December 5, 2007

Protecting Small Non-Profits from Fraud: An Ounce of Prevention

Small non-profit organizations are very vulnerable to fraud.When I say small, I mean small: organizations that raise less than $100,000 per year and have only one paid staff person or no paid staff persons. I'm talking about neighborhood associations, sports and recreation leagues and all manner of civic, political and religious groups. These small organizations are vulnerable to fraud for three reasons:1.The person responsible for collecting and disbursing funds is also the individual who provides the financial reports.2.Many small organizations raise much of their funds in cash. Cash is more easily misappropriated than checks.3.Small non-profits are run by trusting and committed individuals. Sadly these individuals tend to be too trusting.Here are some sadly typical fraud scenarios:1.Cash collected at fund raising events is siphoned off by the organization's treasurer or some other individual with access to cash collections.2.The treasurer writes checks to themselves out of the organization's checking account.3.The treasurer makes unauthorized and inappropriate payments to vendors for products and services for their use rather than the organizations.Example. Onandon is a non profit organization devoted to helping the children of parents who were excessive talkers. Appropriately enough their major fund raising events are silent auctions. Most of the donations at these auctions are made in cash and deposited in the organizations checking account. The long standing treasurer, Mal Feasance, has been skimming cash proceeds from these events to the tune of about $300 per auction. Plus he has been writing checks to himself in the amounts of about $2,000 per year for several years. Mal has complete control over the checking account and prepares all the financial statements. Ounces of Prevention There are three relatively inexpensive and effective ways to prevent and detect these common frauds;1.Proper Control of Bank Statements2.Requiring two signatures on every check3.Preparation of BudgetsBank StatementsIf an organization has a treasurer who collects and disburses funds from a checking and/or savings account, the monthly bank statements should be sent directly to some other board member of the organization before it is passed on to the treasurer. The recipient of the bank should examine the canceled checks to see that disbursements have been made to only appropriate persons or vendors in reasonable amounts. Using this control would prevent Mal from writing checks to himself. Note: this ounce of prevention will not work unless the person receiving the statement actually opens the statement and examines the canceled checks. If the person receiving the statements just passes them along without opening the envelope, this sends absolutely the wrong message to the treasurer.Two Signature Check Policy Require that every check have two signatures. Barring collusion, this would prevent someone like Mal writing checks out to himself. The requirement of having two signers on a check definitely can slow things down and prove cumbersome. But loss of efficiency and convenience is a reasonable price to pay for protecting an organization's scarce resources.Budgets Every organization should have an annual budget approved by the board of directors. The idea is to have a reasonable expectation of revenues and expenses. With a budget actual results can be compared with expected results. If actual expenses are greater than expected this could be an indication that inappropriate expenditures are being made. Similarly, if proceeds (particularly cash) are being deposited at less than expected levels this might indicate that skimming is taking place. If the organization has cash fund raisers such as dinners, car washes, bingos and so on there ought to be budgets for each event. In the case of fund raisers such as car washes, bingo games and the like it is fairly easy to test for cash theft. Some person other than the person responsible for handling and depositing the cash ought to perform a count of the cars washed, bingo cards sold and apply this number to the unit price to compute the expected amount of cash raised. Example. Suppose Onandon has a bingo game at which cards are sold for $15 apiece. If 200 cards are sold, the net cash deposit should be $3,000.A Question of Trust There is a trade-off involved in implementing the above fraud controls in small organizations. These controls assume that responsible individuals may not be fully honest. When people work closely together in small organizations it is natural for trust to build over time. But diligent observation of fraud controls requires people to maintain a certain degree of distrust. This means that small nonprofits have to be willing either to maintain a degree of mistrust to protect their assets or maintain trust and risk loss of their assets. This is usually not an easy trade-off to make.The Responsibility of the Board of DirectorsIt is the responsibility of the board of directors to insure that adequate controls are in place to protect the organization's assets. In small organizations it will be necessary for actual board members to be involved in the implementation of the controls discussed here. It is also important for board members to understand why these controls are necessary. If board members lose sight of the importance of these controls they are apt to become lax in their implementation and as a consequence the organization's assets will be placed at risk.
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About the Author: Michael Sack Elmaleh is a Certified Public Accountant and Certified Valuation Analyst. His book, "Financial Accounting: A Mercifully Brief Introduction", has received wide critical acclaim. He has nearly 30 years of accounting and 10 years of teaching experience.His web site is