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Risk Management for Nonprofits: 10 Ways to Mitigate Fraud

June 12, 2012
Personal Finance
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Nonprofits may have their hearts in the right place, but, like any organization that performs monetary transactions, the risk of fraud is ever-present. Kelly and Owns, LLC estimated $84 billion in domestic fraud in 2008, the most commonly cited cause being lack of internal controls. From churches to charities, nonprofits must take the proper precautions to protect themselves against corrupt individuals and mendacious management. We’ve outlined 10 techniques for reducing the risk of fraudulent activity amongst nonprofits. While this article provides a solid introduction to fraud mitigation, we urge you to invest a substantial chunk of time in researching this crucial facet of the nonprofit sector.

1. Lead by example

One of the simplest techniques management can employ is making clear the ethical principals of the organization. This can be done in two ways: directly and indirectly. Directly address the issue by incorporating fraud mitigation into employee training. Make it clear such behavior will be closely monitored, perpetrators prosecuted to the full extent of the law. Indirectly reinforce this message through managerial example. The organization’s leaders should consistently demonstrate honesty and vigilance in detecting and disciplining unacceptable behavior. Don’t turn your organization into a paranoid, accusatory regime, but let employees and volunteers know, firmly and kindly, they are being watched.

2. Divide and conquer

There is safety in numbers. While this adage normally suggests protection against hostile outside forces, it is equally applicable in detecting threats from within. This is an essential general guideline to keep in mind as you set up checks at every level of the organization. Divide tasks in such a way money must be handled and monitored by multiple individuals. A single person acting alone is less likely to attempt fraud when others are involved in a transaction. For example, after a fundraising event, it would be poor practice to assign a single person to counting, recording and depositing cash donations.

3. Fortify your bank account

Money in the bank may not be as guarded as it should. Severely limit access to funds by taking a couple simple precautions. First off, don’t use a debit card. Debit protections are limited and missing money can be difficult to recoup. And secondly, set up your account to prohibit cash withdrawals. Cash is a slippery substance. Withdrawals should come in the form of a check made out to the bookkeeper. This adds an additional step, making withdrawals easier to track and control.

4. Meticulous accounting

Every organization needs a carefully and thoroughly documented accounting system. This is perhaps the easiest way to detect suspicious activity. Setting up an effective system simply means recording everything. Standardize a means of writing down every monetary transaction, no matter how small. Record who does what and when. In the example of fundraising donations, keep track of who collects the money, who counts the money, who recounts the money, who deposits the money and so on. Set up clear paper trails easy to follow back to the source. Depending on the scale of your operation, it may not be a bad idea to hire a nonprofit accounting expert.

5. Using a credit card

Your organization will likely benefit from use of a business credit card. Cash and checks are not always practical, and, as we mentioned before, debit cards are not a good idea. Credit has better protections and won’t drain your funds in the event of fraud. The key in using a credit card is keeping receipts. For every purchase, be sure to procure, document and file a receipt. At the end of each billing period, double check receipts and make sure the total charges add up to the amount on your statement.

6. Screening employees

Assembling a trustworthy team is obvious. This will involve performing background checks on potential hires. Find out up front whether the applicant has a history of misconduct. Doing so can save you a world of trouble. Also, request references and actually contact them. If a few reliable sources can vouch for the applicant, that’s a great start. Use interview time to address issues of fraud. You can get a reading of the applicant’s character through simple conversation. Walk him or her through hypothetical scenarios pertaining to fraud. This will inform you of the applicant’s thought process along with sending the message that your organization takes such matters seriously.

7. Set a budget

You can’t get much more basic than this. Set a budget and stick to it. This is a way of knowing where your money will go before it actually goes there. By creating expectations, you can see where your money should be going and compare it with the reality of the situation. Budgeting will help to prevent overspending. You will know how much money should be devoted to each category and be able to better recognize discrepancies. It is likely you will need to adjust your budget as time wears on. That’s fine. But regardless of the predictability of future assets, always proceed with a budget based on your best estimates.

8. Audits

Periodic surprise audits will help verify the organization’s finances. While not performed for the sole purpose of detecting fraud, audits are instrumental in reviewing the flow of money. Not all organizations will be able to afford an audit. If this is the case, employ an alternative outside party to review accounting information and transaction history. An outside party can act as a much-needed second set of eyes and help detect oversights. In addition to actually detecting fraud, such reviews double as preventative measures, letting employees know the organization is actively watching for missteps.

9. Signatures on checks 

Requiring two signatures on checks written in the organization’s name will insure at least two people have reviewed and approved the transaction. Again, this goes back to dividing up labor and increasing the number of people necessary to complete a transaction. If a person is permitted to write checks without supervision, the door for fraud is wide open. Blank checks should also be avoided whenever possible.

10. Petty cash

Reducing fraud occurs at every level of the nonprofit’s finances. Most organizations maintain a supply of petty cash for small, often unpredictable transactions. Do not make the mistake of losing track of how petty cash is spent. Yes, it is usually intended for miscellany, but, as it comes in the form of dollar bills, petty cash is easy to abuse. Hold onto receipts and a keep a tight record of expenditures. Careful control of small transactions will dissuade fraud at higher, more detrimental levels.