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Preparing for a Nonprofit Financial Audit: 4 Steps to Follow

Janet Martin September 18, 2023

Nonprofit audit documents for a financial audit
Fundraising Automation
When you think about the term “financial audit,” the first thing that comes to mind is likely the audits that the IRS conducts of individuals’ or businesses’ tax returns. However, because nonprofits are exempt from paying federal taxes, nonprofit financial audits are more often conducted independent of the IRS by external auditors. 

The purpose of these audits is not only to ensure your organization complies with nonprofit-specific regulations, but also to increase transparency in your financial management processes. Your auditor will analyze a variety of financial information and make recommendations for how your nonprofit can improve its policies and procedures.

To maximize the benefits of your nonprofit audit, you’ll need to do some preparation beforehand. In this guide, we’ll walk through the following steps to ensure your organization is ready for its financial audit:

  1. Select the Right Auditor for Your Nonprofit
  2. Pull Required Documentation
  3. Review All Accounts and Transactions
  4. Clean Your Nonprofit’s Database

Although the audit itself will likely take just a few weeks to complete, your preparation may stretch over several months. Assign each task to a team member who has the skills and experience to handle it, and create a schedule to ensure everyone stays on track. Additionally, if you’ve worked with a nonprofit accounting firm, they may be able to assist with preparation since they’re familiar with your organization’s finances and the audit process. Let’s dive in!

1. Select the Right Auditor for Your Nonprofit

Just like any other outside professional your nonprofit works with, your auditor needs to be the right fit for your unique situation. Choosing an auditing firm that specializes in working with nonprofits, has a good track record, and can meet your deadline is critical.

Here is the basic process for choosing an auditor:

  • Start your research online. Conduct a Google search for auditing firms in your area, read reviews of each one, and begin comparing fee structures to find a price range that aligns with your nonprofit’s budget.
  • Ask for recommendations. Reach out to other nonprofits in your network to ask whether they’ve conducted financial audits and if so, what they thought of their auditors. Your accountant may also be able to recommend good auditing firms to your nonprofit, helping you start to create a shortlist.
  • Issue a request for proposals (RFP). To narrow down your list even further, it’s a best practice to create an RFP that asks auditors to provide details such as a statement of the work they plan to do for your organization, a preliminary quote for their services, and references. The responses to your RFP will allow you to compare your options side by side.
  • Make your decision. Once you’re down to two or three potential auditors, check the references they provided in their RFP responses and conduct a short interview with each one. Then, you’re ready to extend an offer to your top choice!

Of the steps to prepare for an audit, this process often takes the longest—anywhere from one to three months. The earlier you can start, the better!

2. Pull Required Documentation

After you select an auditing firm, they’ll typically issue a Provided by Client (PBC) list to your nonprofit. The purpose of this list is to ensure your auditor has easy access to all of the financial information and documentation they’ll need to conduct the audit.

Some of the documents that might be on this list include your organization’s:

  • Financial statements. Jitasa’s financial management guide lists four types of nonprofit financial statements you should have on hand for your auditor: your statement of activities, balance sheet, cash flow statement, and statement of functional expenses.
  • Bank records. Deposit slips, check registers, and monthly statements from each of your nonprofit’s bank accounts all fall into this category.
    • Tax forms. While your past Form 990s are the most important tax documents that your auditing firm will want to see, they may also ask for the employer copies of your W-2s, 1099s, or other forms you’ve issued to your employees.
  • Fiscal policies handbook. In addition to reviewing your organization’s financial activities, your auditor will also want to learn more about the procedures listed in your fiscal policies handbook that guide those activities.

In addition to these core documents, your auditor’s PBC list may also ask for a wide variety of contracts and receipts. To make it easier for you to keep track of all of these documents, create a secure digital file where you can store everything leading up to your audit.

3. Review All Accounts and Transactions

Reviewing all of your nonprofit’s accounts and transactions before your audit can help you make sure everything is in order for the auditor. Plus, this kind of in-depth review is a good financial habit to get into as your organization closes out each fiscal year.

When you conduct your review before your audit, make sure to examine your organization’s:

  • Account balances, ensuring they accurately reflect your financial statements and other internal records.
  • Accounts payable and receivable, taking particular note of any uncleared transactions.
  • Investments such as brokerage accounts, stock holdings, or endowments.
  • Capitalization, or categorization of material and immaterial assets.
  • Payments of membership dues or service fees if your nonprofit relies on these income sources.

Remember to correct any errors you find along the way as well. As you review the above information, take special note of undeposited funds in any of these areas. Figure out why the funds weren’t deposited, and properly deposit them as soon as you can to ensure your financial documentation accurately reflects how your resources are allocated. This is both for your auditor’s benefit and to improve your internal financial management practices.

4. Clean Your Nonprofit’s Database

Clearing undeposited funds is one part of keeping your nonprofit’s financial data “clean,” or as error-free as possible. A clean database will provide your auditor with the most accurate view of your financial records so they can make informed recommendations.

To begin cleaning your database, NPOInfo’s guide to nonprofit data hygiene recommends pinpointing any instances of ambiguous, duplicate, inconsistent, misplaced, or missing data in your records. Then, verify existing information, purge any inaccuracies, and fill in gaps in your records as needed.

Keep in mind that your nonprofit’s financial data may be stored in several different systems, such as your accounting software, fundraising platforms, and constituent relationship management (CRM) solution. All of these systems need to be cleaned in order to ensure accuracy for your audit and beyond.

To give yourself enough time to complete all four steps above, check the deadlines set by any organizations who are asking for your audit reports (such as your state government or a grantmaking organization) and start your preparations four or five months before. You may also want to request an extension on your Form 990 to give your organization time to start incorporating recommendations from your audit before filing your tax return.

No matter what your timeline looks like, the bottom line is that preparing effectively for your financial audit will help your auditor make more accurate recommendations to improve your nonprofit’s financial management practices.

Is your nonprofit organization getting the most out of its technology? PairSoft’s natively integrated fundraising automation has helped thousands of organizations go above and beyond their goals. Get a demo today.

Headshot of Janet Martin

Janet Martin

Janet joined the PairSoft team upon its merger with Paramount Workplace, where she was also an integral part of the sales team for years. Janet resides in Michigan with her family.

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