or pension or endowment fund management. The expectation seems to be that they will learn these functions on the job.
Because of the historical inattention to the treasury function, additional guidance will be provided regarding what treasurers can contribute. Birkett and Sharpe have identified five treasurer competencies in the corporate sector, which provides a checklist for you to evaluate your own organization. These competencies and our added commentary for nonprofits' unique situations are provided in Exhibit 4.5.
Source: Competencies in the left column are from W.P. Birkett and Ian G. Sharpe, “Professional Specialisation in Accounting VIII: Treasury,” Australian Accountant (February 1997): 49–52.
A visual and compelling argument for moving beyond accounting/reporting/control overemphasis and bringing treasury staff and expertise and financial management proficiency onboard has been developed by Kaufman, Hall and Associates and is shown in Exhibit 4.6. This framework, shown in Panel A, portrays our Chapter 3 financial leadership emphasis as well as this chapter's emphases on CFO as financial educator, strategic business partner/consultant, and liquidity captain (or “Chief Liquidity Officer”23 when there is not a salaried treasurer on staff). While this graphic is particularly applicable to budgeting and financial planning, we see it as applicable to most financial decision‐making and financial management activities. In the second panel of Exhibit 4.6, Panel B, we have taken the strategic leadership role graphic, combined it with Charles Kim's take on what he sees in practice, and then inserted our own thoughts. The “Strategic Partner” role (Quadrant 4) is an aspiration for all nonprofit CFOs in our view. It is a long‐term climb for a finance director in a young and small nonprofit, but gives a goal for which to strive.
Exhibit 4.6 Treasury Analyst and CFO as Strategic Partner
Charles Kim of Kaufman, Hall and Associates pinpoints the broader role that the CFO (or finance director) at colleges, and we believe all nonprofits, must play to be an indispensable member of the mission‐centric leadership team:24
(iii) Financial Function: Service Center or Profit Center? Traditionally, departmental or other units in the organization have been identified as responsibility centers. Managers are then held responsible for the results of their units. This generally meant that departments were considered cost centers or service centers, although some organizations also designated some units as profit centers or investment centers. The distinction has to do with what the unit has control over and responsibility for. Cost or service centers cannot generate revenue directly, so they are held responsible for the level of cost they incurred. They are doing something necessary for the organization's survival but are consuming scarce resources, which must be conserved. The telecommunications area in a private school or college would be a cost center. “Physical plant” or “buildings and grounds” activities function as cost centers in most organizations.
To control costs, manufacturing businesses determine benchmarks (standard costs) for labor and material, which indicate costs on a per unit basis. The benchmark cost of a unit of output is often based on time studies or engineering estimates. It represents what the cost of production should be under attainable good performance, and thus serves as a basis for measurement or comparison.25 Cost overruns are then identified, the cost or service center made aware of them, and the manager of the cost or service center is expected to implement corrective action(s).
If the unit also generates revenues and has a high degree of control over the amount of revenue generated, it may be treated as a profit center. Net revenues are then the focus of periodic evaluations. A copy center at a college is an example. An investment center is held responsible for net revenues and the amount of resources (usually measured as assets) used by the area. Think of its results as “return on investment.”
Why discuss profit centers in a book about nonprofits? Because there is some disagreement over whether the treasury area in either a company or a nonprofit should be treated as a profit center. Advocates argue that it is legitimate to assume that the treasury department can be held responsible for net interest revenue. First, note the calculation of net interest revenue:
Net interest revenue = (interest revenue − interest expense)
Investments generate interest revenues, while amounts borrowed result in interest expense. The treasury area controls interest revenue by choices on short‐term versus long‐term investments, the instruments chosen for investment, and the interest rates earned (see Chapter 12). Treasury controls interest expenses by their choices on amounts of short‐term versus long‐term borrowing, the degree of utilization of credit lines, and the interest rates negotiated when borrowing money. Therefore, the argument is to hold the treasurer's office responsible for net interest revenue, particularly in an investment foundation or endowment.
The counterargument is that treasury should be a service center. Proponents of this idea are concerned that the treasurer will take undue risks by investing in inappropriate instruments (such as the now‐infamous Orange County bond‐and‐derivatives debacle that landed the County in bankruptcy) or simply not arrange enough financing. It also is argued that treasurers cannot control the overall level of interest rates earned or paid. The service center approach has been the accepted approach for most nonprofit treasury operations to date.
Profit center advocates' rejoinder is that (1) the investment policy controls risk, and (2) the absolute level of net interest revenue may not change much because investment and borrowing rates move up and down together.
There are reasons for and against the profit center approach to treasury management. As a profit center or a service center, the function should maintain accountability so that idle funds are invested and prudent risks are taken to enhance returns. Normally, the service center is the most prudent, but for conduit organizations such as investment foundations, a profit center approach is defensible.
Focus on activities. Nonprofit organizations may not be able to develop standard costs, but they may still estimate what good cost performance on an activity should be. Using a three‐pronged approach, your organization can find innovative ways to increase contributions and accomplish its mission for less cost instead of using the current period's performance as a barometer of success:
Tackle the fundamental problems and eliminate “nonproductive structured cost.”
Redesign services, activities, and business processes to reduce cost.
Organizations should focus on streamlining business processes and activities and managing and reducing the workload, not just the workforce. Other fundamental activities include asking clients' and donors' advice, continually improving every process (e.g., donor communications), eliminating wasteful activities, reducing workload in each area where feasible, classifying items as utilized or unutilized (as opposed to fixed and variable cost splits), and controlling the process instead of the results. Involving the individual who performs the activity means one is able to tap that person's expertise. Wherever possible, set a target as a minimum level of performance. What may be the most important idea, and most challenging, is to focus on outputs and outcomes, not inputs. While outputs and outcomes are difficult to measure and quality is complex, effort should be made to quantify outputs and outcomes where possible. Automate, simplify, and computerize processes wherever possible to reduce human error and mistakes.
Correctness of your cost analysis. Evaluating cost center performance depends closely on a correct appraisal of costs. An example of mistaken cost analysis is the evaluation of fundraising events. Are all of the costs incorporated into the evaluation? Quite often, even in organizations that computed and reported the event's net revenue (revenue less expenses), the cost of staff time and services necessary to put the event on was not included in the expense total. Instead, only rent, music, food, and prize expenses were considered.
Let us consider another activity: paying a supplier's invoice. The activity cost includes all resources used (e.g., people, equipment, travel, supplies, computer systems) in paying that invoice. The cost of the process of “payables” would be narrowed down to the cost per invoice paid. Quality, cost, and time would be looked at jointly, so as to prevent a myopic cost‐only approach to managing the payables function. Always look for a measure that should capture costs directly for the particular activity you are studying. “Per invoice” works well as the key measure for payables. The activity focus enables one to spot “cost drivers,” in which you identify a root cause or an earlier activity that has a great impact on an important activity's cost, such as the processing and payment of an incorrect invoice. Identification of these cost drivers can lead to prevention rather than costly rework. One is always on the lookout for non–value‐added cost, which means some amount above the minimum amount of time, supplies, or space absolutely essential to add value to the organization.
So how does this “activity management” approach differ from traditional cost accounting? When each organizational unit accumulates costs by cost category and controls costs on this basis, we have traditional cost accounting. When costs are accumulated and controlled by activity, we have progressed to activity‐based management. Partially processed “works‐in‐progress,” such as opened but undeposited donation checks, or invoices that have not been sent out, tie up funds that would otherwise be available.
(iv) How Can Finance and Accounting Activities Be Evaluated? Consider the finance and accounting function and the activities it is involved in. Effective organization of that function can reduce waste and provide impetus to the rest of the organization to engage in activity analysis. For example, the accounts payable area engages in these activities: answering inquiries, receiving invoices, and paying vendors. Calculating a cost per activity for each of these is a logical starting point for more effective management of the payables area. “Cost per bill paid” is one such measure. Similarly, the payroll area collects/maintains employee data and issues checks. Those two activities provide a logical focus for cost analysis and cost management.
(j) INTERFACE OF CFO WITH CEO. Close and regular communication must take place between the CFO and the CEO. As partners in the overall management of the organization, a good working relationship is also vital. As a strategic business partner and internal business consultant, the CFO is an important part of the CEO's support team. The CFO is also in the best position to question assumptions as well as to rein in a free‐spending culture where it exists.
(k) INTERFACE OF CFO WITH THE BOARD. Occasionally the CFO is an ex officio, nonvoting member of the board of directors. In all organizations, the CFO should serve as a financial advisor, financial educator, and sounding board for the directors. Well‐run nonprofits have CFOs whose board‐facing role is not merely dumping financial reports in the lap of the board treasurer and disappearing until the next meeting's reports are due. Explaining what the numbers mean, why they are at these levels, and what possible means the organization may pursue to achieve and maintain its liquidity target are all key responsibilities of the CFO. The CFO does not inherit the board's financial responsibility, but is an invaluable ally in enabling the board to carry out that responsibility. The best CFOs also help board members perceive the risks that the organization faces, and how those risks may impede programmatic and financial objective accomplishment.
This concludes our discussion of financial structure. Next we turn to a discussion of accountability structure, in which individuals are held accountable for their duties and responsibilities.
4.3 ACCOUNTABILITY STRUCTURE
(a) ACCOUNTABILITY STRUCTURE. Accountability may be defined as “the acknowledgment and assumption of responsibility for policies and decisions, including the obligation to be answerable for resulting consequences.”27 The greater demands for accountability, as well as the many changes in the ways organizations transact business today, require new financial policies, procedures, and techniques. An accountability structure is a way of documenting and clarifying the responsibilities everyone has in this new environment.
(i) Definition. An accountability structure details each of the tasks or processes within a unit and identifies the roles of each person in accomplishing the task or process. Our focus is on the accountability structure for the finance office.
(ii) Purpose. Businesses are reviewing how they give authority to their units and their staff, with an eye to empowering and streamlining operations. One important aspect of an accountability structure enables the movement toward giving a unit full responsibility and accountability for its business transactions, by removing the middleman as much as possible. In addition, an accountability structure:
Eliminates any confusion about roles and responsibilities
Details for all parties within the unit how the work is performed
Verifies compliance with company, government, and any other regulatory agency regulations and guidelines
Provides a method of reviewing the accountabilities in the unit to ensure they are kept current and accurate
Serves as a guide for measuring performance
(b) ESTABLISHING AN ACCOUNTABILITY POLICY. To set up an accountability structure, you first need to be clear about your objectives and goals, and have a method of sharing and conveying those goals to the company, staff, donors, customers, regulatory agencies, and others. Developing a formal policy about accountability can achieve this objective. As with any policy, your policy on accountability should include a general policy statement, core principles, and an interpretation of policy.
(i) General Policy Statement. A policy statement presents a brief description of the goal of the policy, such as:
(ii) Core Principles. Core principles further define the policy statement. They are the rules or practices adhered to in order to comply with the policy statement, such as:
(iii) Interpretation of Policy. Policy is often written in a language that is technical and not easy for everyone to understand. Policy is a legal document; however, an interpretation of the policy can assist others in applying the policy properly. A policy interpretation can look like this:
Individuals delegating accountability can do so only to the extent that this same accountability has been delegated to them.
Individuals delegating accountability are responsible for ensuring the qualifications of the individuals to whom they delegate as well as the proper fulfillment of their responsibilities.
Qualified individuals are those who:
Are actively involved with the activities being conducted
Possess a working knowledge of the budget, an adequate level of technical skills required to use the various application systems involved, and an awareness of policies, rules, laws, regulations, or other restrictions on the use of funds sufficient to either ascertain compliance or seek additional assistance
Have sufficient authority to fulfill their responsibilities so they can disallow a transaction without being countermanded or subjected to disciplinary action
Each organizational head must officially record all accountability delegations as well as any cancellations or modifications of such delegations, once established.
Each business transaction (including commitments) must be reviewed on a timely basis by the individual accountable for the affected accounting unit(s). In instances where this individual prepared the transaction, a second qualified individual must review that transaction and, in so doing, accepts responsibility for the accuracy of the transaction and compliance with all applicable policies, rules, and regulations.
Each organizational head (or designee) must regularly review its official record of accountability delegations and related maintenance procedures, to ensure that it remains secure, accurate, and current.
Each organizational head (or designee) must monitor the effectiveness of the accountability delegations to ensure that all accountable individuals are performing their functions in accordance with all policies, guidelines, laws, regulations, and related training instructions.
The chief administrative officer (or perhaps a program officer) is responsible for the financial resources within his or her operating unit. This officer may delegate responsibility to others. These delegations must be recorded in a document that specifies:
The kind or type of work the employee performs (e.g., purchasing, accounts payable, payroll, personnel)
The qualifications, training, and/or credentials of the individual that justified the assignment of their duties
The individuals responsible for reviewing work (including type and conditions) performed by others (e.g., review all Purchasing transactions performed by the department, or all Purchasing transactions for a specific account)
An alternate to serve when an individual normally assigned to perform this work is not available (vacation or other absences)
The accountability structure must reflect universally accepted business practices:
Separation of duties (the person who receives cash should not also deposit it or reconcile the transaction)
No conflict of interest
Individuals must understand to whom and where they go when they suspect irregularities. In addition, management must set a tone that encourages and supports individuals contacting superiors and others when suspicious of irregularities.
(c) CHECKLIST FOR ASSIGNING RESPONSIBILITY. The list that follows details the tasks and responsibilities in the financial arena. Each item on the list that is performed at your organization needs to be assigned to a specific individual.
Task or Responsibility
Performed By
Collect past‐due accounts
Design and maintain cash management systems
Determine appropriate financing vehicles and techniques
Determine return on investment (ROI) on technology
Distribute expenses to subsidiaries and other units
Establish and monitor service provider performance standards
Establish borrowing policies and strategies
Establish communication strategy
Establish contingency plans
Establish corporate objectives and strategies
Establish credit policies of the organization
Establish employee benefit, pension, and other funds
Establish financial policies
Establish investment policies
Establish lending limits of the organization
Establish policies and standards for technology
Establish pricing and compensation
Establish reporting standards
Establish risk‐management policies
Establish service quality of the organization
Establish technology policies with respect to security and standards
Evaluate industry standards/benchmarks
Evaluate outsourcing opportunities
Evaluate technological solutions
Evaluate the financial strength of the organization
Forecast cash flows
Forecast international cash flows
Implement security and fraud prevention programs
Implement technological plans
Implement technological solutions
Initiate fund transfers
Initiate loans
Maintain relationships with creditors
Manage accounts payable
Manage accounts receivable
Manage bank balances
Manage brokerage relationships
Manage cash
Manage collections
Manage compliance with audit requests and recommendations
Manage corporate liquidity
Manage daily cash position
Manage disbursements
Manage insurance
Manage foreign exchange
Manage fund assets
Manage general ledger
Manage interest rates
Manage international financial institution relationships
Manage international investments
Manage lease requirements
Manage leases
Manage long‐term investments
Manage mergers, acquisitions, and divestitures
Manage property
Manage relationships with analysts and investors (if have for-profit public unit)
Manage risks
Manage tax and legal issues
Manage trade financing
Monitor donor relationships
Monitor compliance with financial policies
Monitor compliance with corporate objectives and strategies
Monitor compliance with risk management policies
Monitor compliance with technology policies
Monitor employee benefit payments
Negotiate acquisitions and mergers
Negotiate credit arrangements
Perform float analysis/cash optimization reviews
Prepare financial reports
Reconcile and submit corrections for errors
Report on significant industry changes and directions
Select technology vendors
(d) DESIGNING AN ACCOUNTABILITY STRUCTURE. There are six steps to designing a structure:
Step 1. Determine which tasks or processes are performed in your unit. To determine which tasks or processes are performed in your unit, you may need to survey the staff concerning what they do. Other potential resources are job descriptions, job cards, products, and reports.
These major categories might include:
Purchasing
Accounts payable
Payroll
Personnel
Accounts receivable
Step 2. Determine where and how these tasks or processes can be divided into steps among individuals to enable appropriate separation of duties.
Purchasing
Price quotations/bids
Order placement
Document preparation
Receiving
Accounts payable
Document preparation
Document review
Invoice matching
Reconciliation
Accounts receivable
Receipt of cash or other monies
Tally sheets
Document preparation
Transport to bank
Reconciliation
Step 3. Determine which staff members have the skills necessary to perform the tasks, processes, or steps. An example of this process is presented in Exhibit 4.7.
Exhibit 4.7 Determining Staff Members' Strengths and Weaknesses
Step 4. Determine which role the individual will perform as well as the preparer/performer or reviewer/auditor of the action or process. When determining the role an individual will play in a process or action, the person with the most knowledge should generally be given the responsibility to review the entire action. The decision is often based on the supervisory or management position the individual holds. While it may appear contrary to tradition, the best reviewer of an action is the person with the most knowledge, regardless of his or her ranking within the area.
Establish guidelines or rules that each role requires. After establishing these rules and guidelines, detail how individuals should properly perform their functions, to whom they go for advice or training, and how they can properly question a transaction, process, or action without fear of reprimand. A primary (denoted PP) and a backup (noted PB) should be assigned to each step (see Exhibit 4.8).
Exhibit 4.8 Determining Task Preparer and Auditory
Step 5. Determine whether the workload is distributed appropriately or reasonably. After determining who has primary responsibilities and backup responsibilities, review the structure to assure that work is distributed evenly across the unit and make adjustments as necessary. Be sure to factor in work schedules, seasonal fluctuations, and attrition (impacts of retraining and cross‐training).
Step 5. Review the structure for accuracy. Before implementing your accountability structure, review it carefully to make certain that all tasks or processes have been included and that the staff assignments are consistent with the individual's abilities. (Cross‐training may be necessary.)
(e) MONITORING AN ACCOUNTABILITY STRUCTURE. After you have developed an accountability structure, begin to monitor its effectiveness. Initially monitor the structure to determine that the initial design works in principle. You may need to make adjustments to the initial design.
(i) Types of Reviews. After the basic structure has been implemented and determined to be reasonably accurate and functional, periodic reviews of the structure should be performed. Several types of reviews or factors that should be performed or included follow:
Determine whether additional processes or tasks have been added to the units' responsibilities.
Determine whether changes in workload have affected the quality of the work performed.
Determine whether individuals are performing their role and responsibilities as intended.
Determine that policies and procedures are being followed.
(ii) Schedule of Reviews. The accountability structure should be reviewed at regular timed intervals and as necessary. The uniqueness of your organization will determine how often changes in workload or responsibilities occur. Use these guidelines:
Monthly: Review or scan products, reports, and output to determine that all tasks and processes are being performed.
Quarterly: Review or scan products, reports, and output for quality, accuracy, and compliance with policy.
Annually: Provide performance reviews to all staff members detailing how effective their work has been during the previous year. Where necessary, make changes to the individual's performance objectives and responsibilities, and provide counsel and training where needed.
As you implement these reviews, you are achieving a solid internal control structure. Notice that our accountability structure discussion has focused on things that the CFO and others can do internally to better ensure effectiveness, efficiency, and adherence to policies and procedures. Together these goals should enhance external accountability to stakeholders. We return to some specifics that your organization can implement in our chapter conclusion. First, though, we delve further into the arena of ethics.
4.4 ETHICS
A thorough discussion of business ethics is beyond the scope of this book. However, ethical conduct is interwoven with governance and accountability and is the first principle of an internal control system. Principle 1 (of the 17 internal control principles in the COSO framework) states, “The organization demonstrates a commitment to integrity and ethical values.” The four “Supporting Points of Focus” are (1) Sets the tone at the top, (2) Establishes standards of conduct, (3) Evaluates adherence to standards to conduct, and (4) Addresses deviations in a timely manner.28 In the following section we provide a brief overview of ethical guidelines.
Operating and financial decisions are often subject to interpretation. Consequently, a decision maker may often find himself or herself in a quandary over how to ensure compliance. Our best advice is to do your best to thoroughly understand the rules and regulations that apply to the particular issue at hand. Use this information, along with your best judgment and possibly another's opinion, to make your decision. Guard against the tendency to rationalize and apply “situational ethics,” which simply means engaging in dishonesty or other unethical behavior “because this case is different.” The accounting scandals in the corporate sector have forcibly reminded us that there are moral absolutes of right and wrong that need to be adhered to in personal and organizational decision making.
A simple example illustrates the point that judgment must be combined with an understanding of rules and policies:
Another challenge is red tape, because bureaucracies are inherently complex and confusing. When faced with the realities of the red tape affecting the ability to get things done, individuals may feel it is their ethical responsibility to cut through it. This dilemma places the individual in a gray area between the ethical responsibilities of complying with the regulation or law and our society's push to cut through red tape. Being professional, though, implies doing what is in the client's best interests and what adheres to the mission, above even loyalty to the organization and its norms.29 In many such cases one is best served by getting a superior's view of the ethics of a decision before forging ahead with it.
(a) ETHICS CHECK. As indicated in the audit and audit committee sections of this book, audit as a means of assuring compliance is necessary when reviewing all business transactions. Exhibit 4.9 reinforces the fact that a decision that is not illegal or fraudulent may still be unethical.
It is also necessary to perform an audit of decision making within your organization. Constantly review and monitor the interpretations of regulations and laws and assist individuals forced to make these difficult ethical decisions with the stress that this creates. Further, the manager should be certain that individuals have not determined they can decide arbitrarily to ignore all laws, rules, and regulations out of habit because of “special circumstances.” Once an individual has seen a possible need to make an exception, will the individual know how far he or she may go before the action becomes immoral or illegal?
Discussions about ethics do not occur often. Many times the ethics issue is ignored for fear that even broaching the subject might cause or raise suspicion. Certainly formal, established policy on how far an individual can go in deviating from internal rules and regulations would be unreasonable, but a discussion or pamphlet outlining the company's attitude toward compliance is certainly advisable. It is also possible to teach or monitor company ethics using analogies. Most important, individuals within the company must understand the basic assumption that all rules, laws, and regulations must be adhered to and that only when the situation or task makes it absolutely necessary to deviate from the strict interpretation are they to consider such an option, and that they need to seek the advice of the department head, CFO, or ED/CEO when making these decisions.
(b) MAKING ETHICAL DECISIONS. It is especially tempting to break the rules when the organization is financially strapped. One recurring problem for businesses and nonprofits alike is stretching payables beyond their due date. How can boards and top management instill a culture dedicated to integrity in the organization? A starting point is instruction on the three tiers of ethical standards by which employees and volunteers can judge their actions, as shown in Exhibit 4.10.
Source: Adapted from Richard Chewning, Biblical Principles and Economics: The Foundations (Colorado Springs, CO: NavPress, 1989), 278.
In the first tier, the concern is whether the action is legal or at least consistent with the relevant law's intent. This requirement would be the minimal one of all employees and volunteers. The middle tier moves beyond this to ask whether an impartial observer would judge the organization's decisions, way of conducting business, and reasons for its actions to be both prudent and mutually beneficial to all parties. The Golden Rule applies here. It is clear that stretching payables violates the middle‐tier standard. Going beyond this, the top tier requires a commitment to enhancing the well‐being of the people with whom business is conducted, even if there is a cost to the organization. As one moves from lower to higher tiers, a greater commitment to relationship enhancement is necessitated. Summarizing, do what is legal, but always strive to make decisions that build and strengthen relationships rather than tear them down.30
Individuals within the organization need to be reminded constantly that compliance with regulations, rules, and laws (lower tier) is consistent with the mission of the organization. The development and periodic review of an accountability structure, as a regular, integral part of day‐to‐day business, provides a mechanism for accomplishing this.
(c) ETHICAL CHALLENGES FACED BY NONPROFITS. We are all familiar with the episodes of abuse of power by those in the ED/CEO role at nonprofit organizations. Many times these involve shirking of responsibility (in effect, over‐delegating roles and responsibilities to subordinates) or subverting organizational resources to private benefit. Organizations diverting funds raised for one purpose to a different use represent another obvious ethical breakdown.
Although we do not wish to minimize these scenarios, the three categories we focus on here should be of special interest to the CFO and to the board:
Conflicts of interest. A conflict of interest exists in any “situation in which a person has a private or personal interest sufficient to appear to influence the objective exercise of his or her official duties as, say, a public official, an employee, or a professional.”31 Such conflicts corrode the trust donors, volunteers, and clients have in the organization. Board members may wish to steer business to their banks, insurance companies, or law firms. The nonprofit organization may spawn a for‐profit subsidiary and then wish to use the parent organization's tax‐exempt status to build a brand that is capitalized on to aid in the marketing of the products/services delivered by the for‐profit. Conversion from nonprofit to for‐profit status is alleged by some to represent a similar ethical breach. Allowing an association's name and/or logo to be placed on a company's product packaging – apparently endorsing this company's product over competitors' offerings – and affinity credit cards appear to some to represent similar misuse of the organization's brand name. Earned‐income ventures bring with them ethical conflicts along with the incremental revenue stream.
Fundraising. In order to maintain the trust that comes from cultivating and maintaining donor relationships, fundraisers have an ethical obligation to understand the donor's intentions and obligations as well as to provide assurance that donations are used as and where intended. Accordingly, many organizations now subscribe to the “Donor's Bill of Rights,” which includes a number of items of which both the finance staff and the board finance committee should be aware and supportive:
Donors should be informed of the donation's intended use and the organization's capacity to use the monies effectively for that use.
Donors should reasonably expect the board to exercise prudent judgment in its stewardship responsibilities.
Donors should have access to the organization's most recent financial statements.
Donors should have assurance that all gift‐related information is handled with respect and confidentiality.
Donors should feel free to ask questions and receive prompt, truthful, and forthright answers.32
At the time of this writing approximately 2,200 faith‐based organizations hold voluntary membership in the Evangelical Council for Financial Accountability (ECFA), which indicates that the organization subscribes to seven standards, including the following:
Budgeting. The “fixed performance contract” built into the budget‐setting and budget‐approval processes may lead to gaming and deception, especially in commercial nonprofits, such as healthcare and educational institutions. Higher‐level managers may push hard to get better financial results, while lower‐level personnel may attempt to gain easier targets to reduce stress and increase the chance of gaining favorable performance evaluations and even performance‐based incentives. (We address budget ploys in more detail in Chapter 8.) Awareness of this conflict is an important first step; some organizations have gone to a “Beyond Budgeting” approach that includes several changes in managerial principles:
Replace goals with targets, focusing on relative improvement instead of incremental numbers, and disconnect goals from evaluations and rewards.
Adopt a two‐year to five‐year time frame rather than the traditional one‐year time frame.
Base goals on relative performance improvement that is ethical and sustainable.
Give out rewards based on teams' relative success as compared to external benchmarks, and do this in hindsight based on a formula.
Link any bonus pool to key performance indicators that are consistent with goals and strategies.
Engage in action planning as a continuous and inclusive process, not as an annual top‐down event.
Make resources available as required rather than being allocated in advance and base allocations on key performance indicators that serve both as goals and controls (often in ratio format).
Establish internal agreements for service provision within the organization that facilitate spending coordination, with the agreements being demand‐driven.
Base controls on key performance indicators, rapid information updates, and a “coach and support” leadership style.34
(d) AN EFFECTIVE ETHICS AND COMPLIANCE PROGRAM GOES BEYOND A CODE OF ETHICS/CONDUCT. One thing businesses and nonprofits have learned in recent years it that it is not enough to have a code of ethics, or what some call a code of conduct. This is partly due to the day‐to‐day behavior that employees see around them, which they assume to be rational and normal.35 A code communicates a clear set of expectations to employees but does not prevent ethical lapses. Enron had a wonderful code of ethics. Realistically, no organization can prevent every conceivable instance of unethical behavior, but it can greatly reduce the chance of such behavior occurring and possibly forestall repeated occurrences.
Joan Dubinsky, drawing on work done with Dawn‐Marie Driscoll and W. Michael Hoffman at the Center for Business Ethics at Bentley College, has devised steps and related diagnostic questions that comprise an effective ethics and compliance program. These steps follow a values‐oriented rather than a rules‐focused approach. We have adapted the framework slightly in Exhibit 4.11. Notice that having a code of ethics/conduct is only one of the 10 steps. Your management team and board should run through the questions periodically to ensure the steps are being implemented.
Source: Adapted from Joan E. Dubinsky and Curtis C. Verschoor, “10 Steps to an Effective Ethics and Compliance Program,” Strategic Finance (December 2003): 2, 4.
Exhibit 4.11 Ten Steps to an Effective Ethics and Compliance Program
Every nonprofit manager has a moral responsibility to ensure that the organization's objectives are satisfactorily achieved. Saying “we are nonprofit, therefore not business‐like” is not an excuse for ineffectiveness or inefficiency. In his classic management guide, Chester Barnard noted that the ED/CEO is responsible for creating “moral codes for others,” establishing morale and employee loyalty, and “the morality of standards of workmanship.”36 As Peter Drucker commented in a 1999 interview, “The vast majority of nonprofits are not so much badly managed as not managed at all.”37 We note increasing professionalization in the sector in the 21st Century, but suspect that Drucker's statement is largely true for many smaller and newer organizations.
The Ethics Resource Center in its 2014 Ethics Survey offers 6 key elements that make an ethical culture.
Formal policies and procedures which explicitly document ethics policies. They establish an ethical code of conduct and incorporate conflict‐of‐interest, whistleblower protection and transparency/disclosure policies.
Monitoring compliance with procedures that include effective internal controls, periodic signing of acknowledgement of policies and prompt action when an issue arises. They also recommend measuring employee beliefs and attitudes about the ethical culture and publicizing results.
Communications about ethics should be consistent in internal meetings, speeches, blogs, and other forms of communications.
Leadership: The CEO, senior managers, and board members all need to lead by example by consistently adhering to the highest standards. This includes being transparent about organizational performance.
Consistency: Application of policies and practices uniformly (avoid favoritism, special treatment and side agreements).
Accountability: Everyone must be held accountable for his or her conduct. Take swift and fair action when misconduct occurs and accept appropriate organizational responsibility.38
4.5 STRUCTURE, ACCOUNTABILITY, AND ETHICS IN PRACTICE
Immediately following the passage of SOX in 2002, several surveys were conducted to help us draw a profile of actual practices in today's nonprofit. We include Grant Thornton's 2004 board governance survey, the Association of Executive Search Consultants senior executive pay survey, a survey of Canadian recreation associations, and a survey of US healthcare executives.
Grant Thornton surveyed 700 nonprofits and determined that:
Two‐thirds of the nonprofits' boards have discussed the implications of Sarbanes‐Oxley for their organizations.
Almost half of the organizations have made changes in corporate governance policies in the past years, largely due to the new law and possible state and local government initiatives.
84 percent of the organizations now have audit committees, up from 77 percent in 2003.
55 percent of the organizations have a combined committee handling audit and finance, even though this is not a recommended practice due to the different functions that are served by audit committees and finance committees.
Although it is recommended that the audit committee meet with external auditors at least twice a year, 62 percent of the audit committees met with auditors either once or not at all.
83 percent of the organizations maintain a conflict‐of‐interest policy; of these, 85 percent have board members sign the policy, 49 percent have executive managers sign, and 39 percent have all employees sign.
The CEO or CFO of 36 percent of the organizations hires the external auditor, even though the best practice is for the audit committee or the board of directors hire and oversee the external auditor.39
Nezina and Brudney investigated benefits and costs to nonprofit organizations who adopted key provisions of Sarbanes‐Oxley (SOX). Their survey found:
More senior executives now trust for‐profit companies more than nonprofit organizations regarding honesty in administering pay practices. This startling finding was unearthed by the Association of Executive Search Consultants worldwide survey: 48 percent of executives state that for‐profits have a better reputation for honesty in executive pay practices, as opposed to 40 percent asserting that nonprofits have a better reputation.41 This study suggested that businesses' stakeholders demand disclosure, unlike those holding a stake in nonprofits, who tend to scrutinize nonprofits less. In our opinion, this is probably less true for larger organizations like the Red Cross or American Heart Association, however.
Malloy and Agarwal surveyed a large Canadian sports federation with 70 affiliates and inquired into the factors driving one's perception of ethical work climate.42 They found that length of service, existence of ethical codes, organization size, and the degree of peer pressure do not effectively influence that ethical perception. Instead, the level of education (more educated workers tended to rate the organization higher on a scale of “Machiavellianism”), decision style (autocratic style led to a greater perception of “Machiavellianism”), and superior and volunteer influence do influence one's perception of an ethical work climate. Since climate has been shown to influence ethical conduct, these are important findings.
Jurkiewicz surveyed 1,069 senior and midlevel nonprofit health executives in the United States and discovered that these individuals perceived intense ethical tensions. These tensions were linked to many factors, including the level of care provided by the institution, budget improprieties, lying, and personnel issues. The higher‐level executives felt they were unable to change their organizations' ethical environments. The majority (59 percent) stated that they knew of overtly unethical business practices in their organizations. The top five issues they listed when asked what unethical practices they were aware of and would eliminate if they could were: privacy/confidentiality violations, discrimination, hiring and personnel matters, board members' preferential treatment, and lying to clients. These executives also expressed a strong desire to get rid of these practices, but the fact that many of the conflicts arose between them and either higher‐level executives or board members may have led to an inability to right the wrongs.43
4.6 NEW FORMS
Recent years have seen an increase in cross sector (private, government, and nonprofit) collaboration working together to solve societal problems that individual organizations cannot solve alone. In a book published in 2013, Eggers and MacMillan introduce the concept of the Solution Economy that relies on cross‐sector convergence and new forms of collaboration. The book cites multiple examples of how these collaborations can solve problems that require new ways of thinking and working. They note that in some cases, government acts at cross‐purposes (e.g., fighting traffic congestion while subsidizing road use). While this may seem counter‐intuitive, the authors provide multiple examples of how this is already at work and realizing some success. Their main theme is that traditional roles for these types of organizations are being re‐examined and re‐purposed. They identify a growing global movement of organizations joining forces to deliver better social outcomes. This was generally considered to be in the realm of government and nonprofits but commercial organizations have joined in these efforts as well.44
A new form of private company engagement is emerging called the B Corporation. These organizations look beyond stockholder expectations to stakeholder needs. They are redefining success in business by using their innovation, speed and capacity for growth to help alleviate social and environmental problems in addition to earning a fair return for their shareholders. The “B” in B Corporation stand for benefit, but is not the same as a benefit corporation (L3C discussed below). Sustainability is a primary value in these types of organizations and they must meet a rigorous set of standards to be certified as B Corporations.45
L3C Companies are limited liability companies (LLC) that are considered to be hybrid organizations. These companies are designed to attract private investments in ventures designed to provide a social benefit. The L3C has an explicit primary charitable mission and only a secondary profit concern.
The L3C Company has a statutory design that matches the requirements of a program related investment (PRI) which is an investment made by private foundations with a socially beneficial purpose that is consistent with the foundation's mission. The L3C form eases the PRI statutory requirements for these types of investments. The L3C is not a nonprofit organization so the IRS tax exemption is not involved. They pay income taxes the same way any company does but this growing trend provides a fair return for owners while serving a societal purpose.46
These new forms and initiatives create the need for financial literacy that goes beyond knowledge of nonprofit finance. They provide for new possibilities and enable greater flexibility and creativity in meeting societal challenges. The financial management discipline requires cross‐sector knowledge as well as the capacity to engage on a growing edge.
4.7 CONCLUSION
Regardless of how well an organization's finance function is managed in areas such as budgeting, strategic decision making, cash management, investing, and risk management, breakdowns in accountability and ethics can do irreparable damage to the organization's reputation and fundraising ability. Wise decisions regarding the organizational structure, accountability structure, and ethics code and oversight reduce the chance of serious problems.
We conclude with several pointers that bring this chapter's material together. Drawing on work done by Sheldon Whitehouse, who argues that Sarbanes‐Oxley guidelines serve as a useful benchmark for nonprofits even though most of these provisions do not legally bind the nonprofit, the current Form 990 does require a statement about ethics policies and governance in significant detail. Part VI, Section B lists Whistleblower Protection and Document Destruction Policies which are required for nonprofit organizations.47 Here is a suggested checklist:
Ethics statement
Are all relevant areas addressed?
Do we have it in written form, updated as appropriate?
Do all board members read and sign the statement when joining the board, and regularly thereafter?
Do board members also sign a statement affirming that they have neither a criminal record nor personal bankruptcy record?
Conflict of interest
Has a thorough policy, including policy planks regarding disclosure, been adopted?
Are loans to directors or senior staff forbidden in this policy?
(For any conflicts not forbidden) Are any apparent conflicts of interest reviewed and approved through a careful reporting and recusal process?
Audit review
Is the organization large enough to have an annual outside audit? [We would add: If it is not, is a compilation or review done instead?]
Is there an audit committee?
Does the audit committee meet Sarbanes‐Oxley independence and expertise standards?
Is the audit committee made up solely of individuals who are not board members?
Is at least one audit committee member a financial expert?
Does the organization consider rotating its outside auditor every five years or so? [For some organizational types, particularly faith‐based organizations, audit firms possess the needed interest and expertise to serve audit, compilation, and review needs.]
Certified financials
Does the ED/CEO sign off to the board on the financial statements?
Does the board comprehend, review, and approve the IRS Form 990 through appropriate committees?
Does the board have a policy requiring appropriate disclosures?
Education
Is there an education policy for board members?
Do policies specify fiduciary and governance obligations and the necessary financial expertise to make prudent decisions in areas pertinent to this organizational type?
Whistleblowers
Has a means been established for whistleblowers [employees having become aware of and now reporting illegal or unethical conduct] to identify problems to management and to the organization's legal counsel?
Is the policy communicated clearly and regularly to staff?
Has the organization established a non‐retaliation policy, and is it communicated to staff and carefully followed?
Document retention
Is there a policy stipulating which documents should be retained and for how long, and for the destruction of documents?
Does the policy allow for the protection of the privacy of confidential information, including personal financial or medical information as well as sensitive business information?
Attorneys
Has the board requested and received from the organization's attorney a review of the attorney's reporting and disclosure obligations related to the Rules of Professional Conduct? Does the board understand the contents of this review?
Has the board examined the SEC reporting requirements for attorneys and adopted portions deemed appropriate?48
Careful attention to the foregoing issues goes a long way toward ensuring that your organization's governance, accountability, and ethical stance will aid its reputation and fundraising ability in the years to come. Appendix 4A provides a sample set of bylaws for an educational foundation. Appendix 4B portrays the responsibilities and qualifications you should look for in your board, board chair, ED/CEO, treasurer/CFO, board secretary, board nominating committee, board finance committee, and volunteers. Appendix 4C provides a listing of some of the best governance and ethics resources should you wish to learn more.
Governance and accountability structures depend on a sound set of financial policies for their implementation. In our next chapter we survey the policies that will support your control and treasury functions in achieving and maintaining financial management proficiency.
Collect past‐due accounts