BOARDS / GOVERNANCE   FINANCIAL MANAGEMENT

The Finance Committee: What is it and What Does it Do?

 

Calculator and Graphs

A board of a nonprofit is generally empowered to create committees at its discretion, subject to the organization’s bylaws and the laws of the state of its incorporation.  For each committee it creates, the board should determine the level of authority to be given to the committee and how it will maintain appropriate oversight of the committee’s actions.  When properly used, committees can serve to alleviate some of the workload of the full board and to help increase board efficiency (for more information on committees generally, see our prior post on board and non-board committees, standing and ad hoc committees, and common missteps).

One common committee that nonprofits choose to create is a finance committee.  Although the specific parameters for and expectations of each committee should be set out by the board in a charter or other document, a finance committee will typically be responsible for monitoring and communicating to the board about the organization’s overall financial health.  Its core duties are likely to include participating in and overseeing:

  • the development of the organization’s budgeting and financial planning,
  • the creation of the organization’s internal controls,
  • the preparation and distribution to the board of timely, accurate, and user-friendly financial reports, and
  • the implementation of safeguards to protect the organization’s assets. 

The finance committee may be tasked specifically with (1) working with the staff to develop an annual and/or multi-year operating budget, (2) setting long term financial goals for the organization, such as creating working capital or cash reserve funds, gross and net revenue targets, or creating a fund for maintaining or replacing equipment, and (3) ensuring adherence to the budget and achievement of the adopted goals by monitoring and reporting the organization’s financial activity.   With respect to internal controls and accountability policies, the finance committee may take the lead in creating such policies, ensuring that they are appropriately documented in a manual or otherwise, and confirming that they are being followed.  The committee may also work with the staff to develop useful and readable formats for financial reports, set expectations regarding the desired quantity and subjects of reports, and present financial reports to the full board.  In presenting the financial reports to the board, it may be prudent for the finance committee to ensure that the board is alerted to any existing or projected financial problems the organization is facing or is expected to face.  Finally, the finance committee may be charged with reviewing the organization’s insurance coverage to ensure that its assets are appropriately protected.

When it comes to selecting the individuals to serve on the finance committee, the board will need to consider who has the appropriate financial experience and knowledge.  If an organization has a sufficient number of board members with financial backgrounds and understanding, it may be possible for the finance committee to be structured as a board committee composed solely of directors.  In this case, the board will need to consider and determine the scope of authority it wishes to delegate to the committee and whether it wants the committee to be authorized to act with the authority of the board in approving the financials or otherwise.  If, however, an organization has a small board or otherwise does not have a sufficient number of directors who are appropriate to serve on the finance committee, it may need to look beyond board members to identify individuals who can add valuable expertise to the committee.

In some smaller organizations, the finance committee may also take on the duties that may fall to an audit committee and/or an investment committee in a larger or more financially complex organization.  The principal responsibilities of an audit committee are typically to recommend to the board the retention and termination of an independent auditor, review the audit report with the auditor, present the report to the full board, and recommend any changes in organizational or management practices as a result of the audit to ensure compliance with best practices.  Note that, under the California Nonprofit Integrity Act, certain California organizations may be required to create and maintain an audit committee and that, if the organization also has a finance committee, it must be separate from the audit committee.  Members of the finance committee may serve on the audit committee, but must constitute less than half of the audit committee and the chair of the audit committee may not be a member of the finance committee.  A separate investment committee may make particular sense for an organization that has considerable reserves or manages an endowment.  The investment committee may be responsible for hiring and evaluating professional advisors, monitoring the organization’s investment performance, and drafting an investment policy based on the organization’s risk tolerance and other factors.

Keep in mind that, although the finance committee may serve in a leadership role in the areas discussed above, the entire board has fiduciary responsibilities for the organization and remains accountable for protecting the organization’s financial wellbeing. 

CALIFORNIA LAW   FINANCIAL MANAGEMENT

FTB 199N: Annual Electronic Filing Requirement for Small Tax-Exempt Organizations

FTB

For accounting periods starting on or after January 1, 2010, small California tax-exempt organizations are required to file an annual return with the Franchise Tax Board (FTB) by the 15th day of the 5th month after the close of the organization's tax year. Currently, tax-exempt organizations with annual gross receipts that are normally $50,000 or less may complete this requirement by submitting a Form 199N, or what is commonly referred to as the e-Postcard, with no cost to file. (See FTB Form 199 and electronic Form 199N requirements). These organizations may also elect to instead file a Form 199 but organizations with annual gross receipts that are normally over $50,000 may only complete their annual filing requirement by submitting the longer and more detailed Form 199. Previously, the FTB required only those organizations that had an average gross receipts amount of more than $25,000 to file an annual return.

The California e-Postcard requires basic information about the organization, such as:

  • Entity ID number or California Corporation number
  • Organizational name (and any other names the organization uses)
  • Federal employer identification number
  • Tax year (or any changes to the initial tax year)
  • Mailing address
  • Name and address of a principal officer
  • Website address, if applicable
  • Total gross receipts
  • Whether the organization terminated or went out of business, if applicable
  • Contact person's name and telephone number

An organization that fails to file this form for three consecutive years will automatically lose its exempt status. Some organizations are exempt from this filing requirement such as churches and political organizations. Organizations that have an exemption application pending with the FTB can still file the e-Postcard so long as the organization's gross receipts are normally $25,000 or less.

For additional information about the filing, or to file the e-Postcard, go to: 199N California e-Postcard.

CALIFORNIA LAW   EVENTS   FINANCIAL MANAGEMENT

UPMIFA: One Year Later

On January 14, 2009, Jill S. Dodd of Manatt, Phelps & Phillips, LLP and Bert W. Feuss of the Silicon Valley Community Foundation presented "UPMIFA: One Year Later" for the Northern California Planned Giving Council.  UPMIFA is the acronym for the Uniform Prudent Management of Institutional Funds Act, which California adopted effective January 1, 2009, and which replaced the Uniform Management of Institutional Funds Act (UMIFA).  UPMIFA provides rules about how an endowment fund can be invested and spent.

Endowment Defined

Under UPMIFA, an endowment fund is generally defined as a fund not wholly expendable on a current basis under the terms of a gift instrument.  An endowment fund does not include either a fund that the institution's board itself designates as an endowment ("quasi-endowment"), or a program-related (exempt function) asset.  A gift instrument may be any written record from the donor or from the institution so long as both parties were, or should have been, aware of its terms.

Spending Restrictions

UPMIFA provides the following spending restriction from an endowment fund:  "so much … as the institution determines to be prudent for the uses, benefits, purposes, and duration for which the endowment fund is established."  The factor to consider in making this determination are:

  1. Duration and preservation of fund
  2. Purposes of institution and the fund
  3. General economic conditions
  4. Possible effect of inflation or deflation
  5. Expected total return from income or appreciation
  6. Other institutional resources
  7. Institution's investment policy

In California, spending more than 7% of the average fair market value of the endowment fund (averaged over the last three or more years) creates a rebuttable presumption of imprudence.  Spending less, however, does not create a presumption of prudence.  So, institutions should evidence their consideration of the 7 factors listed above.  Finally, the spending rules under UPMIFA will not apply if the gift instrument explicitly sets forth contrary spending criteria (e.g., 10% each year).

Implementation Issues

Dodd and Feuss identified the following implementation issues regarding decision of whether to spend or accumulate:

  • What are your organization's policies?
    • Spending policy should support the needs of both current and future beneficiaries
    • Spending policy should be aligned with investment policy 
  • Interpreting donor gift instructions
  • Past solicitations of endowment gifts
  • Commingling of "true endowments" with "quasi endowments"
  • Determining a spending rate
  • Treatment of underwater funds (lower market value than original/historical gift value)
    • What is a prudent amount of time to recover historical gift value while also preserving purchasing power for a fund that is intended to last in perpetuity?
    • Reduce spending by variable amounts based on the amount each fund is underwater
    • What is operationally feasible?  How many variables can you manage?
    • What other resources can be tapped to close funding gap?
    • Is the donor willing to modify the terms of the gift instrument?

In addition, the presenters listed a number of variables in the spending equation (e.g., investment return expectations, investment expenses, smoothing formulae) and marketing/donor considerations.  And they emphasized that it was most important for boards to go through the process of considering these issues, factors, and variables in coming up with appropriate policies.  Such actions would go a long way in protecting board members against a charge of breaching their duty of care, even if the endowment funds perform poorly.

For additional information on UPMIFA:

Uniform Law Commission – UPMIFA website (including state law comparisons)

UMIFA and UPMIFA: The Law of Endowments by Erik Dryburgh

UPMIFA: New Law Affects Lawyers Advising (and Serving on) Charity Board in California by Paul J. Dostart, Barbara A. Rosen & Patrick B. Sternal - California Tax Lawyer (Fall 2009)

FINANCIAL MANAGEMENT

Minimizing Financial Fraud

Despite the strong ethical culture of the nonprofit sector, the EthicsResource Center (ERC) has reported that financial fraud is more prevalent in nonprofits than for-profit businesses or the government. In their article, “Minimizing financial fraud” (Nonprofit Observer, Fall 2008), San Francisco Bay Area CPA Firm Lautze & Lautzeprovides a quick guide to a multi-faceted defense of process, people, and prosecution/publicity to combat financial fraud.

First Line of Defense – The Process.  A sound accounting process can most simply be understood as an internal system of controls that allows an organization to “divide and conquer.”

  • Divide tasks: By dividing the responsibilities of handling incoming funds and expenses among many people, an organization can reduce the likelihood of cash disappearing without at least one employee’s knowledge. For example, separate individuals should be responsible for opening mailed donations, making bookkeeping entries, and depositing the checks, respectively. This is similarly applicable to expenses in which the person who authorizes a purchase should be different from the person who writes the check.
  • Divide finances into manageable parts: System controls such as using receipts with preprinted tracking numbers for outgoing money and confirming incoming invoices against the goods or services billed for is a great way to ensure the individual transactions that make up the organization’s cash flow have all been be accounted for.
  • Use experts to help conquer trouble spots: Occasional audits can help locate any gaping loopholes that exist in the current process and identify areas where further structure  is needed.


Second Line of Defense – The People
. Financial fraud prevention with employees can occur as early as the employee application process. Positions that involve access to and control over sensitive materials such as cash and donor records require diligent screening.

  • Background checks and calling references and previous employers are essential.
  • The interview itself provides another opportunity to learn how the applicant would handle certain scenarios (i.e., what the applicant would do if he or she thought records were being kept inaccurately) before the individual ever has access to or control over the organization’s sensitive materials.

Additionally, supervision and accountability should continue once the employee is hired.

Third Line of Defense – Prosecution and Publicity. An organization that has suffered financial fraud should not indulge in a concern over bad publicity at the cost of responding to the fraud “swiftly and appropriately.” Often, a fear of bad publicity will cause an organization to sweep the problem under the rug or feel reluctant to prosecute or terminate the employment of those involved in the theft. However, pursuing applicable employment consequences and criminal charges against those responsible for committing financial fraud not only sends a message to the public that the organization is working to preserve its integrity but also sends a message to current employees that reinforces the organization’s ethical culture that such behavior is not tolerated. Although a financial fraud situation carries some potential for negative publicity, taking action can actually generate a powerful and positive external and internal publicity effect.

The Lautze & Lautze Nonprofit Observer publication, Fall 2008, is available here.

- Emily Chan

FINANCIAL MANAGEMENT

Avoid Common Accounting Missteps

In their Fall 2008 Nonprofit Observer publication, San Francisco Bay Area CPA Firm Lautze & Lautze offers advice on how to avoid 8 common accounting mistakes among nonprofits (summarized below):

1. Follow accounting procedures

Every nonprofit, large or small, should establish a formal, documented, and detailed accounting process that includes all aspects of managing the organization’s money (i.e., accepting donations, paying bills, depositing donations, etc.). The procedures should be in writing and followed every time by the person who regularly performs the accounting task and anyone that should fill in for that person.

2. Accurate data entry

“Little errors don’t go away; they just become bigger problems.” No discrepancy should go unnoticed. Double-check entries each time and check accounts against bank statements with each entry.

3. Establish a budget

Budgets provide a baseline to prevent overspending and allow the investment of surplus money. Beginning with a basic budget that can be tailored with time is better than no budget at all. Additionally, a “miscellaneous category” is appropriate but should not be the majority expense.

4. Select experts in nonprofit accounting and stay informed

Nonprofit accounting has certain accounting responsibilities that are not applied universally (i.e., contributions). Once an expert in nonprofit accounting has been hired, a board must continue to stay informed about the basic accounting operations and the process.

5. Categorize all money

All money, both in and out, should be appropriately categorized. This is especially crucial for a nonprofit that receives earmarked donations. Everyone involved should understand the different accounts and how they are used.

6. Use a filing system

Establish and follow a daily or weekly filing schedule for all accounting paperwork (i.e., receipts, invoices, bank statements, etc.).

7. Establish a petty cash fund

This fund is aimed at satisfying small expenditures that are easier handled with cash (i.e. buying a pizza for volunteers staying late). It should be handled with just as much care as all other money of the organization. The fund should authorize access for only a limited number of individuals, kept under lock and key, and require receipts for all expenditures.

8. Automatic back-ups of accounting information

A Web-based system has the additional advantage of storing the information off-site should a natural disaster, fire, or other emergency occur.

The key to avoiding many common accounting mistakes is taking your time and double-checking your actions. When in doubt, consult an accounting professional.

The Lautze & Lautze Nonprofit Observer publication, Fall 2008, is available here.

- Emily Chan