Section 5. Creating a Financial and Audit Committee

Learn the role of a finance committee in a nonprofit, what its purposes are, why it's necessary, and how to set up and use one in your organization.

 

• 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.