Chapter 43. Managing Finances | Community Tool Box

• What are the elements of an annual budget?

• Why should you prepare an annual budget?

• Some practical considerations

• Planning and gathering information to create a budget

• Putting it all together: Creating and working with a budget document

 

Download the Program Based Budget Template mentioned in this video here.

 

What are the elements of an annual budget?

It can be daunting to start the process of creating a budget, especially if you're not familiar with some of the common accounting and budget terminology you will encounter, so we have provided a glossary of terms covered here, located toward the bottom of the page under the In Summary section of the page.

It is important for organizations to create accurate and up-to-date annual budgets in order to maintain control over their finances, and to show funders exactly how their money is being used. How specific and complex the actual budget document needs to be depends on how large the budget is, how many funders you have and what their requirements are, how many different programs or activities you're using the money for, etc. At some level, however, your budget will need to include the following:

• Projected expenses. The amount of money you expect to spend in the coming fiscal year, broken down into the categories you expect to spend it in - salaries, office expenses, etc.

Fiscal year simply means "financial year," and is the calendar you use to figure your yearly budget, and which determines when you file tax forms, get audited, and close your books. There are many different fiscal years you can use. Businesses often use the calendar year -- January 1 to December 31. The federal government's fiscal year runs from October 1 to September 30. State governments -- and therefore state agencies and many community-based and non-profit organizations that receive state funding - usually use July 1 to June 30. Most organizations adopt a fiscal year that fits with that of their major funders. You'll want to prepare your budget specifically to cover your fiscal year, and to have it ready before the fiscal year begins. In many organizations, the Board of Directors needs to approve a budget before the beginning of the fiscal year in order for the organization to operate.

• Projected income. The amount of money you expect to take in for the coming fiscal year, broken down by sources -- i.e. the amount you expect from each funding source, including not only grants and contracts, but also your own fundraising efforts, memberships, and sales of goods or services.
• The interaction of expenses and income. What gets funded from which sources? In many cases, this is a condition of the funding: a funder agrees to provide money for a specific position, for instance, or for particular activities or items. If funding comes with restrictions, it's important to build those restrictions into your budget, so that you can make sure to spend the money as you've told the funder you would.
• Adjustments to reflect reality as the year goes on. Your budget will likely begin with estimates, and as the year progresses, those estimates need to be adjusted to be as accurate as possible to keep track of what's really happening.

Why should you prepare an annual budget?

• It sharpens your understanding of your goals
• It gives you the real picture - by accurately showing you what you can afford and where the gaps in funding are, your budget allows you to plan beforehand to meet needs, and to decide what you're actually able to do in a given year
• It encourages effective ways of dealing with money issues - by showing you what you can't afford with known income, a budget can motivate you to be creative - and successful - in seeking out other sources of funding
• It fills the need for required information - the completed budget is a necessary element of funding proposals and reports to funders and the community
• It facilitates discussion of the financial realities of the organization
• It helps you avoid surprises and maintain fiscal control

Some practical considerations

It's important to note that not everyone has the skills or desire to create and manage a budget single handed. Fortunately, there's help available, both within the organization (by hiring a bookkeeper, accountant, or CFO) and elsewhere. There are organizations like SCORE (Service Corps of Retired Executives) that exist to assist with things like budgeting. Local universities or government agencies may maintain offices that help small businesses and non-profits with financial planning. The possibility of an accounting or similar position shared with or loaned by another organization may also exist.

Planning and gathering information to create a budget

The preliminaries: What will you need to spend money on next fiscal year?

It is important to know what the priorities are and what makes the most sense for the organization at its particular stage of development. Actually figuring out what you should be spending your money on involves an organization-wide planning process.

Consider these questions:

• What are the activities or programs that will do the most to advance your cause and mission, and that you think you can carry out with the income and resources you know you have or can foresee?
• How many staff positions will it take to run those activities or programs well?
• How much, how (hourly wages, salary, consultant fees, benefits), and from what sources will those staff members be compensated?
• What else will be needed to run the organization and its activities -- space, supplies, equipment, phone and utilities, insurance, transportation, etc.?

Estimating expenses: What will it all cost?

Step 1: Develop ways of estimating your expenses

Estimate your expenses for the coming fiscal year. In some cases -- yearly rent, or salaries, for instance -- you'll probably have real figures for what these expenses will be. In other cases -- telephone and utilities, etc. -- you'll have to estimate of an average monthly cost.

Be sure to add in some money in a "miscellaneous" category, in order to be prepared for the unexpected. There are always expenses you don't anticipate, and it is part of conservative estimation to make allowances for them.

Conservative estimation: When preparing a budget, try to be as accurate as possible. Always use actual figures if you have them, and when you don't, estimate conservatively for both expenses and income.

When you estimate expenses, guess high -- take your highest monthly phone bill and multiply by 12, for instance, rather than taking an average. By the same token, when you're estimating income, guess low -- the smallest number realistically possible. Estimating conservatively when you plan your budget will make it more likely that you stay within it over the course of the year.

Step 2: List the estimated yearly expense totals of the absolute necessities of the organization

For most organizations, they include, but aren't necessarily limited to:

• Salaries or wages for all employees, listed separately by position
• Fringe benefits for all employees, also broken out by position. Remember that even if you have no formal fringe benefits, you still have to pay part of the Social Security and Medicare taxes, as well as Workers' Compensation and Unemployment Insurance, for any regular employees (people who work a fixed schedule). These costs can be considerable, amounting to 12 to 15% added on to your total payroll.
• Rent and/or mortgage payments for the organization's space
• Utilities (heat, electricity, gas, water)
• Phone service
• Internet provider or server costs, depending on your organization's needs
• Insurance (liability, fire and theft, etc.)

Step 3: List the estimated expenses for things you'll need to actually conduct the activities of the organization

• Program and office supplies: pencils, paper, software, educational material, post-it-notes, etc.
• Program and office equipment. Wherever you classify computers and peripherals, copiers, faxes, etc., be sure to figure in the annual estimated costs of repairs or service contracts in addition to purchase or lease costs.

For budgeting purposes, it may be useful to separate program supplies and equipment from office supplies and equipment. In the case of state and federal funding, at least some office expenses are often considered "administrative", and funding for administrative expenses may be limited, sometimes to as little as 5% of your budget.

Step 4: List estimated expenses for anything else the organization is obligated to pay or can't do without

• Loan payments
• Consultant services - these may include an annual audit, accounting or bookkeeping services, payments to other organizations for specific services, etc.

Most non-profit organizations are required, either by funders or by the IRS, to undergo an audit every year. This means that a CPA (Certified Public Accountant) must check the organization's financial records to make sure they are accurate, and work with the organization to correct any errors or solve problems. If there is nothing illegal or seriously wrong, the CPA then prepares financial statements using the organization's books, and certifies that the organization follows acceptable accounting practices and that its financial records are in order. The larger an organization's budget, the more complicated an audit is likely to be, the more time it is likely to take, and the more it is likely to cost. An audit of a $100,000 budget might cost $2,000 to $4,000, for instance; that of a $1 million budget might cost $15,000.

• Printing and copying, if not done within the organization
• Transportation: travel expense for staff, participants, and/or volunteers; and vehicle upkeep and expenses for any organization-owned vehicles
• Postage and other mailing expenses

Now that you've gathered your necessary expenses, you can take a look at your wish list.

Step 5: List estimated expenses for things which you aren't sure you can afford, but would like to do

These might include staff positions, new programs (including staff, supplies, space), equipment, etc.

Step 6: Add up all the expense items you have listed

This total is what you would like to spend to run your organization. In other words, it's your projected expense for the coming fiscal year.

Estimating Income: Where are we going to get all that money?

Use last year's figures, if you have them, as a baseline and estimate conservatively, rather than being overly optimistic, and laying yourself open to disappointment and worse.

Step 1: List all actual figures or estimates for what you can expect from your known funding  sources

This includes sources that have already promised you money for  the coming year, or that have regularly funded you in the past. These may include federal, state or local government agencies; private and community foundations; United Way; religious organizations; corporations or other private entities.

Step 2: If your organization fundraising, estimate the amount you'll raise in the next fiscal year

Fundraising efforts might include community events (a raffle, a bowl-a-thon), more ambitious events (a benefit concert by a world-class performer), media advertising, or phone or mail solicitation.

Step 3: If you charge fees or sell services, estimate the amount you'll take in from these activities

This could be consulting services your organization offers, training materials that you created that can be sold to others interested in the same work, etc.

Step 4: If you solicit members who pay yearly dues or fees, estimate the amount that membership will yield

Step 5: If you sell items, estimate what these sales will bring in

This could include pins, T-shirts, books, blood pressure cuffs, etc.

Step 6: If you sublet or rent space to others, record the estimate of what this will bring in

Step 7: If you have any income from investments, estimate what you'll realize from these

This could include investments, endowment income, annuities, or interest income (e.g., from a certificate of deposit, or from a Money Market or checking account)

Step 8: List and estimate the amounts from any other sources that are expected to bring in some income in the coming fiscal year

Step 9: Add up all the income items you have listed

This total is the money you have to work with, your projected income for the next fiscal year.

Putting it all together: Creating and working with a budget document

Analyzing and adjusting the budget

Step 1: Lay out your figures in a useful format

If your budget is going to be useful, it has to be organized in such a way that it can tell you exactly how much you have available to spend in each expense category.

The easiest way to do this is by using a grid, usually called a spreadsheet. In its simplest terms, a spreadsheet will have a list of funding sources along its top edge and a list of expense categories running down its left-hand edge, so that each vertical column represents a funding source, and each horizontal row represents an expense category. Where each column and row meet (this meeting place is called a cell), there should be a number representing the amount of money from that particular funding source (the column) that goes to that particular expense category (the row). A simple spreadsheet for a small organization might look like this:

Spreadsheet: United Consolidated Metropolitan Health Agency (UCMHA)

	Dept of Public Health	United Way	Membership	Dept of Welfare	Totals
Salaries	15,000	2,500	2,500	21,000	41,000
Fringe	3,000	500	500	4,200	8,200
Supplies	300	200	0	500	1,000
Equipment	1,500	1,500	0	0	3,000
Phone	400	150	0	600	1,150
Utilities	500	200	0	500	1,200
Insurance	800	200	0	400	1,400
Rent	4,000	500	0	3,000	7,500
Totals	25,500	5,750	3,000	30,200	64,450

A spreadsheet format allows you to assign restricted funds to the proper categories, so that you can see how much money is actually available to you for any given expense category. In the above example, if the Department of Public Health says that no more than $18,000 of its grant can be spent on salaries and fringe, for instance, then you know that you have to find the rest of the $49,200 total in those categories from other sources.

Step 2: Compare your total expenses to your total income

• If your projected expenses and income are approximately equal then your budget is balanced.
• If your projected expenses are significantly less than your projected income, you have a budget surplus. This circumstance leaves you with the possibility of expanding or improving the organization, or of putting money away for when you need it.
• If your projected expenses are significantly greater than your projected income, you have a budget deficit. In this case, you'll either have to find more money or cut expenses in order to run your organization in the coming year.

Step 3: (For balanced budgets) Make sure you are able to use your money as planned

If you've filled in the numbers in accordance with your funding restrictions, your spreadsheet should immediately let you know whether you have enough in each of your expense categories. If there is a problem, there are several ways of addressing it.

• It may be possible to come to an arrangement with the funder that allows you to use the money in the ways that you'd like to, or that allows you more freedom
• You may be able to reassign some expenses from one category to another. If you don't have enough money to pay an Assistant Director, for example, it may make sense to make her the coordinator of a particular program, and to pay part of her salary out of the funds allotted to that program.
• In some cases, it might be necessary to rethink your priorities a bit, so that the money can be spent in accordance with funding restrictions

It's important to remember, however, that the mission, philosophy, and goals of your organization should drive its funding, and not the other way around. Creating a program simply to make use of available funding is usually a bad idea, unless the program is one you've already planned for, and will clearly fit in with and advance the mission of your organization.

Step 4: (For budget surpluses) Be aware that it may not show up as cash until the end of the coming fiscal year

• The most conservative course is to try to stick to your budget, and invest the excess money at the end of the year. This will give you something to draw on in emergencies, or money you can use in the future for something that the organization really wants or needs to do.
• "Invest" here doesn't necessarily mean putting money in the stock market, which usually doesn't make sense unless you have a lot of money, and you're willing to stay with it for a long period of time - ten years or more. Certificates of Deposit, which give high interest rates in return for keeping money in the bank for a set period (generally, you can choose a period of from six months to five years), or Money Market accounts, which give a high interest rate in return for keeping a large balance, are easy ways for an organization to earn interest on its money, while still keeping it available for emergencies.
• You can use your surplus to improve working conditions within the organization: raise salaries, add a benefit package, etc. It is important to remember that once you've instituted this type of change, you're obligated to maintain it.
• You can buy items that you haven't been able to afford previously
• You can consider adding positions or starting a whole new program or initiative, perhaps one you've been planning for a long time. If you're starting a new program, you're also implicitly making a commitment to maintaining it for a period of years, so that it will have enough time to be successful.
• You can think about a long-term capital investment, like buying a building. You could lock in your rent for the duration of the mortgage (probably 20 years), and you might be able to provide the organization with income as well, by renting part of the building to other organizations.
• Your surplus may not be large enough to enable your organization to make significant changes on its own, but it may provide the means for you to enter into a collaboration with other organizations to achieve a goal that none could have accomplished alone.

Step 5: (For budget deficits) Consider combining several or all of the following possibilities to make your budget work

• If you have enough money in the bank or in investments from prior years, you can use it to make up the gap in your budget
• You can try to raise the additional money you need through grantwriting, fundraising efforts and events, increasing your fees for service, etc. If you have a plan for raising money - such as a raffle to finance a new copier - it should be listed with your estimated income. But be aware that such a projection isn't "real" money until the financial goal it represents is actually reached.
• You can explore saving some money by collaborating with another organization to share the costs of services, personnel, or materials and equipment
• You can try to cut expenses by reducing some of your costs: use less electricity, use recycled paper, try to get donations of some items you planned to buy, etc.
• You can cut expenses by eliminating some things from your budget

A Guide for Budget Cutting

If you're going to cut your budget, it's a good idea to have a rational system for doing so. Here is a suggested step-by-step process which allows you to look at what is more and less necessary, and to make considered decisions about what you can do without and what you can't.

• Look first at those items that aren't essential to the running of the organization.
• Can you cut or cut down the amount of physical, tangible items you need to run the program, or cut the cost of services in some way?
• Finally, if nothing else will serve to balance the budget, you may have to consider cutting back on whatever it is the organization does, which usually translates to dealing with the positions of paid staff.
  • Reduce the hours of one or more staff, if people are on hourly wages - for instance, consider reducing the work week from 40 to 37.5 hours, or even further
  • Reduce one or more positions from full to half time - keep in mind that in many organizations, this reduction would eliminate benefits for those affected
  • Ask staff to pay a larger share of their fringe benefits (if there are fringe benefits)
  • Lay off one or more staff members

You can borrow the money you need, being sure to add the loan payments to your projected expenses and figure them into your revised budget

Creating an actual budget document

While the spreadsheet is probably what you'll use to keep track of your finances, you might also want to put the budget in a form everyone in the organization can understand.

Probably the simplest budget document is one which lists projected expenses by category and projected income by source, with totals for each. Thus, anyone can see how much you intend to spend, how much you intend to take in, and what the difference is, if any. Referring back to the spreadsheet example above, a simple budget would look like this:

UCMHA Annual Budget for Fiscal 2001 (July 1, 2000 to June 30, 2001)

Expenses:	Estimated Dollar Amount:
Salaries	41,000
Fringe	8,200
Supplies	1,000
Equipment	3,000
Phone	1,150
Utilities	1,200
Insurance	1,400
Rent	7,500
Total Expenses	64,450
Income:
Department of Public Health	25,500
United Way	5,750
Membership	3,000
Department of Welfare	30,200
Total Income	64,450

Another possible form would be similar, but would include a budget narrative, explaining how various items were arrived at.

The salary item, for instance, might look like this:

Salaries
Director ($17.00/hr for 20 hrs / week, for 52 weeks)	$17,680
Health Educator ($14.95/hr for 30 hrs / week, for 52 weeks)	$23,322
Total Salaries	$41,002

Other categories would be handled in the same way, with explanations of what they included and how the money would be spent.

A final possibility would be to use the spreadsheet itself as a budget document, for those who wanted to see exactly how the money was to be allocated. Many organizations provide their Boards with both a simple budget and a spreadsheet, so that those Board members who are eager to understand the organization's finances can get a clear picture, while others can simply see whether the budget is in balance.

Working with your budget

Most organizations make sure to review their budgets on a regular schedule - once a month is usually reasonable - and revise them to keep them accurate. If you get a grant you didn't anticipate, or if your spending estimates are off, these things should be figured into the budget.

The budget becomes the basis for financial documents that you might prepare during the course of the year (balance sheets, for instance) which give an up-to-the-minute picture of the financial status of the organization.

Your budget should:

• Tell you if there are still any gaps in funding, and exactly where they are
• Show you exactly what you need to do to close those gaps
• Make it possible to keep careful track of your money, to adjust to changes, and not to overspend

In Summary

Devising a budget process that examines the organization's priorities, and using it to produce an accurate, balanced budget for the coming fiscal year will help you keep control of the organization's finances, and will help guide the work of the organization. A rational and accurate budget will allow you to give accurate reports to funders and to spend their money as you have promised. And it will give you clear guidelines about what you can spend and when.

Glossary

This glossary covers some of the basic accounting terminology used in the section.

Accounting: The method by which one keeps track of and manages money. There are various accounting systems that an organization can use, but the goals of all of them are to assure accurate records, and to give the organization the ability to know exactly how its money is being spent and how its financial position compares to its budget at any given moment.

Audit: A CPA (Certified Public Accountant) checks the organization's financial records to make sure they are accurate, and works with the organization to correct any errors or solve problems. The CPA then prepares financial statements using the organization's books, and either certifies that the organization follows acceptable accounting practices and that its financial records are in order, or explains any problems with the financial records and suggests corrective measures.

Balanced Budget: Projected expenses and projected income are approximately equal.

Budget Deficit: Projected expenses are significantly greater than projected income.

Budget Surplus: Projected income is significantly greater than projected expenses.

Conservative Estimation: Using the highest reasonable figures when estimating expenses and the lowest reasonable figures when estimating income, so you will be more likely to create a budget that will keep you from overspending.

CPA: Certified Public Accountant. A certified audit, which is what most funders require, must be conducted by a CPA.

Fiscal Year: This term means financial year, and is the calendar which you use to figure your yearly budget (July 1 to June 30, for example) and which determines when you file tax forms, get audited, and close your books.

Fund Accounting: The practice of keeping a separate record of the expenditures for each separate grant or contract administered by an organization. Thus, a grass roots AIDS prevention initiative might keep separate records for funds they receive from the Department of Health, the Department of Social Services, the Department of Welfare, a local community foundation, and the AIDS Action Committee.

Line-Item: An expense category (salaries, telephone, office supplies).

Line-Item Budget: Generally, a budget agreed upon with a funder that specifies how much of the funder's money will be spent on each line-item. It could also refer to any budget that is broken out by line-item.

Projected expenses: The amount of money you expect to spend in the coming fiscal year, broken down into the categories you expect to spend it in -- salaries, office expenses, etc.

Projected income: The amount of money you know or can reasonably expect to take in for the coming fiscal year, broken down by sources -- i.e. the amount you expect from each funding source, including not only grants and contracts, but also your own fundraising efforts, memberships, interest and investment income, and sales of or fees for goods or services.

Spreadsheet: A grid format for setting out a budget in order to see expenses, income, and the ways they interact all in one place. In a budget spreadsheet, each vertical column represents a funding source, and each horizontal row represents an expense category. In the space where a column and row meet (called a cell) a number represents the amount of money from that column's funding source spent on that row's expense category.

___You know the elements of an annual budget

___You know why you should prepare an annual budget

___You are prepared for the amount of time and effort spent on your budget to bear some relation to the size of your budget

___You have determined what you will need to spend money on in the next year, using these six steps to estimate your expenses:

• Develop ways of estimating expenses
• List yearly expense totals for absolute necessities
• List estimated expenses for things needed to conduct the activities of the organization
• List estimated expenses for miscellaneous costs
• List estimated expenses for items you aren't sure you can afford, but would like to obtain if possible
• Add up all of your expense items

___You understand how to estimate your organization's income, following these nine steps:

• List all actual figures or estimates of amounts you can expect from your known funding  sources
• Estimate the amount you'll raise in the next fiscal year from fundraising
• Estimate the amount you'll take in for fees or services you provide
• Estimate the amount you will receive from yearly membership dues or fees
• Estimate the amount you will receive from items you may sell, such as pins, T-shirts, books, blood pressure cuffs, etc.
• Estimate the income from any spaces you sublet or rent to others
• Estimate the income you will receive from any investments, endowment income, annuities, or interest income (e.g., from a certificate of deposit, or from a Money Market or checking account)
• List and estimate the amounts from any other sources that are expected to bring in some income
• Add up all the income items you have listed to determine your total projected income for the fiscal year

___The five steps of analyzing and adjusting your budget have been followed:

• Laying out your figures in a useful format
• Comparing total expenses to your total income
• Knowing what to do if your budget is balanced
• Knowing what to do if you have a surplus
• Knowing what to do if you have a deficit

___If necessary, you have ideas on how to trim your budget

___You understand how to create a budget document

___You know how to work with your budget, including when and how to review and/or revise it

• Why does your organization need a money management plan?

• What does the everyday management of your money include?

• How do you create a money management plan?

• What issues are involved in being tax-exempt?

• How do you handle cash flow?

• What are some day-to-day money management issues?

• What are some investment issues?

Families need to keep control of their finances to make life flow smoothly. The same is true in spades for organizations.

In order to manage money properly, you need:

• A budget that's realistic and accurate, so that you can start with a good idea of what you have available to spend, where that money will come from, and what you want to spend it on
• A variety of ways of gaining access to cash so it can be used (a checkbook, credit cards, an ATM card, etc.)
• A way to keep track of cash so you don't overdraw your account or spend more than you have
• A system for paying your bills on time, and for making sure that you have enough money to do that
• A steady stream of income so you can afford the things you need
• Good relationships with the people who pay you for the work you do, and whom you pay for the things you need, so that you can make arrangements with them for advances, loans, or more time in emergencies or difficult situations

Why does your organization need a money management plan?

If your organization is tiny, and its finances come from bake sales and occasional ten-dollar contributions - in other words, if your income and expenses are only one or two thousand dollars a year - you may not need a money management plan beyond keeping your checkbook balanced and paying your bills on time. But if there's any complexity at all to your financial situation, a money management plan is necessary for several reasons.

• It will enable you to continue to fulfill your purpose - i.e. make sure that there's enough money to provide services, keep your initiative going... whatever it is your organization was founded to do.
• It will help to ensure that you get the most out of your money. Good money management will stretch your dollars by helping you use them as effectively as possible.
• It will make it possible to keep control of your finances, and particularly of your cash flow.
• It will help you maintain good relationships with your landlord, your suppliers, and anyone else whom you pay for goods and services. Life is much easier when people and organizations pay their bills on time. Landlords and others are much more likely to make repairs, fill special orders, and generally be friendly to those who make their lives easier.
• It will establish your credibility in the community. Your organization will get the reputation of one that takes care of business, and is serious about its financial commitments as well as its mission. This kind of reputation can add greatly to your fundraising success, since people want to put their money where they know it will be well-managed to do the most good.
• It will save you time in dealing with money. You'll spend far less time trying to track down a missing receipt, or redoing something because you didn't do it right the first time, or engaging in other forms of waste motion.
• It will save you a great deal of worry, because you'll know exactly how much money you have and how it's being spent.
• It will give you more time to devote to the actual purposes of your organization. Money is a means for you to reach your goals. The more effectively your money is managed, the more effectively you'll be able to use it.

What does the everyday management of your money include?

Many directors of organizations, especially in such areas as human services, health, or education, find money management boring, or even frightening. They see it as all about math, and worry constantly about whether they understand algebra well enough to handle finances, or whether a simple error in addition will push their organizations over the edge. But good money management is actually about systems and decisions. The systems are the ones you set up to keep track of and actually handle your money. The decisions are those you make about where to get and what to do with your money. Whether and how well you set up those systems, and the information and assumptions you use in order to make your decisions - not your background as a theoretical mathematician - will determine how well your money gets managed.

If you really find handling money difficult, it may be possible to delegate the money management part of the organization to someone who has the desire and the skills to take it over. Large corporations almost always have a CFO (Chief Financial Officer) who deals with the financial side of the operation. If your organization has a large enough budget, or can find a volunteer who is both competent and reliable, you may be able to do the same. A word of caution, however: even in an organization where there is a CFO or other person who manages the money, it's important that the director at least have a clear understanding of what's going on, and know what questions to ask in order to be sure that money is being used properly.

This kind of financial help can come from within the organization, in the form of a Board treasurer or a Board member or volunteer who is an accountant. It can also be found through other organizations, such as SCORE (Service Corps of Retired Executives), whose members volunteer their professional services to non-profits and others in need.

Some systems you might want to put in place:

• An accounting or bookkeeping system, that will enable you to get whatever financial information you need quickly and easily, and that will make any required reporting as easy and accurate as possible.
• A banking system that affords the organization as much flexibility and as little cost as possible through the use of one or more accounts in one or more banks,
• A money-handling system that clarifies who in the organization has the physical responsibility for various money-related tasks - making deposits and withdrawals, writing checks, paying bills, etc.
• A petty cash system that makes it possible for staff to gain access to small amounts of money for purchasing everyday items: stamps, coffee, etc.
• A payroll system that assures that everyone gets timely and accurate paychecks, with the proper fringe benefits, deductions, etc. included.
• A payables and receivables system that defines the procedures you use to pay bills and to bill for the goods and services you provide.
• A grants management system that allows you to keep track of the finances of each grant or contract separately, and to spend funders' money in the ways you've agreed to.
• A system for handling cash flow issues

"Cash flow" is a term you'll see many times in this section. It refers to the actual flow of money through the organization, as opposed to what's on paper. If you're owed $500.00 by your friend, but he hasn't paid you yet, and you only have $5.00 in the bank, that's a cash flow issue. You can't pay your electric bill with the fact that your friend owes you money. Organizations deal with this issue all the time. Money from grants and contracts often flows slowly, and fundraising is unpredictable. Bills, on the other hand, come regularly, and salaries have to be paid. How well your organization manages cash flow can make a tremendous difference in its health, financial and otherwise.

Some examples of decisions you need to make:

• What kind of accounting system will you use, and will you computerize your accounting?
• What types of bank accounts and banking are best for your organization?
• Who has the authority to make day-to-day money decisions and to sign checks?
• What constitutes full-time employment and what constitutes part-time? Who gets what kinds of benefits?
• Will you use purchase orders for your ordering and buying? Which suppliers - for phone, office and program supplies, equipment, etc. - will you use?
• Will you set up a separate bank account for each major grant? How will you handle reporting to funders?
• Which bills and obligations will you settle first if you're short of cash? How long will you wait before you borrow money?
• What will you actually spend your money on?

Most organizations will find that if they think carefully about the decisions they make, and set up - and continually fine-tune, if necessary - systems that work for them, the math will usually take care of itself.

Another important aspect of money management lies in the attitude that goes into it. It is possible to be too concerned with money, and too careful about it. This kind of over-cautious attitude may lead to an unwillingness to take risks or to change, an attitude that can stultify an organization. By the same token, a too-casual attitude can lead to financial and even legal difficulties for the organization. It's important to understand just how important money is to what you do, and also to realize that it's not the only thing that's important. Keeping a clear perspective is key to managing money rationally.

• What does tax-exempt status have to do with money management?
• How do you handle cash flow issues?
• What are the day-to-day decisions and concerns you'll face in carrying out a money management plan?
• Investing extra money?

How do you create a money management plan?

Every organization needs a money management plan. The nature of that plan depends upon the size and scope of the organization's finances, however. Much of the material in this section is admittedly geared toward organizations with five-figure or larger budgets. If your organization's budget is only a few thousand - or a few hundred - dollars, your money management may consist of little more than a checkbook and a calculator. It is important to understand what kinds of systems may be needed, however. Small organizations often grow, and even if they don't, they still have to manage their resources effectively in order to do their jobs. So if your organization is small, you may not need to use all, or even most, of the money management strategies described in this section. But you will need some of them, and understanding money management in a larger sense should help you to make the most of what you have.

Accounting

The discussion of accounting here is meant only to help you approach setting up an accounting system and some of the issues an organization must face in the process; none of the information about accounting in the Community Tool Box should substitute for conferring with an accountant or other financial professional.

If your budget is very small - only a few hundred or a few thousand dollars - you may not really need an accounting system at all; but you'll still need to balance your checkbook, keep track of money in and money out, and pay attention to cash flow. A basic understanding of the issues here will still be necessary for you, even if your accounting system is no more than a check register and a stack of receipts in a desk drawer.

When setting up an accounting system, you will need to determine whether you will use a cash basis or accrual system to keep your books.

Cash basis/Modified cash basis accounting

Many small not-for-profits use cash-basis rather than accrual-basis accounting to record expenses and revenues. This means that they only record revenue when the cash is received, and only record expenses when they are paid. Some not-for-profits use modified cash-basis accounting, where they will record payroll taxes withheld from employees or large revenue or expense items on an accrual basis.

Accrual basis accounting

Accrual-basis accounting reports income when it is earned and expenses when they are incurred. Most businesses track all expenses and revenues using accrual accounting. If you get public money (and, quite possibly, even if you don't), the accrual method is more accurate and more effective. It tracks line items better, and tells you how much of your annual budget you've actually spent. If you go purely on a cash basis, it's a little like not recording the checks you write from your personal checkbook, but only checking the balance occasionally. Doing that, you can end up overdrawn with no trouble at all, since your balance rarely matches the amount you've actually recorded in your checkbook. If you use accrual, you always know when you can spend and when you can't; it makes sense in that circumstance to keep track of cash as well, but not necessarily to keep books on a cash basis.

Another one of the most important elements of an accounting system is the working relationship between the organization's accountant or bookkeeper and the rest of the staff. Words that mean one thing in common English mean something slightly - or radically - different in accounting language, and this situation can lead to massive confusion and incorrect or incomplete financial information. One nonprofit director struggled to get from his organization's bookkeeper a statement of how much real money came in and went out in a particular year. It literally took years to determine that the bookkeeper meant something different by "cash" than the director did. Once the language problem had been solved, the information was easily obtainable.

This issue can cause errors in the other direction as well. An accountant or bookkeeper may not get the information she needs because of the language barrier, or because other staff members don't perceive the bookkeeper's requests as important, and, as a result, the books may not be accurate.

Yet another potential concern lies in the difference between nonprofit and for -profit enterprises. The bookkeeper in the anecdote above had never before worked in a nonprofit business, and therefore didn't realize that it was important to stick to the budget. He didn't understand why the director was so insistent on finding out where the organization's income and expenses were in relation to what was projected. The result was frustration on all sides.

The bottom line here (pardon the pun) is that the relationship between the accountant or bookkeeper and the rest of the staff is incredibly important in determining whether an organization's accounting system will work well or not. It is more than worth it to take the time to bring language and other differences out in the open, correct any misunderstandings, and clarify what's necessary on both ends in order for the organization's financial management to function smoothly.

Banking

If your organization or initiative has a small budget - only a few thousand dollars - a single checking account may be all you need from your bank. But if your budget is large and complex, with a number of funders, you may need more than one account, or more than one kind of account, as well as some other services. Before you start looking for a bank, you need to decide what you want from your banking system.

Some of the possibilities include:

• The best interest rates you can find, including interest on your checking account
• The availability of high-interest accounts (Money Market, for instance) for times when you have extra cash that you expect to hold on to for a while
• Overdraft protection (essentially a short-term loan up to a certain amount), so you can pay your bills when you're short of cash
• The willingness of the bank to loan your organization money if needed
• A different - and perhaps even a different kind of - account for each of your major grants or contracts (Do you want these all in the same bank?)
• Payroll direct deposit for employees
• A banking package giving you favorable rates - your organization may be passing large sums through that bank every year, so consider what you should get in return

Other issues might include security (Are the bank's deposits federally insured?), convenience (Is the bank close by? When is it open? How many ATM's can you use without a fee?), how easy the bank's services are to use, how the bank treats people from your organization, the bank's relations with the community (Does it encourage small business development?), the bank's philosophical stance regarding the issues your organization addresses (Does it lend to low-income and minority homebuyers, for example?), and personal relationships with bank officers.

You should shop for a bank the same way you'd shop for a car. Arrange an interview at each bank you're interested in, explain what your needs are, and discuss how those needs can best be met by that particular bank. Pick the one you think can do the best job for your organization. If you carefully make decisions about what you need, and choose your bank equally carefully, you'll come up with a banking system that's right for your organization.

Money handling

Having a banking system implies that someone has to be authorized to use it. Who in the organization has the authority to make final decisions about spending, and to sign checks and other financial documents, such as loan agreements or contracts? There are several ways to answer these questions, and the answers are different for different organizations.

Who makes financial decisions?

The answer here is usually the director, the Board of Directors, or some combination of the two. In many organizations, the director presents an annual budget to the Board for its approval, but, once the budget is approved, makes the day-to-day financial decisions without Board permission. If there are major deviations from the budget, the director comes back to the Board with a new budget, explains the changes, and has the new budget approved. This model is probably the most common among nonprofit organizations of all kinds. It allows for Board input and oversight through the budget process, but gives the director the freedom to make the decisions that go with her responsibility for the running of the organization.

In some organizations, the Board makes all financial decisions, and the director carries them out. In others, the director makes all financial decisions, and either no Board exists, or it has only a consulting role. This last model is unusual in larger organizations, where large sums of money are at stake.

There are other variations on all of these themes. Directors and Board finance committees or treasurers may share fiscal responsibility, Boards may hold veto power over directors' decisions, or other officers - the accountant or chief fiscal officer (CFO), for instance - may hold decision-making power about money. The best advice about this issue is to choose a system that gives everyone the powers that go with his level of responsibility, and that allows him to carry out that responsibility as effectively as possible.

Who signs checks?

The person(s) designated to sign checks for the organization usually reflect who makes decisions about money. It makes sense to have at least two people able to sign checks (in case someone is sick or on vacation). In organizations where the financial decisions are shared between Board and director, a check may require the signatures of both the director and either the chair or the treasurer of the Board.

In some organizations, payroll and payables checks - or even all checks - are signed by the accountant or bookkeeper, rather than the director. In larger organizations, where there are several separate programs, the director of each program may have a separate account, and may be responsible for spending - and for reporting, both to the funder and to the organization's accountant - for her program.

One standard procedure, often required by auditors, is that checks over a certain amount - usually several thousand dollars - be signed by two people, even if most checks get only one signature. This is to assure that large expenditures have been properly approved, and to keep someone from heading for Rio with the bank balance of the organization.

Who can use ATM cards and credit cards?

Who has access to the appropriate PIN numbers and cards? In most cases, these will be the people who make financial decisions and sign checks. Sometimes, however, convenience is also a factor: the bookkeeper or a staff member who lives across the street from the bank may be an obvious choice.

Who signs documents for the organization?

Most organizations choose an official signatory, the person whose signature commits the organization to a contract or other legal document. In most organizations, this is usually either the director or the chair of the Board, or, in some cases, both. As with check signing, who you choose as your organization's signatory probably should reflect who makes the decisions about money and the organization's functioning.

Petty cash

Petty cash is the money you keep in a drawer for when you realize there's no aspirin in the office, or when someone needs paper towels. The amounts of money covered by petty cash are by definition tiny compared to the overall budget of the organization (you might easily spend less than $100.00 a year). If they're not handled and recorded properly, however, they can drive bookkeepers and auditors insane. If your books are going to balance, you need a system to make sure that both who spent any petty cash and what they bought with it are recorded accurately.

One possibility is to simply start with a petty cash line in your budget. A certain amount of cash is drawn against this every month, and either distributed as needed, or distributed in set amounts to those who need petty cash. A way of reporting on spending is agreed upon by all concerned, and every expenditure gets recorded as soon as it's made. As long as everyone follows the system, it all works fine. The reality is that petty cash is almost always a pain. The easier and simpler your system is, the more likely it is to be followed.

Payroll

Payroll is the largest expense for most non-profits. It may seem that no real system is necessary: after all, you just have to write out a check every week or two for the amount of an employee's pay, right? Well... not exactly. There are a number of questions to answer before you make out and distribute your payroll.

• How often does everyone get paid?
  • Most organizations pay either every two weeks (the most common) or every week, but some pay monthly or on some other schedule.
• If the work year is less than 52 weeks, will you still pay on a 52-week schedule?
  • Most school systems and other educational organizations that take summers off pay their employees on a 52-week schedule, but other options are certainly possible.
• How flexible are you willing to be?
  • Does everyone get the check on the same day regardless of whether that's a work day for each person or not? Can employees decide individually on their yearly pay schedules?
• How do you define full- and part-time, and how does that affect benefits?
  • Some organizations give everyone the same benefits, or a share of benefits, regardless of how many hours a week they work. Others don't give benefits to part -time employees. Benefits are often denied to employees working fewer than 20 hours a week, and full-time is often defined as 30 hours a week or more
• How will you handle benefits?
  • Will those who don't need health insurance, for instance (because they get it through a spouse or some other source), be given the equivalent in some way? Will you hire a professional to prepare and administer a benefit program?

Remember that even if you don't offer any benefits at all, you're still responsible for paying - on a regular schedule - half of employees' Social Security and Medicare taxes, as well as for withholding all relevant federal and state income tax. In most states, you're also responsible for Unemployment and Workers' Compensation. If you fail to pay any of these on time, you get hit with both interest and penalties (worst on the federal taxes). The IRS may not inform you of your error for a year or more, and they charge interest and penalties for that whole period, even though you may have had no idea that you owed them anything.

• Will the organization do its own payroll?
  • Many banks and accountants offer regular payroll services, which may include direct deposit, mailing checks directly to employees' homes, or other possibilities. One of the advantages of hiring out payroll is that the payroll service may take responsibility for errors in withholding, etc.
• If the organization does its own payroll, will it use payroll software or some other check-writing system?
  • There are a number of payroll software programs on the market that include Social Security and Medicare taxes, and can easily be programmed to withhold appropriate amounts from each paycheck. They can also then print out the whole payroll - checks and records alike - saving a great deal of time. The drawback is the expense of both the software and the checks - specially printed and connected to be fed through a computer printer. Generally, the larger your organization, the more likely a software system is to be cost effective.
  • Check-writing systems - paper-and-pencil packages that allow you to make copies of checks and record payroll journals on the first writing, without having to resort to copiers or recording numbers by hand in two or three separate places - can be cost- and time-effective for some smaller organizations.

Payables and receivables

Payables are those expenses which you owe, but haven't paid yet. These include outstanding bills for goods you've bought, rent or mortgage payments, bills for last month's utilities, bills for services you've already received, etc.

Receivables are those items of income that you're owed for services or goods you've already supplied, or regular payments from funders which are due, but haven't arrived yet.

If your accounting system is computerized, then your payables and receivables system essentially has to be. Some questions to think about while setting up a system to handle payables and receivables:

Payables:

• Who actually pays the bills? The director? The bookkeeper?
• When do bills get paid? As soon as they're received or due, or simply on a regular basis (e.g. every two weeks, or once a month)?
• Will you use a purchase-order system to buy things? Purchase orders are printed forms, numbered in sequence, on each of which you record a particular purchase. The seller gets a copy, and you keep one yourself, allowing you to track the things you've ordered or bought, and when and how much you've paid for them. Purchase orders provide a record for your organization of what it's bought from - and what it owes to - whom, and they give the seller a record to bill from. Whether or not a purchase order system makes sense for your organization probably depends on how tight your fiscal controls are. Some accounting software can print out purchase orders automatically when you record an order, and make the process much easier.

Receivables:

• Who actually sends out bills?
• When does billing get done (or, in the case of grants, when do you apply to "draw down" - i.e. receive - money)? As soon as you've provided the goods or services, or simply on a regular basis (monthly, for instance)?
• How long will you give people to pay, and how do you communicate with people whose payment is late?

Grants management

If you receive grants or contracts, from public or private sources, they generally come with some clear expectations from the funder about what you'll do with the money. A grant is a gift of money which you usually must agree to spend in particular ways. A contract pays you for goods or services you provide, generally after the fact (i.e. you supply the goods or do the work and then bill the funder for your costs at a rate you've both agreed upon).

In the case of public money - and, to a large extent, of private money as well - the greatest difference between grants and contracts can be when you get paid. With a grant, you generally receive money on a regular basis, or all at once, whether you've spent it yet or not. With a contract, you often don't get any money until you've actually spent your own to provide goods or services. Many organizations would agree with an adult education provider who was asked the difference between a grant and a contract. He answered, "Life and death."

There are advantages to contracts as well. Often, a contract gives you more control over how you can spend your money. And not all contracts require that you spend money before you can receive it; some call for money to be provided on a regular schedule, or allow it to be drawn in anticipation of services. But in general, the grant/contract distinction holds.

With most grants and contracts, the terms of how your organization can spend its money are laid out very specifically. The funder and the organization will agree on amounts for particular line items (a line item is an expense category, which occupies a single line in a budget: "salaries," for instance, or "office supplies "). The funder then expects the organization to stick to these amounts, either exactly, or within specified limits (say, 10%). If the organization fails to fulfill its commitments without renegotiating the grant or contract (which is usually possible, at least within reasonable limits), it may be asked to return some or all of the money. It is therefore obviously crucial to be able to track each grant and make sure that spending is within the limits agreed upon, and that the called-for work or service is provided.

How will you track line items? The answer to this question can be complicated, because it often means juggling several different grant budgets. Your organization's overall budget for office supplies may be $300.00, for example, but that may be divided among three different grants, with different amounts in each. Not only do you have to be careful not to spend more than the $300.00 you've budgeted, but you have to be careful to assign your spending to the right grants. If you have accounting software, it may be helpful here.

How will you track separate grants? One possibility is to keep a separate bank account for each grant or contract. While this is probably the most efficient way to handle the issue, in practice it's often difficult because of cash flow. Keeping a separate set of accounting journals for each grant or contract is usually a much better option. With good accounting software, you can set up a system that will record your income and expenses by grant, and integrate them into the general ledger (the books of the organization as a whole) at the same time.

What issues are involved in being tax-exempt?

Most non-profit organizations are tax-exempt, but tax-exempt status doesn't come automatically. The organization has to first apply for and obtain non-profit status from the state, and then apply to the federal government for tax-exempt status. After federal tax-exempt status is granted, the organization can apply for a tax exemption from the state. Got that?

This discussion here of non-profit and tax-exempt status is primarily focused on the number of ways those issues can affect money management in your organization and make some demands on you if you want to take advantage of it.

First, there's that matter of obtaining tax-exempt status in the first place. You'll probably need to work with an attorney or CPA in order to fill out and submit the applications for non-profit and federal tax-exempt status. But once those are granted, your job isn't over. There are still several things you have to do - some of them only once, and others continually - in order to make sure that you actually don't pay any taxes (thus saving your organization a good bit of money, which you can then use to further your mission).

• Apply for state tax-exempt status. This has to be done after you receive notice of your federal status, but you will need to supply copies of your federal tax exemption, your articles of incorporation (if you're incorporated), your latest tax form, and some other information as well. While federal tax-exempt status excuses your organization from paying any income taxes, state status not only includes exemption from state income tax, but also covers sales tax, property tax, and any other state and local levies. State tax exemptions generally have to be renewed at regular intervals (every five years is common).
• Make sure that the correct forms are used when purchases are made. In order to avoid sales tax, in most states an official representative of your organization must fill out and sign, at the time of purchase, a form provided by the state that specifies the amount of the purchase, the amount of the tax, etc. You also need a form if your organization sells to others. It is contingent on someone in the organization to make sure that whenever anyone buys or sells anything taxable for the organization, he has copies of the appropriate form signed by the appropriate person.
• Remove taxes that you've been paying on your phone, utilities, and any other regular payments. The fact that you've received federal and state tax-exemptions doesn't mean that everyone automatically takes the taxes off your bill. Getting the electric company, the gas company, the phone company and others to remove your taxes can be an annoying process. All of them require documentation, and it's not unusual for each to require something different. It's a pain, but your organization will save a good deal as a result.
• Fill out tax forms. Even though you have tax-exempt status, you still have to fill out forms for both the IRS and the state. The IRS form is the 990, and has to be filed just like a for -profit tax form. Furthermore, failing to file - or failing to file on time - incurs the same penalties as if you were a for-profit business. Many non-profits have their taxes done by a CPA as part of their yearly audit.
• Arrange and undergo a yearly audit. An audit is the careful checking by a CPA, according to federal regulations, of an organization's books. Any organization receiving public funds over $25,000.00 must undergo an annual audit of a certain type, and there are particular guidelines for non-profit audits in general. Among other things, such audits generally must confirm that any granted or contracted money was spent in the way agreed upon in the grant or contract, that Board meetings actually took place, and that the organization provided whatever services it said it was providing.

How do you handle cash flow?

As explained above, cash flow has to do with the availability of cash at a given moment. The organization may be owed a great deal of money from funders and other sources, but if it doesn't have cash in the bank, it can't pay its bills. Community based and grass roots organizations deal with this problem constantly. While there's almost no way to avoid it completely, there are ways to minimize it. The first step is to understand and anticipate why cash flow problems might arise for your organization.

Causes of cash flow problems

There are numerous reasons that an organization may experience cash flow problems. The most common probably stem from late payments by funders. Some of the reasons that a promised grant or other payment hasn't arrived yet might include:

• The money hasn't been released to the funder yet - this is particularly likely in the case of public money, which is subject to funding approval at a number of levels

In Massachusetts in 1999, for instance, the state budget wasn't approved until November, five months after the June 30th end of the previous fiscal year. Until the budget was approved, no state agency could receive any funds from it, and the agencies' grantees and contractors in turn could get no funds, either.

• The funds are simply late - the funders are backed up, their computer system crashed, they're understaffed, etc.
• The funding is still in process. Perhaps you haven't gotten the funder a crucial piece of information, or they're still checking something in your proposal, or you're still negotiating about particular line items - in any case, you won't see any money until the process is completed.
• You're on a payment schedule, and the next payment isn't due for another month
• You applied for payment late (perhaps because your billing system is less than efficient)
• You may be awaiting payment for services already performed, and for which your organization has already spent a lot of money
• You may be waiting for revenues from a planned event - a carnival, a benefit concert - that hasn't taken place yet
• You may be waiting for a fundraising appeal or membership drive to take effect
• You may simply not have enough money to do what you're trying to do. If this is indeed the issue, it's not really a cash flow problem, and you have some hard choices to make.

Ways to address cash flow problems

While you may not be able to stave off cash flow problems altogether, there are number of things you can do to reduce their impact and prepare your organization to weather them.

• Try to anticipate when cash flow problems may occur. Summer and early fall, when the state budget may still be in deliberation, could be a problem if you 're dependent on public funding, for instance. If you have a fundraising event or drive planned in September and another in May, March and April might be a time when you're running short. Because of a difference in funders' fiscal years, there may be a lull in funding at a particular point.
• Set your priorities beforehand. What do you have to pay - or to buy - and what can you defer when you're waiting for cash flow to catch up with your bills and obligations? All but the most necessary office supplies can probably wait until you have some cash. The phone company will usually continue your service as long as you make some payment - often as little as $10.00 - on your bill. Figuring out ahead of time what you have to pay or buy and what you can put off will both make it possible to get through shortages of cash and contribute greatly to your peace of mind.
• Develop a cash flow contingency plan based on your priorities and the situation of your organization. Such a plan could include:
  • Negotiate beforehand with your major suppliers, utility companies, landlord, etc. to explain your situation and work out an arrangement that's agreeable to both of you. If your landlord, for instance, understands that there are months when paying full rent will be difficult, she may be willing to take partial payment at those times, and wait for the rest until you have it. In general, informing your creditors beforehand of the possibility and negotiating some mutually acceptable arrangement will buy you both time and goodwill.

What do you pay first, and what do you put off if you can't meet all your obligations because of cash flow? In almost all cases, payroll has to come first. The organization has an absolute obligation to its employees to maintain their livelihood if it possibly can. What comes next depends to a certain extent on who will let you slide how much. Landlords who rent to community based organizations are often sympathetic, for instance, whereas large utilities may not care who you are or what you do - they just want their money. At the same time, they want to keep you as a customer, and are usually willing to negotiate. It's generally easiest to put off those who don't provide goods or services upon which the life or death of your organization depends. There are ethical issues here as well, however: while the phone company won't go broke if you don't pay your bill on time, the local printer who produces your brochures might, even though he might also be more willing to wait for payment. What's your ethical obligation here?

• Arranging with your bank for short-term loans - at favorable rates, if possible - at the times you need them
• Putting aside a certain amount of money whenever it's available as a hedge against later cash flow problems
• Making absolutely certain that you apply for as much of your funding as possible from each funder as soon as it's allowable to do so

A temptation in a bad cash flow situation might be to put everything on a credit card, and take the benefit of the 30-day period before payment is due, or simply use the debt as a short-term loan. Remember before you take that route, however, that if you don't pay within the specified time, you'll be charged an exorbitant interest rate on your balance - usually 18% a year (you can get a much better deal on a short-term bank loan). Be aware also that different credit card contracts are different. Somewhere in the fine print in your credit card contract, it may mention that if you use your card to withdraw cash, every other purchase you make in that month from that moment will be charged interest at the maximum rate. Or there may be rules about what happens if you don't pay your minimum balance on time. Make sure you know exactly what's in your contract before you use a credit card to deal with cash flow problems.

What are some day-to-day money management issues?

Once you've set up your systems and everything's in place, you have to deal with the everyday tasks of actually using and keeping track of your money. Day-to-day handling of money, in addition to cash flow, involves the same kind of comparison shopping, looking for bargains, and negotiating for the best deals that careful families do. It also means maintaining your systems and making sure they're actually being used. Having great software doesn't help if no one enters the numbers, or if no one records them in the first place.

An important element of everyday money management that we won't discuss in detail here is the building and sustaining of personal relationships between people in your organization and landlords, suppliers, customers, and funders. It's always easier to negotiate, to get something done quickly, to get a break on a payment time, etc. if you have a personal relationship with the person you're appealing to. It also makes doing business in general smoother and much more pleasant. The reality is that the world runs on personal relationships: the more and the better you can cultivate, the better for your organization and the simpler your financial management will be.

Shopping for goods and services

You obviously want to make your money go as far as possible. One way to ensure that is by comparing the prices of different suppliers, and looking for the best deals on goods and services.

Some other things to consider:

• Looking carefully at stores or service firms you might want to do business with, and comparing not only their prices, but what kind of support they offer, and exactly what you're getting for the money. Cheapest is not always smartest.
• Using catalogues. Sometimes, catalogues contain items that aren't sold in stores, and may also feature specials, or simply be cheaper in general than store prices. With most catalogue orders, you have to figure in the extra shipping and handling fees; but some catalogue houses ship free if you order more than a certain amount. In addition, you can figure in the amount the organization saves by not having to pay someone to actually go out and shop.
• Becoming part of a buying collaborative. Nonprofit organizations often band together - sometimes joining with larger entities, such as school systems or city governments - to negotiate large-volume deals with suppliers. You may be able to get office supplies, furniture, or other items at greatly reduced rates if you're part of a group that orders these things in huge quantities.
• Sharing equipment, positions and services. Two or more organizations may be able to save money by sharing a copier, a receptionist, or trash pickup.
• Using the Internet. Major bargains often appear on-line, especially if your needs aren't state-of-the-art. You may be able to get the one- or two-year-old version of a dynamite accounting software package (which will probably be more than powerful enough for your needs into the distant future) for a small fraction of its original cost. Discontinued lines of furniture, computers and other electronic equipment, toner for copiers and printers, or just plain low prices on things you need can often be found with a little searching. Once again, you have to add shipping and handling fees, but you'll save on person-hours.

With any of these strategies, remember that it's important to balance the money you save with the value of what you get - the level of service, for instance, or free technical support - and the time and effort you spend. If it takes someone in the organization a day to find a bargain on a new computer, what's the difference between that day's pay and the amount you saved? If it's not considerable, it's probably not worth it. By the same token, if you buy an inexpensive piece of equipment that's constantly out of the office being fixed, or you get a deal from a CPA firm that regularly messes up your tax returns, you haven't found a bargain.

Negotiating with funders

As mentioned above, you're obligated to fulfill the terms of a grant or contract. Those terms aren't necessarily cast in stone, however, and most funders are willing to negotiate, at least within broad limits, about such things as payment schedules and uses of money. After all, the funders are concerned that you do what you've been funded for as well as possible. They're usually willing to do whatever they can, within reason, to make that happen.

Renegotiating your payment schedule may mean that you can stave off cash flow problems. The ideal is being able to ask for money whenever you anticipate needing it. It will take the funder a certain amount of time to deal with the request for funds - anywhere from a few days to months, in the case of some state or federal bureaucracies - and you have to leave enough time so that you'll actually receive the money before you run out of what you have.

Most funders have a mechanism that allows them to approve changes in your line -item budget (although not in the total amount of funding) up to a certain point in the fiscal year. This gives you the opportunity to address unforeseen circumstances, or simply to respond to the real expenses of your project. As long as you can justify the changes, and as long as the changes are directed toward accomplishing what you 're funded to do, funders will almost always approve.

Maintaining systems

As you use your money management plan day-to-day, you have to make sure that all the systems you so carefully designed continue to work properly.

Some of the areas that have to be maintained:

• Data entry and backup. Any systems that are computerized - accounting, payables /receivables, payroll - need the right numbers put into them constantly so that they'll always be up to date. In addition, they should be backed up regularly - ideally every day - so that you won't lose all your data if the power goes out or if your hard drive crashes. If those systems aren't computerized, the data entry - using pencil and paper - is still just as important, and can be even harder to maintain, because it takes longer.
• Paying bills and billing. Your system is useless unless someone actually does the paperwork on a regular basis, and keeps careful records.
• Payroll and payroll taxes. Someone has to make sure that Social Security, Medicare, state and federal taxes, unemployment, and workers' compensation are all paid correctly and on time. In addition, whoever is in charge of payroll has to keep up with changes in the tax laws, as well as with any changes in employee benefits, so that he withholds the proper amount from employees' checks in either case. W-4 forms (employees' declarations of the number of their exemptions) have to be on file, and W-2 forms (the employer's declaration of how much was withheld and paid in all categories of taxes from each employees' pay for the year) have to be issued to employees, with copies sent to the federal and state governments, between January 1 and January 31.
• Audit and organizational tax requirements. An audit has to be arranged each year, for which someone in the organization has to gather and provide all the necessary financial and other records, often including Board meeting agendas and minutes, actual contracts and grant agreements, and records of services provided or activities conducted. In addition, the Form 990 (for the IRS) and any relevant state tax forms have to be completed and sent to the appropriate agencies within three and a half months of the end of the organization's fiscal year.
• Printed forms. If you use purchase orders or other printed forms for financial systems, they have to available when they're needed, whether that means buying generic ones, running them off on a computer printer or copier, or ordering them from a printer.

In addition to general system maintenance, it's important to evaluate systems continually to make sure they're working efficiently, and to make changes where necessary to make your money management as effective as possible.

What are some investment issues?

If your organization is one of the lucky - or well-run - ones whose cash flow is healthy, you may find yourself with extra money in the bank. Rather than letting it sit around gathering dust in a no- or low-interest checking account, you might consider investing at least part of it in a something that yields higher interest.

A Certificate of Deposit (CD) gives you a high rate of interest in return for leaving your money in the bank for a specified length of time - usually from three months to five years. A three- or six-month CD provides high interest, but doesn't tie up your cash for too long. If the organization needs cash, the money can be withdrawn before the time is up, but there is a substantial interest penalty (i.e. the CD's final interest rate will be considerably lower than if you kept it for the full period).

A Money Market Account yields high interest in return for keeping a certain minimum balance. While Money Market interest is lower than that of a CD, cash in a Money Market Account is available without any penalty as long as the minimum balance (usually about $5,000.00) is maintained.

Both CD's and Money Market Accounts provide good ways of putting aside money for short periods of time to deal with anticipated cash flow problems. They also provide the opportunity for longer-term high interest opportunities.

For most organizations, investing in the stock or bond markets makes less sense, since these are by nature long term propositions that carry a certain amount of risk. Because of ups and downs in stocks, cautious investment strategy means staying in the market for at least ten years, which may defeat your organization's investment purposes. In addition, your investment needs managing, and management fees are charged whether you're making any money or not. Unless your organization has an endowment or some other amount of money large enough to generate significant income (and which you can afford to have tied up for a long time), investing in stocks and bonds is seldom useful.

If you have a larger amount of money to play with, you might consider a capital investment. A capital investment means taking some of your capital - the worth of your organization - and using it to buy something which itself becomes part of the capital of the organization. For instance, you might consider, as many non -profits do, buying a building.

Some of the advantages of this course of action:

• There are numerous federal and state programs available to provide low-interest mortgages for non-profits
• You can lock in your rent (i.e. your mortgage payment - as a tax-exempt organization, you'll pay no property tax) for the period of the mortgage, typically 20 years. This allows for easier financial planning, since you know exactly what you'll be paying for space.
• The building itself is an asset of the organization which can be sold if necessary, or can be kept until the organization owns it free and clear
• You may be able to generate income - perhaps enough to cover the mortgage and upkeep - by renting out the parts of the building you don't use yourself. If you can eliminate your space costs in this way, you'll improve your cash flow situation tremendously.

Other possible capital investments, depending upon the needs and purposes of your organization, could include buying vehicles, major pieces of medical equipment, land, etc.

In Summary

Good money management is largely a matter of making good decisions and setting up good systems to manage your financial operation. If you can set up systems that work for your organization to handle your daily accounting, payroll, payables/receivables, and grants management issues; if you can anticipate and deal with cash flow problems; and if you can invest wisely when you have money to spare, then you'll have your money management under control. This will allow you to do a better job at whatever it is your organization is trying to do, and thus to provide more benefit for your target population and for society.

Tool: Spreadsheets

A spreadsheet is a way to display a budget or the finances of an organization in a way that makes it clear how much money can be and/or has been spent for each line item from each funding source. In its simplest terms, a spreadsheet is a grid with a list of funding sources along its top edge and a list of expense categories running down its left-hand edge, so that each vertical column represents a funding source , and each horizontal row represents an expense category. Where each column and row meet (this meeting place is called a cell), there should be a number representing the amount of money from that particular funding source (the column) that goes to that particular expense category (the row).

While you can make a spreadsheet either by hand or by computer, the advantage to a computer spreadsheet is that it allows you to put formulas in particular cells to total up a column or row, or to otherwise make sure that the number in that cell reflects a change elsewhere. In the spreadsheet below, for instance, each of the cells in the "Totals" row at the bottom automatically adds all the figures in its column, so that if you enter a new number in one of the cells in that column, the total at the bottom will change automatically. The same is true for the cells in the "Totals" column on the right, with the difference that those cells are set up to total their rows. In the "Fringe" row, each cell - except for the "Total" ones - is set to figure 25% of the total salaries in its column, because you already know that fringe benefits are 25% of salary.

Consolidated United Conglomerated Community Health Program

	United Way	Department of Health	County	Raffle	Totals
Coordinator Salary	2,000	22,000	5,000	1,000	30,000
Aide Salary	5,000	8,000	4,000	1,500	18,500
Fringe	1,750	7,500	2,250	625	12,125
Rent	750	5,500	2,000	125	8,375
Insurance	0	1,500	0	0	1,500
Office Supplies	500	1,200	275	0	1,975
Program Materials	0	1,300	475	0	1,775
Totals	10,000	47,000	14,000	14,000	74,250

Because the cells change their totals automatically when new figures are introduced , a computer spreadsheet makes it easy to test out different ways of spending money , and to see immediately how much you can afford to spend in particular categories.

Have you included the following systems in your management plan?

___Accounting

___Banking

___Money-handling

___Petty cash

___Payroll

___Payables and receivables

___Grants management

___Handling cash flow issues

Have you included the following decisions in your management plan?

___Computerizing your accounting

___Types of bank accounts

___What constitutes full-time employment

___Which bills and obligations to settle first

___Determining your elegibility for tax-exempt status

Have you determined a plan for handling cash flow?

___Anticipate when cash flow problems may occur

___Set your priorities beforehand

___Develop a cash flow contingency plan based on your priorities and the situation of your organization

Have you considered the following management and investment issues?

___Day-to-day money handling

___Shopping for goods and services

___Negotiating with funders

___Maintaining systems

___Investing in a Certificate of Deposit

___Investing in a Money Market Account

• What is accounting?

• How is not-for-profit accounting different from accounting for for-profit organizations?

• What is an accounting system?

• When should you develop an accounting system for your organization?

• Why should you do accounting for your organization?

• How do you do accounting for not-for-profit groups?

For many community organizations, how to get cash is the burning question on everyone's mind. "How can we possibly get the money we need to do what we want to do?" Usually, the director, the staff, Board members - everyone - spends a good deal of time and energy trying to find the best answer to this question. And find it again, and again, and again.

Often - and to the detriment of many not-for-profit organizations - the equally important question "How do we handle the money we do have?" is ignored or is handled haphazardly, without proper thought and expertise. Proper accounting procedures are often left by the wayside, to be addressed at the last minute, if at all.

Despite this reality, thorough and proper accounting procedures are crucial to the financial sustainability of an organization. In the business world, statistics show that the second leading reason businesses fail is inadequate accounting procedures. For nonprofit organizations, then -- who often have much smaller incomes on which to survive -- the use of good accounting procedures is even more important.

In this section, we'll give an overview of the process of accounting and its uses for your organization. We'll also talk briefly about obtaining help with accounting, both in person and in some of the software that is available to use today.

This section is not meant to take the place of legal or professional accounting advice. In fact, we strongly recommend you obtain the assistance of a Certified Public Accountant (CPA) when trying to make heads and tails of your organization's figures. Instead, this section is meant to give you a foundation of understanding that you can use when choosing and speaking with those who will do the accounting for your organization.

What is accounting?

Accounting is simply a system for providing financial information about a business or other type of organization. This system includes the everyday tasks of documenting, classifying, analyzing, and interpreting the financial (bookkeeping) records of an enterprise. These jobs, taken together, can be used to evaluate the progress or failures of a business and to track its financial condition.

Accounting also includes activities that occur less often, such as auditing and figuring taxes. By auditing, we mean the examination of an organization's accounts by people who had no part in their preparation. Annual audits are required for all publicly held businesses and for many non-profit organizations. They are discussed in more detail below.

While accounting is sometimes confused with bookkeeping, you can see from the above paragraphs that accounting is much more comprehensive. Bookkeeping is simply a means of accurately entering information into the organization's books. Depending on the complexity of your organization's finances, you may or may not require knowledge of accounting. An accountant will generally know how to analyze the organization's finances, and how to set up an appropriate accounting system to track them.

In the United States, there are a lot of regulations that dictate how accounting procedures must be carried out. Most public and many nonprofit organizations are required to follow generally accepted accounting principles (GAAP), which are developed by two different organizations: the Governmental Accounting Standards Board (GASB ) and the Financial Accounting Standards Board (FASB).

The GASB was developed in mid 1980s as a way to oversee accounting for governmental agencies. It works to improve standards of state and local governmental accounting, financial reporting, and to guide the public, including issuers, auditors, and users of governmental financial reports. Some not-for profits that receive government funding are also subject to its control.

Not-for-profits not subject to GASB control should follow the standards set forth by the FASB, which also sets regulations for for-profit organizations. The FASB works to establish and improve standards of financial accounting and reporting to guide the public, including issuers, auditors, and other users of financial information such as funders and Board members.

Special topic in accounting: What is an audit?

An audit is a process for testing the accuracy and completeness of information presented in an organization's financial statements. This testing process lets an independent Certified Public Accountant issue what is referred to as an opinion on how fairly the agency's financial statements represent its financial position and whether they comply with generally accepted accounting principles (GAAP).

The audit report is addressed to the organization's Board of Directors, and usually includes the following:

• A cover letter signed by the auditor, stating the opinion
• Financial statements, including the statement of financial position (balance sheet), statement of financial activity (income statement), and statement of cash flows. Health and social service organizations also have a statement of functional (i.e., operational) expenses.
• Comparison of previous fiscal years (optional)
• Notes to the financial statements, as required by GAAP, which might include information about functional expenses, a depreciation schedule (that is, a schedule of the decline in value of certain items the group owns), further information about contributions and volunteer services, and other significant information not obvious in the financial statements.

In addition to the financial statements, the audit may include results of an investigation on whether the money is being spent exactly as specified in grants and contracts -- both general areas and line items -- and whether the organization functions as it says it does. For example, for audits of one literacy project, the director had to provide the minutes from all Board meetings during the audited year. This regulation was to show that the Board actually met, and also to prove that financial decisions that required a Board vote actually got one.

Some not-for-profits are legally required to obtain audits. Many states require an audit for not-for-profits that receive contributions over a specified amount (the amount varies from state to state) and/or not-for-profits who hire a paid fundraiser. You might want to contact the Secretary of State for regulations in your state. In addition, not-for-profits that receive $300,000 or more in federal funding during a fiscal year are usually required to have a specific audit, called an A-133 audit.

In addition to the financial statements required for audit purposes, not-for-profits are required by federal and state governments to file various information returns to maintain their tax-exempt status and document tax compliance. The primary federal reports are the annual Form 990 and Schedule A to the 990. (These are available from the IRS). State governments may require additional reports.

Your organization may choose to obtain an audit even if you are not legally required to do so.

Common reasons to obtain an audit include:

• Funders commonly request audited financial statements or a review (see below )
• The Board may seek reassurance that the financial information they are considering is accurate and complete. In cases where financial problems or irregularities in the financial system have occurred, the Board and the general public may look to an audit to provide assurance that these problems have been resolved.
• The audit process can be valuable to your executive director and finance staff because it confirms your financial picture and helps you strengthen internal control procedures.
• Finally, an audit signals a new phase in the organization's maturity. As your organization's financial transactions become more complex, undergoing the rigors of an audit will help your staff develop and understand the financial systems required to track and manage finances responsibly.

Alternatives to an audit include a review, which is a more limited examination of the financial statements by a CPA, and a compilation. During a review, a CPA asks questions of management and conducts some analysis, but does not undertake the extensive testing required for an audit. A review provides only limited assurance that the financial picture is fairly presented. A review may cost less than half of what an audit does, however, and it may satisfy state requirements for smaller not-for-profits. Contact your Secretary of State's office for details.

A compilation is a report prepared by an accountant using financial data supplied by the organization. The accountant organizes this financial information into standard financial reporting formats, but does not review the numbers for accuracy or provide assurance regarding the information that is included.

How is not-for-profit accounting different from accounting for for-profit organizations?

The basics of accounting are the same for for-profit and not-for-profit organizations - both record and analyze transactions, both will need to figure taxes, and both may be audited.

However, parts of not-for-profit and for-profit accounting can be very different. Certainly, a huge difference is the fact that for-profits generally spend what they need to spend in order to run the business, and either show a profit or a loss at year's end. If they're generally viable from year to year, and not too concerned about growth except to keep up with inflation, they figure expenses and income will even out.

Most community-based and grassroots organizations, on the other hand, spend only as much as they take in, because there isn't any more. If they can't meet operating expenses, their situation is more serious. Options are: to go out of business; try to fundraise the difference quickly; lay people off or ask them to defer or forego salary -- many staff people in such organizations will do almost anything to keep things going; or beg a bank for a loan that they may not be able to get (or pay back if they do get it).

Some specific differences between for-profit and not-for-profit accounting are:

• Accounting for contributions - Not-for-profits that qualify for tax-exempt status under 501(c)(3) of the Internal Revenue Code can receive tax-deductible contributions. Since this certainly doesn't happen in the for-profit world, there aren't any comparable procedures for handling these contributions. Special procedures have been established for handling different types of contributions. This is discussed in the Statement of Financial Accounting Standards No. 116, Accounting for Contributions Received and Contributions Made; Analysis of FASB 116 provides a helpful summary.
• Capitalizing and depreciating assets - Both for-profits and not-for-profits are required to record the purchase of long-lasting, substantial property and equipment (such as computers, vans, buildings, etc.) as assets in the financial records. They must also depreciate those items for each year in which they have a useful life. However, some assets in the not-for-profit sector receive special treatment. These include museum collections, historical buildings, library books, zoo animals, etc..

Depreciation is the amount of value a piece of equipment, property, or other large, long-lasting item loses each year because of age and wear. If the expected useful life of a computer, for example, is five years, then it will depreciate - lose value - by 20%, or 1/5, each year up to the fifth, when it will, in theory, be replaced. Depreciation is figured as an expense or loss against the assets - the total worth - of the organization.

• Use of cash-basis and modified cash-basis accounting - Many small not-for-profits use cash-basis rather than accrual-basis accounting to record expenses and revenues. This means that they only record revenue when the cash is received, and only record expenses when they are paid. Some not-for-profits use modified cash-basis accounting. They will record payroll taxes withheld from employees or large revenue or expense items on an accrual basis. Accrual-basis accounting reports income when it is earned and expenses when they are incurred. Most businesses track all expenses and revenues using accrual accounting.

If you get public money (and, quite possibly, even if you don't), the accrual method is more accurate and more effective. It tracks line items better, and tells you how much of your annual budget you've actually spent. If you go purely on a cash basis, it's a little like not recording the checks you write from your personal checkbook, but only checking the balance occasionally. Doing that, you can end up overdrawn with no trouble at all, since your balance rarely matches the amount you've actually recorded in your checkbook. If you use accrual, you always know when you can spend and when you can't; it makes sense in that circumstance to keep track of cash as well, but not necessarily to keep books on a cash basis.

• Functional expense classification - Not-for-profits are required to report their expenses by what is known as their functional expense classifications. The two primary functional expense classifications are program services and supporting activities. Supporting activities typically include management and general activities, fundraising, and membership development. Practices vary widely from organization to organization in the not-for-profit sector as to how expenses are categorized by functional areas.
• Development of financial statements - The FASB has issued Statement No. 117: Financial Statements of Not-for-Profit Organizations, which establishes standards for general-purpose external financial statements provided by a not-for-profit organization. Analysis of FASB 117 provides a more in-depth explanation, but basically it requires that those financial statements provide certain basic information that focuses on the organization as a whole and meets the needs of those outside of the organization with an interest in the group's financial situation. .

What is an accounting system?

An accounting system is composed of accounting records (checkbooks, journals, ledgers, spreadsheets, etc.) and a series of processes and procedures assigned to staff, volunteers, and/or outside professionals. The goals of the accounting system are to ensure that financial data and economic transactions are properly recorded and that financial reports necessary for management are prepared accurately and in a timely fashion.

Components of an accounting system:

• Chart of accounts: The chart of accounts is a list of each item the accounting system tracks. You might think of the chart of accounts as the "table of contents" for the general ledger.
  • Accounts are generally divided into five categories: assets, liabilities, net assets or fund balances, revenues, and expenses. Each account is assigned an identifying number for use within the accounting system. Examples of accounts include things such as the payroll account, office supplies, donations, and so on.
• General ledger: The general ledger organizes information by account. In a manual system, summary totals from all of the journals (see below) are entered into the general ledger each month. The general ledger maintains a year-to-date balance for each account. In a computerized system, data are typically entered into the system only once. Once the entry has been approved by the user, the software includes the information in all reports in which the relevant account number appears. Many software packages allow the user to produce a general ledger that shows each transaction included in the balance of each account. For example:

Acct 3102	Account Name: Office Supplies
Beginning Balance @ Sept 30:	$1,535.26
Ck. No. 1729 Mick's Office Supplies 10/12	$347.40
Ck. No. 1746 Quality Paper Store 10/17	$32.89
Closing Balance @ October 31:	$1,154.97

• Journals and subsidiary journals: Journals, also called books of original entry, are used to systematically record all accounting transactions before they are entered into the general ledger. Journals organize information chronologically and by transaction type such as receipts, disbursements (the payment of a debt or other expense), or other transaction types. There are three primary types of journals:
  • The cash disbursement journal is a chronological record of checks that are written,categorized using the chart of accounts.
  • The cash receipts journal is a chronological record of all deposits that are made, categorized using the chart of accounts.
  • The general journal is a record of all transactions that do not pass through the checkbook, including non-cash transactions (such as depreciation) and corrections to previous journal entries.
  • As organizations mature and handle greater numbers of financial transactions, they may develop subsidiary journals to break out certain kinds of activity from the primary journals noted above. The most common examples include payroll journals, accounts payable journals, and accounts receivable journals.
• Checkbook: In very small organizations, the checkbook may serve as a combined ledger and journal.
• Accounting procedures manual: The accounting procedures manual is a record of the policies and procedures for handling financial transactions. The manual doesn't need to be a professional book: it can be a simple description of how financial functions are handled (e.g., paying bills, depositing cash, and transferring money between funds). Creating an accounting procedures manual for your organization helps ensure consistency in how your books are handled. It can be very useful when someone new begins handling accounting duties.

When should you develop an accounting system for your organization?

• If your organization spends or earns any money at all, you probably do some accounting already, even if it is just balancing your checkbook. The important thing to remember is that your accounting system will change as your organization's needs and resources change.
• Each organization is unique, and will develop accounting procedures that make most sense to them. Even a relatively new, small organization, however, should think about the long term from the start. It's never too early to speak with a CPA (especially if you can convince one to donate his or her talents) about what makes most sense to your organization, and where you might be going in the future.
• If it's at all possible, we recommend setting up a regular accounting system, with real books, from the start. It can be very difficult to switch over when you need to, especially since it's usually overdue by the time you realize the necessity. If your organization has a computer, it's worth it to set up an accounting system on it, even if it's only a simple program. If you have to do it after the fact, data entry becomes a serious problem, whereas if you have the data in the computer already, switching over to another program is often not a problem.

Why should you do accounting for your organization?

So, what are the advantages of using proper accounting procedures for your organization?

There are quite a few, including:

• To meet government requirements, such as those prescribed by the FASB and the GASB - not to mention the IRS!
• To help members of the organization and the general public better understand the financial activities and the condition of the organization
• To ensure that financial resources are used effectively and efficiently
• To make sure you're not spending money you don't have

How do you do accounting for not-for-profit groups?

For our purposes in this section, we will look at three things your organization will need to do to handle its accounting procedures:

• Find an accountant
• Choose accounting software
• Carry out the accounting process

Finding an accountant

First, decide who will do the accounting. Will you do it yourself? Doing it yourself will be most feasible if your organization is very small, with very simply financial reporting needs. Alternatively, will you hire an accountant or try to find a volunteer accountant? For many mid-size and larger not-for-profit groups, this is an absolute necessity.

For many community organizations, the best of all options is to find an accountant who is willing to do a little pro bono work for your organization. But how can you find someone who is willing to volunteer their time and expertise? Our suggestions are:

• Ask around. Use the networks of your Board members to find a willing volunteer. Most organizations have someone involved who either is a professional herself, or knows someone who is. Don't be shy about asking for help. Remember, you're not asking for yourself - you're asking on behalf of a cause you believe in.
• Look and see who advertises in publications related to what you are doing. For example, if you are a member of the local AIDS project, you might want to see if any lawyers or CPAs advertise in the local gay press. Some of the people advertising may well be willing to volunteer or work inexpensively for a cause they believe in.
• Another source of cheap or free accounting help is other organizations. You may be able to work out a shared or a donated position. Another alternative is to find an organization that pays people to work for other organizations. For example, the accountant at a literacy project in the Northeast came to the organization through a work program for senior citizens. The work program paid him for two years, at the end of which the literacy project had enough money to pick up his salary.
• Accountants for the Public Interest is a not-for-profit organization whose mission is to encourage accountants to volunteer their time and expertise to not -for-profits and others in need.

The next thing that you and your accountant will need to decide is whether or not you will use accounting software. There's no doubt that accounting software can be very helpful. It offers increased efficiency and accuracy, and better control over the numbers, but it is not a cure-all. A mess on paper will just become a bigger mess if it's entered into a computer without fixing any of the underlying problems.

Choosing accounting software

If you have decided to purchase software, sit down with whoever will do the accounting and make a list of the features you are looking for.

A first decision you will need to make is whether you want fund accounting software or not. Fund accounting software programs are sophisticated software for not-for-profits that use fund accounting methods. That is, they maintain separate balance sheet data (assets, liabilities, fund balance) for each account. This method (and software) encompasses most of the aspects of commercial accounting, but it will include a lot of information that is not part of a commercial program.

Drawbacks to fund accounting software programs:

• Cost - this type of software can be expensive
• Difficulty of use - unless you are an accountant or experienced bookkeeper, you will most likely find the fund accounting software programs daunting

A relatively small not-for-profit organization may find regular business software suitable for its needs. Our suggestion is to discuss your needs in depth with an accountant you trust.

There are a lot of programs on the market that can produce basic fund financial statements, but like anything else, they all have their own strengths and weaknesses. Some questions to ask yourself include:

• What sort of computer and operating system do you have? Do you want to buy new equipment to run the system? Can you run any worthwhile accounting software on the computer you have? (Do you have enough memory and enough storage space on your hard drive to run it?)
• Do you need fundraising software, fund accounting software, or both? If you need both, do they need to be connected?
• How many funds do you have? How independent are they? How many accounting transactions do you conduct each month?
• What is your budget for this project?
• Do you have specific reporting requirements from your funders?
• Can you support the software internally, or are you going to need long-term help from the consultant who installs it?
• Can you get a demo of the software to evaluate it before you buy? This is common practice with many companies.

Information about options for different types of fund accounting software is available from the Nonprofit FAQ.

And before you buy, you should also talk to others about what might be best for your organization. For example, you might speak with an accountant you know and trust for her recommendations. You might also ask other not-for-profit managers in your area what software they use. Then, not only can you get an honest appraisal of the software, you will have someone to talk with when you have questions.

Carrying out the accounting process

Whoever does your accounting (and whether or not they use software to do it), the procedure they follow will be similar. Detailing how to go about the process is beyond the scope of a Tool Box section - remember, the science of accounting takes up many, many college courses.

However, a brief overview of the process shows that it will include:

• Conducting financial transactions
• Analyzing transactions
• Recording transactions in journals
• Posting journal information to the general ledger
• Analyzing the general ledger account and make corrections (e.g., reconcile your information with bank statements)

If you will be involved in your organization's accounting, we strongly encourage you to check out the resources listed below.

In Summary

The tasks involved in doing the accounting for your organization can seem daunting, especially if numbers and formulae aren't a language you speak. As the manager of a community organization, however, it's important to have at least a basic understanding of the vocabulary and ideas, so that when the grants coming raining down on you, you won't let valuable resources slip away through poor management.

Tool: Glossary of accounting terms

Essential Accounting Terms for Not-for-Profit Organizations

• A-133 audit - an audit required for not-for-profits that receive $25,000 or more in federal funding during a fiscal year.
• Accounting - a system for providing financial information about a business or other type of organization.
• Accounting procedures manual - a record of the policies and procedures for handling financial transactions.
• Accounting system - accounting records (checkbooks, journals, ledgers, spreadsheets , etc.) and processes and procedures assigned to staff, volunteers, and/or outside professionals.
• Accrual-basis accounting - accounting procedure that reports income when it is earned and expenses when they are incurred.
• Asset - something with economic value owned by an organization.
• Auditing - the testing of an organization's accounts for accuracy and completeness by people who had no part in their preparation.
• Bookkeeping - the practice of recording business accounts and transactions.
• Cash-basis accounting - accounting procedure that records revenue when the cash is received, and records expenses when they are paid.
• Cash disbursement journal - a chronological record of checks that are written, categorized using the chart of accounts.
• Cash receipts journal - a chronological record of all deposits that are made, categorized using the chart of accounts.
• Chart of accounts - a list of each item that the accounting system tracks.
• Compilation - a report prepared by an accountant organizing financial data supplied by the organization into standard financial reporting formats; does not include a review of the numbers for accuracy or analysis.
• Depreciation schedule - a schedule of the decline in value of certain items the group owns.
• Financial Accounting Standards Board (FASB) - The professional quasi-regulatory organization with primary responsibility for determination of financial reporting standards in the United States. The Securities and Exchange Commission has the power to override FASB standards.
• Fund accounting - a ledger, fund, department and project-tracking system for not -for-profit organizations. Fund accounting includes batch posting for all transactions , with safeguards that prevent the user from quitting posting unless debits and credits balance. Posts to previous, current, or future periods in the current fiscal year . Tracks funds from sources/donors, and maintains budgets and balances for both departments and departmental projects. Produces fund statements, revenue expense statements , budgets, and fund and project listings.
• General journal - a record of all transactions that do not pass through the checkbook , including non-cash transactions (such as depreciation) and corrections to previous journal entries.
• General ledger - a book of final entry summarizing all of a company's financial transactions.
• Generally accepted accounting principles (GAAP) - established accounting rules in the United States administered by the Financial Accounting Standards Board (FASB ) and Governmental Accounting Standards Board. They are largely delineated by Statements of Financial Accounting Standards.
• Governmental Accounting Standards Board (GASB) - organized by the Financial Accounting Foundation, GASB establishes standards of financial accounting and reporting for state and local governmental entities.
• Journals (books of original entry) - used to systematically record all accounting transactions before they are entered into the general ledger.
• Liability - a financial debt or potential loss.
• New assets/worth - the assets of an organization minus its liabilities.
• Opinion - the view of an independent Certified Public Accountant on how fairly the agency's financial statements represent its financial position and whether they comply with generally accepted accounting principles. An opinion is issued on completion of an audit.
• Revenue/sales - total amount generated or collected from goods and services an organization provides.
• Review - similar to an audit but more limited; a review conducts some analysis but does not undertake the extensive testing required for an audit.

___You know accounting is a system for providing financial information about an organization

___You understand the differences between accounting and bookkeeping

___You can name the components of an audit

___You can list major differences between for-profit and not-for-profit accounting

___You know the components of an accounting system

___You understand when and why you should develop an accounting system

___You have a plan for finding an accountant, choosing software, and beginning your accounting process

• What does it mean to be nonprofit and tax-exempt?

• What are the advantages of nonprofit and tax-exempt status?

• What are the disadvantages of nonprofit and tax-exempt status?

• When should you consider applying for nonprofit and tax-exempt status?

• When you might not want to apply for nonprofit and tax-exempt status

• How do you apply for nonprofit status?

• How do you apply for federal tax-exempt status?

• A last word on getting help

In any society, there are rules citizens need to follow. In a good society, these rules have been created to help things run smoothly, for the benefit of individuals and for the community as a whole.

As individuals, others help us learn these rules as we grow. Our parents are quick to point out that we must pay for the candy bar at the grocery store; we take courses in government in school; we register to vote when we turn 18; and as we agonize over our tax forms each April, we know where we can go for help, especially the first time we fill out the paper work and agonize over foreign terms such as "earned income credit" and "total taxable income."

Organizations are part of the community as well. They don't exist in a vacuum, and therefore, they're bound by laws and regulations, just as private citizens are. And so, like individuals, community groups will go through a "coming of age" when they will decide what their place in society is, what laws affect how they do business, and how they can use those laws to run most effectively.

Unfortunately, help sometimes seems a bit harder to come by than it did when we grew up and learned the laws we needed to follow (whether we liked it or not!). Eventually, a community organization will need to consider its legal position. And this brings up a myriad of difficult questions that make us wish all we had to deal with was a 1040-EZ form.

Some of the questions that most community groups will face are:

• What different types of organizations exist? Just what type of organization are we? What kind of organization should we be?
• We're nonprofit, right? What does that mean? Can we make a profit?
• If we are a nonprofit group, are we tax-exempt? What does tax-exempt mean? Should we apply for it? How? Does it exempt the organization from federal, state, and local taxes?

In this section of the Tool Box, we'll walk you through the answers to these questions, and give you an idea of what it means to be nonprofit and tax-exempt. We'll explore the advantages and disadvantages of both, and talk about when it makes most sense for an organization to apply for such status. At the end, we'll give a brief overview of the nuts and bolts of the application processes.

Will you be able to fill out these applications on your own at the end of this section? Probably not. In fact, we strongly suggest you get professional help - either from a lawyer or an accountant who is well-versed in nonprofit and corporate law - as you decide what form your organization will take, and to help complete and file the papers. This section is not meant to take the place of an attorney or other legal counsel.

What we do hope this section will give you is an understanding of what's out there and what might be useful to your organization. We'd like to demystify some of the "legalese" that's so hard to understand, so you'll be able to make the best choices for your organization. If that makes sense to you, then let's begin.

What does it mean to be nonprofit and tax-exempt?

Are nonprofit and tax-exempt statuses the same?

No, but they are closely related. Nearly all organizations that are nonprofit wish to be tax-exempt as well, so the terms are often confused. Many charitable organizations, for example, are nonprofit organizations and are recognized by the federal government as being tax-exempt. But becoming nonprofit and becoming tax-exempt are different processes, done at different times (usually), and by different government agencies.

A first important distinction to make is that granting nonprofit status is done by the state, while applying for tax-exempt designation (such as 501(c)(3), the charitable tax-exemption) is granted by the federal government in the form of the IRS.

To apply for federal tax-exemption, you need to have been granted nonprofit status first. Further, not all nonprofits are eligible to be tax-exempt. Let's look at each term individually.

Nonprofit status

A nonprofit organization in its simplest variation, is any organization for which those who control or support it do not earn a profit. This doesn't mean that a nonprofit can't make a profit--quite the contrary is true. A nonprofit organization can produce goods and services, and it can earn a profit while doing so. It can even invest those profits (in the stock market, for example) in hopes of earning more money. However, all of the money made must go back into the organization - there is no "profit sharing" among members. Generally speaking, these organizations don't have any owners.

This is one reason that nonprofits are known more and more commonly as "not-for -profits." They may make a profit to help them stay in business, but making money is not their reason for being.

Individual states, and not the federal government, grant official nonprofit status. They may do so in slightly different ways, and give slightly different advantages for obtaining it. However, the federal government can recognize your nonprofit status. If you want to apply for tax-exemption, for example, you must be recognized as nonprofit by the federal government.

There are three types of nonprofit organizations that are recognized for this purpose by the federal government:

• A corporation
• An unincorporated organization
• A trust

Becoming a corporation is perhaps the most common choice for community organizations. For incorporation, the organization must be structured according to specific state laws. These laws include having a "creating document" commonly known as the articles of incorporation, and rules of operation which are commonly known as bylaws. Usually, there is a board of directors and officers, and state laws (usually) limit the liability of members in varying degrees.

Often, incorporation is the best choice for a community organization. Part of this is simply a matter of perception, or of comfort, of the people with whom you work. People are familiar with corporations; they're used to working with them, and often perceive corporations as serious and dependable. Also, the limitations on personal liability mentioned above can be quite helpful.

Basically, the personal liability protection means that if someone feels the organization or one of its members has harmed him, only the organization may be sued, and not individual members if you have this protection. For example, if a potential employee feels she has not been hired because she is hearing-impaired, she can sue the organization as a whole, but not the person who interviewed her. Likewise, if the organization's director gets in an accident and hurts a passerby on the way to a coalition meeting, the organization, but not the director, may be sued.

It's important to note, however, that the limits of this liability do vary from state to state, and you should be aware of the laws that govern what you do. There may be circumstances in which directors or members of corporations may face personal liability. Some insurance companies offer additional insurance for directors and officers of nonprofit corporations.

An unincorporated organization is a group much like a corporation, and often has similar bylaws and purposes. Although the name seems to suggest otherwise, it is still a formal structure with an official structure. However, a constitution or other policies may take the place of the articles of incorporation, and there is no protection against personal liability. Additionally, much less reporting to the state occurs.

A trust generally has more narrow interests than a corporation or an unincorporated group. Many laws which govern trusts are created with charitable trusts (i.e, groups that give away money) in mind. Because of this, becoming a trust is rarely appropriate for a community group.

Going into depth on each of these types of organizations is beyond the scope of the section; for detailed information on each of them, you might speak with an attorney, or read B.R. Hopkins' Starting and managing a nonprofit organization: A legal guide.

And of course, you can certainly be a nonprofit organization in the loose sense of the word without ever filing papers, having a board, or any of those things. For example, a neighborhood group could be very effective without ever incorporating, or having a board, or even elected officers. It's still a nonprofit in practice, though, even if the law does not recognize it. We'll discuss the advantages and disadvantages of becoming officially recognized later in the section.

Federal tax-exempt status

Organizations that are exempt from federal taxes are described sections in the United States Tax Code. The best known type of tax-exemption is 501(c)(3), also known as the "charitable tax exemption." This designation allows exemption from federal corporate and income taxes for most types of revenue. Also, organizations designated as 501(c)(3) are able to solicit tax deductible contributions. 501(c)(3) is most appropriate for many community organizations, and (except where indicated otherwise) it will be used interchangeably with the term tax-exempt for the remainder of this section.

However, before we move on, we should mention that there are a total of 26 exemptions under the tax code for different purposes, and some community organizations might find one of them more appropriate. For example, a group that is involved in heavy lobbying or political advocacy work would be unable to apply for 501(c)(3) status, as it isn't allowed under that statute. So a group heavily involved in social welfare that wants to lobby extensively for political candidates, for example, might find 501(c)(4) status (which deals uniquely with social welfare organizations) more appropriate for their purposes.

So before deciding to become 501(c)(3), it's a good idea to sit down and study other possibilities with an expert. Together, you can decide on the type of exemption that best meets your needs. That way, you won't be trying to push a square peg into a round hole. More information on the different tax exemptions, as well as other technical details not discussed in this section, may be found on the IRS website.

Generally, an organization becomes tax-exempt by applying for the status. This is a fairly long process. The application form (Form 1023 for 501(c)(3) organizations; Form 1024 for others) is approximately 30 pages, and the IRS suggests that it (1023) will take about eight hours to complete--and that's after you have done record keeping (on expenses, revenue, and the like) and learned the law. It usually takes several months to be granted status.

However, several weeks after you complete and mail the forms, the IRS will send you a letter saying your status is "pending." This letter is usually enough proof for funders and others who might require proof of your exempt status.

When status is granted, the IRS will send a "letter of determination" that your organization can then use to prove its tax-exempt status on a more permanent basis. You might need the letters to show to foundations when applying for a grant, for example, or when you are applying for state tax-exemption.

Additionally, however, there are two ways of having tax-exempt status without filing: automatic recognition and a fiscal conduit.

Automatic recognition

Some organizations are automatically recognized as having 501(c)(3) status; they don't need to file. These groups include:

• Subordinate organizations that are evaluated by parent groups, or are covered by a group exemption
• Churches, parts of churches, or associations of churches
• Organizations that are not private foundations and normally have gross receipts of not more than $5,000. For example, a group of citizens trying to convince the city council to create bike lanes on major streets might fall into this category. This recognition is particularly helpful for small grassroots groups who don't have the experience, time, and money necessary to file for exemption.

Even though these groups are automatically tax-exempt, they may choose to file anyway, in order to have the official letter of determination on file. This often makes it easier to solicit contributions and ask for exemptions from state taxes.

Fiscal conduit

A fiscal conduit is an organization that is already incorporated and tax-exempt that administers funds and performs other administrative tasks for your group. Also called a "lead agency," they can be invaluable in helping out with the organization of your group, reimbursing contractors, and sharing space. Local United Ways and public health departments are two examples of groups that often serve as fiscal conduits.

A fiscal conduit may be what you need at the very beginning. The lead agency can do all the paperwork for you, and provide other kinds of less tangible support that can really help you, at least at the start. Why not use that support if it's available?

State tax-exemption

State exemptions can include many different things, including exemptions from sales tax, income tax, and property tax. Again, these laws vary, so check with the Secretary of State's office for rules for your state. In some states, however, the requirements are the same as those of the federal government, and showing proof of 501(c)(3) status is enough to exempt you from many state taxes.

What are the advantages of nonprofit and tax-exempt status?

There are quite a few advantages to having the official status.

For nonprofit status:

• If you want to assume fiduciary responsibility for all of the funds and to contract directly with the state, you will need to be an incorporated nonprofit organization
• As an incorporated nonprofit organization, you'll be able to take advantage of reduced postal rates for many purposes
• And, as an officially recognized nonprofit, you can apply for federal tax-exemption, which leads to many more advantages

For federal tax-exempt status:

• As we mentioned above, you are freed from many taxes, and potential donors can make tax-deductible contributions. The latter is a powerful advantage for many groups who survive mainly on contributions and grants.
• You can apply for grant funds directly. Almost all foundation or government grants require evidence of federal tax-exempt (501(c)(3)) status. If you don't have it, you will need some kind of fiscal conduit in order for your grant application to be considered.
• Your group now becomes more independent, free (or at least freer) from the potential control of fiscal agents or others who have helped you before, even if they have been generally sympathetic.
• The independence you gain can be a psychological boost to your organization

What are the disadvantages of nonprofit and tax-exempt status?

Although applying for official nonprofit and tax-exempt statuses can be very helpful, there can also be some disadvantages to doing so.

• Incorporation creates another level of complexity, responsibility, and regulation that a volunteer-based organization may not be prepared to handle. For example, your organizations must send an annual tax-return to the IRS.
• Filing for incorporation and tax-exemption takes time and money. For example, at this writing (in 1998) the fee for filing for federal exemption is $500 for most groups, and $150 in a limited number of cases. Fees for tax advisors (legal and accounting) can also be substantial.
• For a group in the very beginning stages, incorporation and tax-exemption may not be necessary. It's often best to focus on doing the work, and developing a track record of success. Incorporation and related issues can become a distraction; they can be taken up later.
• Incorporation and federal tax-exemption may limit certain lobbying and advocacy activities. For example, you cannot (as an organization) support candidates for public office.
• The community may perceive creating another nonprofit organization as an additional level of bureaucracy.
• Tax-exempt organizations are taxable, to the extent that they participate in activities unrelated to the performance of tax-exempt functions. While this isn't exactly a disadvantage, it is something you should take into consideration.

When should you consider applying for nonprofit and tax-exempt status?

After taking into account all of the advantages and disadvantages of applying for nonprofit and tax-exempt status, you might decide that they are the right steps for your organization to take. But is now the right time to take the plunge?

Maybe so, if:

• Your group has proven its worth through specific community accomplishments
• Your group, and in particular its leaders, are committed to continuing its activities and staying in existence for the foreseeable future
• Your group plans to be applying for grants on a regular basis, or you will be selling a significant amount of goods/services
• No suitable fiscal agent or fiscal conduit is locally available

When you might not want to apply for nonprofit and tax-exempt status

On the other hand, you might decide that the time isn't right to apply when:

• You are not sure if the organization will continue
• The group does not need outside grants/money for successful operation
• A fiscal agent or fiscal conduit, whose views are similar to your own, is willing to handle any grant applications or other fiscal affairs

Any of these conditions might be enough, individually, to convince you to consider holding off for a while. However, organizations will want to look over all of the details of their own situation, and decide what makes most sense for them.

One more point to take into consideration: if you apply for exemption within the first 15 months of being created, your tax-exempt status can be applied retroactively to the founding date of your organization. The federal government also gives an automatic 12-month extension on this regulation. That means functionally, you must apply within 27 months of being created to avoid taxes for the start-up period of your organization. For groups who know from the outset that they want to be around for the long haul, then, it might make sense to apply relatively early in the life of the organization.

How do you apply for nonprofit status?

Procedures for becoming an official nonprofit organization will vary greatly from state to state, and so we won't spend too much time talking about it here.

But a general overview of the process might look like this:

• Hire legal counsel to help make the decisions and guide you through the process
• Decide if it makes sense for your organization to apply for such status now
• Decide what type of nonprofit organization it makes sense for you to be (a corporation, an unincorporated organization, or a trust)
• Decide the state in which you want to apply for nonprofit status - usually, this will be your home state; but some states have laws that are "friendlier" to nonprofits or to particular causes
• Apply for nonprofit status in accordance with the regulations for your state and type of organization. Contact the Secretary of State's office to learn more about those procedures. If you plan to later apply for tax-exempt status as well, it's important to pay particular importance to the wording and content of items such as your articles of incorporation, as some of the federal government's regulations are very specific.
• Be sure you understand the state's ongoing requirements for reporting and renewal

How do you apply for federal tax-exempt status?

The steps for applying for federal tax-exempt status are quite similar to applying for nonprofit status. There are, however, some important differences.

Briefly, the steps involved are:

• Hire legal counsel to help make the decisions and guide you through the process
• Determine if you are eligible for tax-exempt status, and if your organization is automatically exempt
• Decide if it makes sense for your organization to apply for such status now
• If you are not already a nonprofit organization (as designated by the state), you will need to become so
• Decide the tax-exemption (e.g., 501(c)(3), 501(c)(4)) for which your organization is eligible.
• Apply for exemption from the IRS
• Be sure you understand the ongoing requirements for reporting and renewal

A last word on getting help

Throughout this section, we have suggested getting help from an accountant or a lawyer when you are going through these processes. But those fees add up; how can a relatively poor organization afford this type of counsel?

Our advice is to look for professionals who will either donate their time or do the work at a reduced cost. You might find this help:

• By asking around. Most organizations have someone involved who is either a professional himself, or knows someone who is. Don't be shy about asking for help. Remember, you're not asking for yourself--you are asking on behalf of a cause you believe in.
• The Legal Aid organization in your town should have, at the very least, a list of lawyers in town willing to do pro bono work, and the American Bar Association might as well.
• You might also look and see who advertises in publications related to what you are doing. For example, if you are a member of the local AIDS project, you might want to see if any lawyers or CPAs advertise in the local gay press. Some of the people advertising may well be willing to volunteer or have a reduced fee for a cause they believe in.

When looking for help, you might want to try going through all of the channels listed above, and it may take some time before you find someone competent to help you out. Sheer persistence, however, often makes the difference - don't give up the first time someone tells you no.

In Summary

Understanding the legal system that surrounds the nonprofit world is certainly not an easy thing to do. In this section, we have left out many of the finer points of the law, to give you a general understanding you can use as you talk with legal council, or read through some of the more detailed literature on the system.

As you get more in depth into your study of the laws surrounding nonprofit organizations, it's easy to get lost in the details. But remember, the system was set up to help nonprofits, not hinder them. When you have a solid understanding of the system, your organization can use it to its advantage. By doing so, you've made an important step along the path of becoming a successful, self-sustaining organization.

Example 1: Filing for 501(c)(3) status by the Lawrence (KS) Partnership for Children and Youth

Sydney Karr is the executive director of Lawrence Partnership for Children and Youth in Lawrence, Kansas. Her group, a non-profit corporation, applied for charitable exemption from federal taxes. "The 501(c)(3) status does a couple of things for you ," Sydney said. "The first thing is that it saves you money because you don't have to pay state income tax or federal income tax. The second thing is that it allows you to solicit more donations (because donors don't have to pay taxes for charitable contributions). To many donors that makes a big difference." Sydney also points out that a 501(c)(3) status can be beneficial in terms of purchasing insurance for the corporation, and in terms of state and their unemployment compensation. "Legally, you are a different kind of entity," she said. And that difference can bring benefits to your organization.

Sydney started her application using an example of another organization who had applied, so that her organization would have a sample of the way they should answer questions. "My accountant has alerted me that when you send this paperwork in," Sydney said, "the federal government will send back questions. It could be a series of questions, and quite often they send you a second series of questions and then you answer those . About the third time you send them something, they send you a letter saying you got it." That is standard practice, according to Sydney's accountant. No matter how thoroughly you fill out the paperwork, or how well you think you've done it, they will always have questions for you. And it's not a matter that they're not going to grant you the status, it's just that they always have questions, Sydney said.

So is it necessary to have both an accountant and a lawyer working on your application? Not necessarily, but in Sydney's experience, she got some legal advice from her lawyer, and then worked closely with her accountant. Her attorney, who works for free, said that if he just sent an example from his files from another organization to Sydney, she probably wouldn't have to come back to him for other questions. "It really is my intention to go ahead and do all of the paperwork myself," Sydney said . "But in the meantime, I was talking with our accountant, because he's the person who really knows both the federal and the state regulations, and he has really kind of pointed out to me the need for the 501(c)(3) status."

Getting 501(c)(3) status can help your organizations in more ways then one. Sydney offers an example about when her organization was trying to get directors and officers liability insurance. That's a way to insure the members of the board of directors against personal liability for the decisions that they make on behalf of the corporation , referring to director's and officer's liability in medical or treatment settings. "For instance, if a client or a patient says that he was harmed as a result of what this not-for-profit corporation did, then he could sue the corporation and each individual member of the board of directors," Sydney said. "The board of directors could actually have their own money at stake. I was trying to check into what the cost would be and get some quotes on the insurance. And one of the insurance companies that I was trying to get the quote from would not even give it to us until we had proof of our 501(c)(3) status. That was kind of an interesting kind of sideline that came up."

And that was not the only one. Sydney remembers when her organization was dealing with the state of Kansas on unemployment compensation insurance. Even though Sydney's corporation is a very small one with only three employees, the board decided that they would like to insure any members of the staff against being unemployed, having that state benefit available to them. "In trying to buy into that, and pay into the unemployment compensation fund, I just learned that we have to have 501(c)(3) papers pending at the very least," Sydney said. She ended up not needing the directors and officers liability, because they are not seeing patients.

"One of the things that is very confusing to people," Sydney remarked, "is the fact that when you say you're tax exempt, many vendors believe that means that you don't pay sales tax. I believe there are a few states where this is not the case, but in Kansas and in many states, just because you are tax exempt from income taxes and have that 501(c)(3) status, it does not exempt you from sales taxes." This can be tricky, because some business may set your business up as sales tax exempt, and then they will come back and ask you for your proof of sales tax exemption, when you might hot even had known they had you down as such. That's happened to Sydney. "I just discovered that a bill [that] was $50 and the amount owing was $50." And I said "that's not right, there's no taxes there." And they said "well, you're a non-profit." We know we are, but we pay sales taxes."

Sydney has experienced some hassles in filing her organization forms. She said that, when dealing with a lengthy federal form like the 501(c)(3) application, you may not know what it is they're asking for in each blank, and it might be helpful to look at an example of someone else and the way they've filled it out. Some of the regulations are very specific, and learning exactly what they are asking for before you submit the application can save an organization many headaches.

Example 2: Creating Affirm Youth, a nonprofit organization serving gay youth in Greenville, South Carolina

Recounted by Paul Evensen

I didn't have "start a nonprofit organization" on my list of things to do in life, and I don't think that is why any of us tackle something so overwhelming and challenging . What happens is that you become either very angry or very sad about what is going on in your community. Then, you get excited about what you could do to change things, and you end up half way into it before you know it.

I was compelled by the stories of several young people in my community who had been thrown out of their homes as teenagers because their parents discovered they were gay. The driving question became, "How can we keep families together and gay teens connected to school, churches and their community?" Part of the answer was to start a non-profit organization dedicated to crisis intervention, advocacy, and support.

I spoke with at least a hundred people including pastors, teachers, counselors, leaders in the gay community, parents, and representatives from the whole spectrum of social service agencies. I shared my ideas and solutions and asked for their feedback and suggestions for next steps and who else I should talk to. Most importantly, I asked for their personal commitment.

Through this process I found a fellow "preacher" who could see my vision and was willing to take a primary role in helping bring it about. It turns out he was a preacher in real life and he eventually became the full-time director of the agency . I also found those willing to shoulder key leadership roles on the board. We held a public meeting and announced the new organization, the name, logo, mission, the newly formed board, and the director to a very surprised community.

From there, it was a team effort to put a fund-raising plan together, to further develop the board, to create appropriate services, and to begin outreach.

I would offer several lessons to anyone trying to create a nonprofit:

• Get legal help early. Preferably, find a volunteer with experience in both nonprofit administration and the subject area your group deals with.
• Network quickly and nationally. Go to a national meeting of similar agencies and ask, ask, ask and ask again for what you need. This is where I found free legal help, as well as mentors from neighboring states and cities who could offer invaluable advice.
• It is not about you. It is about the issues and needs that draw us to common action. Many will want to make it about people, personalities, and politics. To counter this always focus on ideas and vision, and surround yourself with key people who do the same.
• Involve new young leaders. The work is very often not about the needs your organization is going to meet. Rather it is about giving the community a chance to learn and act. This includes new opportunities for young leaders to gain skills and experience. Give them a chance and pair them up with a mentor. They'll be running your organization after you're long gone.

Extending yourself to others is the heart of service. Seeing families changed because of work you've done will give your soul immeasurable rewards and an amazing energy to do more.

Example 3: A Sample Letter of Determination from the IRS

What follows is the text of an actual letter of determination. Special thanks to the United Way of Douglas County, Kansas, for furnishing and allowing the printing of this letter.

Internal Revenue Service
Department of the Treasury
1100 Commerce St.
Dallas, TX 75242

Person to contact: First read Tax Examiner
Telephone Number: (214) 767-1870
Refer Reply to: EP/EO:SBP:495ODAL

Date: May 07, 1986

United Way of Douglas County, Inc.
PO Box 116
Lawrence, KS 66044

Gentlemen:

Our records show that UNITED WAY OF DOUGLAS COUNTY, INC is exempt from Federal Income Tax under section 501(c)(3) of the Internal Revenue Code. This exemption was granted AUGUST 1973 and remains in full force and effect. Contributions to your organization are deductible in the manner and to the extent provided by section 170 of the Code.

We have classified your organization as one that is not a private foundation within the meaning of section 509(a) of the Internal Revenue Code because you are an organization described in section 170(b)(1)(A)(vi).

If we may be of further assistance, please contact the person whose name and telephone number are shown above.

Sincerely yours,

Theresa Nelms
FIRST READ TAX EXAMINER

___You understand the importance of legal counsel when applying for nonprofit status and tax-exemption

___You understand that nonprofit status is granted by the state, while the federal government grants IRS tax-exemption

___You know the three types of federally recognized nonprofit organizations are a corporation, an unincorporated organization, and a trust

___You understand that becoming a corporation is the most common choice for community organizations, because it is well understood, promotes continuity, and limits personal liability

___You know that 501(c)(3) is the "charitable tax-exemption"

___You understand that it allows exemption from federal corporate and income taxes, and that it allows solicitation of tax-deductible contributions

___You know there are a total of 26 different exemptions for different purposes

___You understand that there are three ways to become tax-exempt: application, automatic recognition, and using a fiscal conduit

___You understand the advantages of nonprofit status

___You understand the advantages of federal tax-exemption

___You understand the disadvantages of nonprofit and tax-exempt status

___You understand when you should (and when you shouldn't) consider applying for such status

___You understand how to apply for nonprofit status

___You understand how to apply for federal tax-exemption

___You know where to find inexpensive assistance

• What is a Finance Committee?

• Why do you need a Finance Committee?

• Who should be involved in a Finance Committee?

• How do you create and use a Finance Committee?

Most of us in the US have, in recent years, heard a lot about the financial misdeeds of major corporations. Enron, WorldCom, and others have become poster children for white-collar crime. Unfortunately, the nonprofit world is not immune to similar problems. Both United Way of America and the NAACP have suffered scandals in the last few years, involving financial misconduct on the part of their CEOs, and causing serious damage to the images - and finances - of the organizations.

These were high-profile examples, but others that don't make the national media occur every day. Nonprofit organizations fail to fulfill funding requirements or obligations, and are asked to return grant money. Nonprofit board members are found to be awarding contracts to their own firms, or those of friends or family members. Even more common, an audit of a nonprofit turns up woefully inadequate or nonexistent record-keeping and accounting practices.

No matter how small the organization, every nonprofit, if it has any income or expenses at all, needs an accounting system that gives it control over its finances. Depending on the size and character of the organization, that system may be administered by the director, the treasurer, a bookkeeper, or an accounting department. In addition to someone to actually do the accounting, nonprofits need someone making sure that financial matters are being conducted legally, ethically, and efficiently, in order to protect the organization from lawsuits, loss of reputation, and financial disaster.

A common mechanism for financial oversight is a board or organizational committee that works with the organization's executive director to ensure that there's enough money, and that it's being spent according to the mission of the organization and funders' guidelines. Such committees may include non-board members as well, and often are composed of people with financial knowledge and skills.

A good Finance Committee can save you money, can save you trouble, and - in the worst circumstances - can save your organization's skin. This section will examine the role of a Finance Committee in a nonprofit - what its purposes and responsibilities are, why it's necessary, who its members should be, and how to set up and use it in your organization.

What is a Finance Committee?

Note: The following assumes that your organization is large and organized enough to have a board of directors. If you're a small, grass roots volunteer group that may not be the case, but - if you have any budget at all - it's still a good idea to have some financial help and oversight. You might consider finding a sympathetic individual with a financial background - a CPA or attorney, for instance, or a retired business executive - to work with you, or you might put together a small financial advisory group to handle the issues discussed below.. Especially if you're small and have a big task ahead of you, the last thing you want is to be sidetracked by a fiscal issue that may have little to do with your mission.

A Finance Committee is generally a standing committee of the board of directors that works with the director and the financial staff to monitor the finances of the organization. The organization's bylaws may specify that it has to have such a committee, or it may simply be formed because it's needed. If you do establish one, requiring a Finance Committee in your bylaws is not a bad idea. It gives the board financial control of the organization. Since the board is legally responsible for the organization's finances, it makes sense for it to exercise financial control.

A standing committee is one that is ongoing, and contributes regularly to the operation of the board and the organization. Most boards have at least a few standing committees. Standing committees are in contrast to ad hoc (Latin for, roughly, "to this purpose") committees, which are disbanded when their specific, time-limited tasks are done.

A Finance Committee is often chaired by the board treasurer, and may consist of board members only, or may include some people who aren't on the board, but who support the organization and have specific skills that are valuable to the committee. A CPA (Certified Public Accountant), a lawyer, a banker, or an investment analyst might all be good candidates for committee membership, for instance. Committee members, whether board members or not, should also have no financial interest in the organization, except for their fiduciary responsibility.

Fiduciary responsibility is another term for the board's legal responsibility for the organization's finances. It means that the board is expected to know what's going on, and to correct any errors or irregularities it finds. Boards can get in legal trouble - with funders, the IRS, the state Attorney General, or even the Justice Department - if they haven't been paying attention to financial matters, or if they haven't made any effort to get information other than what the director or financial person tells them. They're expected to exercise real oversight - to go over the books, be familiar with treasurer's reports, and otherwise keep track of the organization's money.

Not every board member has to be involved in this process, of course. The board can delegate the task to a single member or small group, which then reports back if there's a problem or something unusual. That's one of the reasons for having a Finance Committee, as we'll see.

Responsibilities of a Finance Committee

Depending upon the will of the board, a Finance Committee can have its finger in many pies. Common responsibilities of Finance Committees include:

Overseeing the financial dealings of the organization in this capacity, the committee might:

• Be familiar with, approve, and review periodically the organization's annual budget
• Make sure funds are being expended according to funders' requirements
• Oversee cash flow and other money management issues
• Monitor debt and debt payback
• Flag potential problems. There are numerous such problems that might come up. Income might look like it's going to be lower than anticipated, or expenses higher. Income-producing activities - fundraising, paid services - might be delayed, or not proceeding according to plan. There may be unnecessary, or unnecessarily high expenditures. Finance Committees are expected to catch and deal with these kinds of issues.
• Act as a resource to help correct fiscal problems and/or discuss fiscal issues. If the members of the committee have the right expertise, they can help to correct or restructure the organization's books and accounting procedures, for instance.
• Ensure that financial reporting requirements - including tax returns to the IRS and the state, reports to funders, and acknowledgments of gifts over $200.00 - are fulfilled
• Catch any illegal, unethical, or incompetent financial dealings engaged in by the executive director, fiscal or other staff, or board members. A Finance Committee can really prove its worth in a situation where the organization is placed in jeopardy by the actions of an individual.

If a committee actually realizes that something illegal is going on, it has an obligation to report it...but to whom? (We're assuming a major infraction - stealing, intentionally misappropriating large sums - not just a mistake on someone's part.) In most cases, the answer is the President or Chair of the board, but there are exceptions. What if the board President is involved in the illegality? Or what if the board President hesitates to deal with the issue, for fear of harming the organization? The committee, or its individual members, have, at the very least, an ethical responsibility here. The organization's reputation, its financial well-being, and/or perhaps its existence, are endangered by illegal actions. In addition, the board is at risk of a lawsuit for not exercising proper oversight if the actions aren't reported. If there's no recourse, the committee should go to the appropriate agency on its own. The damage done will be far less than if the organization waits to get caught...as it inevitably will be.

• Catch any illegal, unethical, or incompetent financial dealings engaged in by individuals or groups that the organization deals with, or financial arrangements that may harm the organization or someone else.

Participating in the annual audit

Unless your organization is quite small, and/or you have no or very little public money, you're probably required to have an audit every year. An audit is a review of the organization's books, financial statements and records, and financial practices by a CPA, who then writes an opinion as to whether the organization's records present a fair and accurate picture of its financial condition, and whether its financial practices are in line with what's considered reasonable financial management. If there are problems with either the records or the methods of the organization, the auditor makes recommendations as to what should be done.

The Finance Committee may be involved in an audit both directly - by supplying required board information, for instance (nonprofit audits often include a check on board minutes, board decisions, and bylaws) - and indirectly, by working with the director or financial officer to prepare for the audit or to develop a good accounting system.

The committee might take on some other audit-related functions as well:

• Participate, if necessary, in formulating a plan to correct any problems the audit finds
• Monitor the implementation of plans to correct problems identified by the audit
• Confer with the auditors about trends in the organization's financial picture
• Evaluate the performance of the auditors, ensure there is no conflict of interest, and make recommendations about their retention

Evaluating the organization's fiscal operation, and those in charge of it

In a small volunteer organization, the Treasurer may be the fiscal operation. In a small professional one, it may be the executive director. A large organization may have a whole accounting department. Whatever the circumstances, the Finance Committee is probably the arm of the board with the most understanding of the process, and most able to make judgments about the competence of the people carrying it out.

A committee that takes on this responsibility might also participate in the hiring and firing of fiscal staff members.

Ensuring that the financial elements of the organization are in accord with its vision, mission, and strategic plan

The board is the guardian of the organization's purpose, and it's their job to make sure that all aspects of its functioning go to advance that purpose. Thus, the committee might act as a watchdog to keep expenses pointed toward the mission, rather than being aimed at some peripheral issue.

Sometimes, without intending it, an organization finds itself spending money on areas that aren't central to what it wants to do. The committee, in those situations, can point out the contradiction, and help steer finances back to the direction they should be taking. It can also make sure that the director or fiscal officer doesn't make financial decisions that affect the direction of the organization without consulting the board.

Reporting to the board and/or Executive Committee about the financial condition of the organization, and/or any financial irregularities or inefficiencies

The committee is the liaison between the board and the fiscal operation. Many nonprofit board members take on a glazed look when finances are discussed. A knowledgeable committee can simplify the information so that everyone understands it, and make sure that the board is fully aware of everything it needs to know. If the committee suggests changes in fiscal policy or in the bylaws to improve the organization's position, or to correct problems, it's important that board members understand why the suggestions are - or aren't - appropriate, and be able to vote from an informed position.

Why do you need a Finance Committee?

• To help a board fulfill its fiduciary responsibility. A Finance Committee gives the board control over the finances of the organization, and is the tool by which it exercises fiscal responsibility.
• To protect the organization from legal challenges and liability. As explained above, the board has a legal duty to exercise control over the financial dealings of the organization. If the financial operation is negligent or, worse, engaged in illegal actions, the board is considered responsible, unless it can show that it exercised reasonable care to keep that from happening. The presence of a Finance Committee is generally considered evidence of reasonable care, as long as the committee does its job (i.e., doesn't ignore obvious evidence of a problem, or simply let the director do something that any reasonable person would know is illegal or foolish).

Boards are legally liable for the actions of their organizations. That doesn't mean that they are blamed for everything the organization does, but that they are expected to oversee the organization, and take action to keep it from harm. If they have done their best in this effort, then they have fulfilled their legal obligation. They are not blamed if they are lied to, or if information is hidden from them, unless they have good reason to believe that such a thing is happening, and don't investigate.

There are generally three legal "duties" that boards and board members must attend to:

• Duty of care: Board members have a duty to exercise the "care that an ordinarily prudent person would exercise in a like situation and under similar circumstances." (From BoardSource, a board development website.)
• Duty of loyalty: Board members must act in the best interests of the organization, even when that conflicts with their own self-interest.
• Duty of obedience: Board members must uphold the mission of the organization, and not act in ways contrary to that mission, or inconsistent with the organization's goals. If, for some reason, a board member finds this morally or otherwise impossible, the ethical course of action is to resign from the board.

• To guard the organization against illegal, unethical, or incompetent activities by fiscal managers. An alert and informed committee should be able to catch both intentional and unintentional mismanagement of funds. Examples of the former might include misappropriation of funds, embezzlement, outright stealing, taking a kickback from a contract, or paying people for work not done. Unintentional mismanagement could involve, for example, major accounting or bookkeeping errors, misunderstanding of the terms of a grant or contract, or failure to address potential budget cuts.

In the case of intentional mismanagement, the committee can take proper action: reporting the situation, recommending the firing of those responsible, making restitution, etc. In the case of unintentional mismanagement, the committee can step in to offer help and advice to correct the situation. In either case, having a Finance Committee can literally save the organization.

• To protect the organization from actual or apparent conflict of interest. We've used the term conflict of interest several times. A conflict of interest is a situation in which an individual's personal interest - or the interests of her family, friends, business associates, etc. - is, or appears to be, in conflict with her responsibilities to others, an organization, a job, an office, or a principle she is required to uphold. Thus, a member of a compensation committee voting on his own - or his brother's - salary is in conflict of interest. A Finance Committee can make sure that any potential conflict is avoided by the board or staff member in question withdrawing from the decision-making process on any issue in which she has a personal stake, or by simply avoiding the issue in the first place.

There are legal gray areas here. In most states, however, board members are legally allowed to be paid for services by the board or organization, as long as the organization discloses the relationship, and treats - and pays - the board member in the same way as it would any other contractor (i.e., shows no favoritism, can demonstrate why the board member was the best person to get the contract, etc.). Some boards choose simply never to engage in any transaction with board members in which money changes hands, or in which the board member can be perceived to be getting special treatment. (An example of the latter might be the hiring of a board member's wife as a staff member of an organization.)

Another issue here is the appearance of conflict of interest, which can be just as damaging as an actual conflict. In general, if there's any chance that anyone might think there's a conflict, the person involved should remove himself from the situation. Judges often recuse (remove) themselves from cases where they might be seen to have some personal interest, even if they haven't. A Finance Committee can guard against the appearance of conflict as well as its actuality by being alert to the way situations are seen from outside the organization. It can be particularly effective in this regard if one of its duties is to review contracts before they're signed.

• To act as the board's eyes and ears in the financial operation, relieving the whole board of having to struggle with the complexities of the organization's finances. The committee can "translate" the finances into ordinary language and simple numbers, so that board members who are not financially sophisticated can still understand clearly the organization's financial challenges and situation, and make informed decisions.

A Finance Committee may be especially valuable and necessary on a board where a majority of members are uncomfortable with fiscal matters and/or numbers. This is often the case on the boards of human service and community-based organizations, where many members may be either recipients of services or people who are heavily focused on the interpersonal and emotional, rather than the more mathematical and logical aspects of their intelligence.

• To act as an advisory panel to the financial operation. Especially if it's made up of people with expertise, the committee can provide advice on fiscal issues in general, correcting inefficiencies and misguided accounting practices, dealing with anticipated shortfalls or surpluses, investing, etc.
• To evaluate both the financial operation and the people in charge of it from a position of knowledge. A committee that works closely with the financial operation is in a much better position to monitor and evaluate performance than is a board that doesn't have that connection. It makes the financial operation accountable, and can - and should - let the board know when someone's doing a particularly good job, as well as when someone isn't working up to standard.
• To help in the hiring of fiscal staff or a new director. Having intimate knowledge of the financial operation gives committee members a much better perspective on the skills and temperament needed to do the jobs well.
• To make the audit easier, both by assisting the fiscal operation in gathering material and cleaning up records, and by working with the auditors beforehand to make sure that they have everything they need to complete the audit efficiently and effectively.
• To interpret the audit for the rest of the board. Audits often point out important financial questions, or raise warnings about the future. They can highlight both the good and bad points of an organization, if you know how to read them. A knowledgeable committee can help the rest of the board understand exactly what the audit has to say, and what that means for the financial future or the direction of the organization.
• To help recommend the hiring, retention, or firing of potential or current auditors. A committee that understands audits, knows what questions to ask potential auditors, and can observe an audit, will have valuable information to pass on to the board. It can also help the organization avoid the kind of conflict of interest by auditors that hurt not only Enron investors, but the Arthur Andersen accounting firm.

Who should be involved in a Finance Committee?

A Finance Committee should certainly include some people with expertise in financial matters, but that doesn't mean that everyone on the committee has to be a CPA. A committee with a diversity of backgrounds can be very effective, also. Some possibilities:

• Board members with the desire and background to be helpful, such as:
  • The organization's Treasurer (often the ex officio chair of the committee)
  • Lawyers
  • Accountants (particularly CPA's)
  • Bankers
  • Investment analysts, stockbrokers, and other financial professionals
  • Directors or officers of other nonprofits
  • Small business owners
  • People who've been on other Finance Committees
• Non-board members recruited specifically for the committee. This is often a good way to establish an organizational relationship with potential board members, or with people who, for whatever reason, may prefer not to be on the board, but support the organization and are willing to help. Retirees, particularly those who have business or financial experience, may be particularly good candidates here, since they often have both the time and the desire to share what they've learned through years of experience.

Another aspect of this type of recruitment is that the people with expertise in finance are often also the people who have the resources to contribute generously to the organization. They may be more likely to do so if they have this kind of connection.

• People without specific financial expertise, but who are willing to learn, and who can ask the kinds of questions that are representative of the understanding of the rest of the board. These folks may be particularly important in interpreting the financial situation for the board as a whole. They may include beneficiaries of the organization, and/or representatives of specific community or population groups, as well as other interested board members.
• People whose very presence lends an aura of legitimacy to the committee and to the financial oversight of the organization. Respected community figures (clergy, college presidents or professors, CEO's, etc.) and former officials (a former State Auditor, for instance) known for financial oversight and integrity might be good candidates.

Particularly in choosing a Finance Committee, it's crucial to avoid even the appearance of conflict of interest. You'd want to ask the following questions, and make sure that committee members withdrew (recused themselves) from discussion of any issue involving an individual or entity with which they had any connection:

• Do you work for the organization?
• Are you related to anyone who works for, or who is planning to apply for a job with, the organization?
• Do you as an individual contract with, or might you contract with, the organization?
• Are you related to anyone contracting with, or who might contract with, the organization?
• Do you have any financial or other interest in, contracts with, or are you employed by companies or other organizations that do business with, or are interested in doing business with, the organization?
• Are you related to anyone with similar interests, contracts, or employment?
• Do you have any connections to the organization's funders?
• Do you have any connections to organizations that compete with the organization for funding?

Most of these circumstances can be addressed by recusal. You might decide, however, that someone who works for or contracts with the organization would have to recuse herself too often to be a useful committee member. You might also decide that other members would feel emotional pressure (even if none was intended) to act one way or another in a decision that involved another member of the committee. It's best to avoid these possibilities if you can, and choose committee members with that in mind. And remember that if there is a situation in which a committee member recuses himself, he's not allowed to discuss the situation with other committee members at all, or to try to influence their decision in any way.

How do you create and use a Finance Committee?

The creation and use of Finance Committees is bound to vary a certain extent from organization to organization. This series of steps ought to be helpful as a general guideline to most boards, however.

Decide what you want the Finance Committee to do

At the beginning of this section, we discussed some possible responsibilities of a Finance Committee. A particular committee won't necessarily have all those responsibilities, however, or may have others that weren't on the list. The real question here is the degree of oversight you want to committee to exercise.

• The committee keeps up to date on the budget, is briefed by the director on spending and income - in other words, it's the eyes and ears of the board, but from outside the financial operation. In this case, it might meet only two to four times a year, with the executive director and/or fiscal staff, and report to the board after each meeting.
• The committee exercises much more direct oversight. It makes suggestions for, or actually requires, particular fiscal activities - expenditures and income generation - carefully and frequently monitors the organization's books and fiscal activities to make sure finances are being used according to their directions, etc. It's likely that a committee this active would probably meet at least 8-12 times a year, and would probably do a lot of work outside of meeting times.
• The committee actually participates in the running of the financial operation. Here, in addition to exercising direct oversight, the committee might be involved in developing the annual budget, making budget revisions as necessary, suggesting and/or helping to write grant proposals, etc.

The appropriate level of oversight depends on the type of organization (volunteer vs. professional; board-run vs. director/staff-run); the degree of expertise and integrity expected of staff; the complexity of the fiscal operation; the past history of the organization; the attitudes and requirements of principal funders; etc.

If there's a professional fiscal staff - a CFO (Chief Financial Officer), a bookkeeper, an accountant, an accounting department - then there should be no need for direct participation in the day-to-day finances of the organization. The Finance Committee in that case is an advisory and oversight body that keeps the board current on financial matters and makes sure that the organization's books are accurate and transparent. If the financial operation is handled by the director, or by a board treasurer who's not a financial professional, then more active involvement on the part of the Finance Committee may be called for.

In general, micro-management leads to problems, but a reasonable level of participation is in fact helpful to everyone. It gives the director and fiscal people support and help (assuming it's collegial rather than adversarial), it keeps the board involved and informed, and it assures that all parts of the organization are on the same track and working together.

In addition to the level of oversight, the board should decide whether it wants the committee to participate in the annual audit. If so, it might take on some, or all, of the following:

• Choosing auditors
• Working with the auditors to facilitate the process
• Meeting with the auditors after the audit to go over and understand their recommendations
• Helping staff develop plans to address the auditors' recommendations, and correct any errors, inadequacies, or problems with the organization's fiscal policy
• Monitoring the organization's adherence to and the success of plans to address issues or to comply with auditors' recommendations
• Reporting to the board on the competence of and proposed retention or dismissal of the auditors

Choose the members of the committee with its and their duties in mind

The more complex and rigorous the oversight you want, the more you'll need a core of people with real fiscal expertise on the committee, for instance. If one of the committee's main jobs is to interpret the organization's finances for the rest of the board, then you'll want people with good communication skills.

Other qualities you might look for include:

• Integrity - an oversight committee, to be taken seriously, has to be made up of members who can be trusted to do the right thing
• Independence - this means not only that a member has no risk of being in conflict of interest (i.e., she's independent of outside pressures and forces), but also that she's able to stand up to pressure - open or subtle - from the executive director, the board chair, or other board or committee members, in order to pursue the best interests of the organization
• Dedication to the mission of the organization
• Effort - the willingness to put in the time and effort to be a productive committee member
• Competence - the willingness and the ability to learn to read financial statements, understand grants and contracts, and comprehend the fiscal operation of the organization, if the prospective committee member hasn't already done so

Establish (with the committee) policies and procedures for the committee

Whether these are set by the board or by the committee itself, it's important to have guidelines for the work of the committee that make it easier to know where to start and what to do.

Useful policies and procedures include:

• A clear statement of the committee's purpose and scope of work that's been agreed to by the board
• The committee's relationship to the rest of the board and organization - to whom is the committee responsible? How does it interact with other committees and with the director and staff? Does it have any exclusive powers?
• Committee size - this will probably be a range, and should be small enough to be manageable, but large enough to allow for a diversity of opinion and ideas. Most groups seem to function best with about 6-12 members.
• Length of membership - you may want to include in this area some provision for staggering terms, so that there are always at least a few experienced members on the committee.
• Meeting schedule, including a minimum number of meetings (e.g., 12 per year), with the understanding that extra meetings may be necessary from time to time. There might also be a requirement here that members attend a certain number of scheduled meetings in order to keep their seats on the committee.
• Internal governance procedures - these include election or appointment of the chair, recording of meetings, setting the agenda, communication procedures, etc. This may also cover the actual running of meetings, if they're formal. (Will you use Robert's Rules of Order, for example?)
• Exercise of power - does the committee have the right to suggest changes in or courses of action for the fiscal operation? To demand them? To remove fiscal power from someone without the approval of the rest of the board? If it can do any or all of these, how does it go about them?
• Evaluation and personnel function - if the committee evaluates the auditors and/or the fiscal staff, what's the mechanism for doing so? To whom and how is the evaluation reported? Does the committee participate in personnel decisions concerning the fiscal staff? Hiring and firing?
• Reporting - to whom does the committee report irregularities? What is the mechanism for doing so? Does a report require a committee vote, or is it the responsibility of individual committee members?
• Ethics - when is it appropriate, if ever, for the committee, or one or more members, to act independently of the board? (And when, if ever, is it appropriate for a member to act independently of the committee?) What are the committee's ethical obligations - to the board, to the organization, to funders, etc.? What are the ethical obligations of each member?

Develop training for the committee

Depending on its functions, you might want to conduct training in any or all of the following areas:

• The organization's budget and financial operation. This might include a presentation or workshop by the Treasurer, executive director, and/or the fiscal staff, as well as some study of the organization's books and financial records by committee members on their own.
• Current grants, contracts, bequests, endowment, and other funding. Again, this would probably be a combination of presentation and committee members' reading documents on their own.
• Laws governing nonprofit finances. This would introduce or review the laws governing 501(c)(3) and other nonprofit status, state laws, tax requirements, etc., as well as board liability and responsibilities. If the board includes an attorney, she'd be the obvious trainer here.
• The auditing process. This would cover both the organization's legal obligations and the logistics of an audit. A CPA board member or a representative of the organization's auditing firm might be appropriate trainers.
• Committee policies and procedures, and ethical considerations.
• Committee responsibilities to the board. These might include protecting the board from legal difficulties, regular reporting, assisting in maintaining financial stability, etc.

How often training takes place, and who's involved, depends on the size and character of the organization, the level of involvement of the committee, the prior experience of members, etc. New members should certainly be trained as they are appointed, but that training might be conducted by the committee itself.

Veterans may participate in training new members, thus renewing their own knowledge as well. We see this as desirable both for refreshment of knowledge and as a team-building activity. The committee may also choose to undergo retraining at intervals, or to be trained in particular topics as they arise.

Determine (with the committee) exactly how the committee will function and carry out its duties

This includes the nitty-gritty of committee operation - the logistics of the implementation of its mandate.

• Frequency, timing, and nature of meetings - not only when the committee will meet, but whom the meetings will include (the organization's director? financial staff?), and what they will cover.
• How the committee will interact with the financial operation - will it simply monitor and provide support? Advise? Direct?
• What information the committee will review on a regular basis - this might include monthly or longer-interval financial and profit-and-loss statements, funding proposals and contracts, service statistics and reports, the organization's actual books or journals, bills and receipts, a computer-based accounting program, etc.
• How the committee will report back to the board - will it give regular reports at board meetings? Report only to the board Chair? Have a seat on the Executive Committee? Report only when there's a problem? Report regularly on the financial state of the organization? On trends and possible future financial scenarios?
• What the committee will do when it finds a problem - this will undoubtedly vary according to whether the problem is caused by an error or faulty practice, or caused by some intentional misdeed, and by whether someone has tried to cover it up. If the situation needs to be reported, as well as remedied, to whom does the report go? To the board Chair? The executive director (assuming she's not implicated in the situation)? The full board? The oversight agency or funder?
• How actively the committee will be involved in devising and/or monitoring remedies for financial or legal problems

Once these guidelines for its functioning have been set, it's up to the Finance Committee to do its job. That job should have the support of the board and its Chair, and of the Executive Director and financial staff as well, for a well-functioning Finance Committee can be a benefit to an organization and everyone connected with it.

Most Community Tool Box sections end by urging Tool Box users to maintain whatever activity or institution the section covered. This section is no exception, but the encouragement here is slightly different because of the nature of a Finance Committee.

Just as White House reporters are sometimes accused of getting too friendly with the Administration to report the news objectively, Finance Committees can so identify with the financial operation of an organization that they lose their oversight capability. Committees can also become so familiar with the financial operation that they fail to pay close attention to it, and therefore miss important trends or errors or irregularities. It's important not only that the committee continue to function for the life of the organization, but that it maintain its independence and freshness - perhaps by making sure that membership is regularly varied - so that it can continue to serve the organization well.

In Summary

Nonprofit organizations can be subject to gross financial errors or illegal financial dealings just as for-profits can. For that reason it may be wise for a nonprofit board to include a Finance Committee among its standing committees. The purpose of such a committee is to monitor the organization's financial operation and catch inadequate or incompetent practice, financial errors, or unethical or illegal actions - intentional or unintentional - on the part of the director or financial staff. The committee can also participate in and/or evaluate a financial audit and auditors and help to interpret financial information to the board as a whole.

The establishment of a Finance Committee is often taken as an indication that the board is properly exercising its legal and ethical responsibility to monitor the finances of the organization. Since a board is legally liable for the operation and actions of the organization, this can be important in protecting the board and the organization from lawsuits in case of any impropriety.

Specific reasons for establishing a Finance Committee include:

• To help a board fulfill its fiduciary responsibility
• To protect the organization from legal challenges and liability
• To help catch both intentional and unintentional mismanagement of funds
• To protect the organization from actual or apparent conflict of interest
• To act as the board's eyes and ears in the financial operation
• To act as an advisory panel to the financial operation
• To evaluate both the financial operation and the people in charge of it from a position of knowledge
• To help in the hiring of fiscal staff or a new director
• To make the audit easier
• To interpret the audit for the rest of the board
• To help recommend the hiring, retention, or firing of potential or current auditors

The membership of a Finance Committee may include both board members and non-board members who are supportive of the mission of the organization. It is usually helpful to involve at least some people with financial expertise - CPA's, lawyers, financial analysts, bankers, and others who've had experience running or monitoring a financial operation. It may also be useful to include members who will ask the sorts of questions that financially less sophisticated board members might ask, as well as people whose integrity and community standing lends credibility to the committee. All members should either be totally free of, or able to circumvent honestly (e.g., by withdrawing from discussion and decisions on particular issues) any conflict of interest.

The ideal membership, structure, and functioning of Finance Committees will be different for different organizations with a variety of needs.

A general series of steps to establishing and using such a committee, however, should probably include:

• Deciding what you want the committee to do.
• Recruiting committee members with the duties of the committee in mind. General characteristics of good committee members: integrity; independence; dedication to the mission of the organization; the willingness to put in the time and effort to be a productive committee member; and the willingness and ability to learn to read financial statements, understand grants and contracts, and comprehend the fiscal operation of the organization.
• Creating (with the committee) policies and procedures for the committee. These might cover internal governance, relationships with the board and staff, meeting schedules, reporting mechanisms, and ethical obligations.
• Developing training for the committee. Areas covered should probably include the organization's budget and financial operation; current grants, contracts, bequests, endowment, and other funding; laws governing nonprofit finances and board liability; the auditing process; committee policies and procedures and ethical considerations; and committee responsibilities to the board.
• Determining (with the committee) exactly how the committee will function and carry out its duties.

It's important to maintain the committee's functioning by keeping it independent and fresh, so it can continue to benefit the organization.

What is a Finance Committee?

___You use a standing committee, which may include both members and non-members of your board, to oversee your organization's financial operation.

Why do you need a Finance Committee?

You establish a Finance Committee because:

___A Finance Committee helps a board fulfill its fiduciary responsibility.

___A Finance Committee can protect the organization from legal challenges and liability.

___An alert and informed committee should be able to catch both intentional and unintentional mismanagement of funds.

___A Finance Committee can protect the organization from actual or apparent conflict of interest.

___A Finance Committee acts as the board's eyes and ears in the financial operation.

___A Finance Committee can act as an advisory panel to the financial operation.

___A Finance Committee can evaluate both the financial operation and the people in charge of it from a position of knowledge.

___A Finance Committee can be helpful in the hiring of fiscal staff or a new director.

___A Finance Committee can make the audit easier.

___A Finance Committee can interpret the audit for the rest of the board.

___A Finance Committee can be helpful in recommending the hiring, retention, or firing of potential or current auditors.

Who should be involved in a Finance Committee?

___You recruit board members who have a financial background, and who want to serve on the committee - CPA's, lawyers, financial analysts, bankers, etc.

___You recruit non-board members who would be valuable to the committee and with whom your board can benefit by establishing relations.

___You recruit board members who are financially less sophisticated, and who might therefore represent the board at large, and ask the kinds of questions they might ask.

___You recruit people who, by their known integrity and community standing, can lend credibility to the committee.