Nonprofit Red Flags

Posted on Wednesday, December 21, 2022

There are certain things that stand out when looking at a nonprofit that should raise concern.  If these issues aren’t addressed, they could lead to bigger problems or even to the fall of the organization. 

Low Cash Balance

Cash flow is key to operating any organization.  Without adequate cash, an organization is unable to pay for normal everyday operations.  Is the organization generating enough revenue, either earned or contributed?  Is the organization’s expense too high?  Is the organization collecting receivables in a timely manner?  Best practices state that a nonprofit should have enough cash on hand to cover 3-6 months of expenses.  If your organization has a low cash balance, you need to determine why and the steps on how to increase the balance to a reasonable level.

High Debt Balance

A low cash balance often forces an organization to rely heavily on debt.  This could be either line of credit or loans.  In either case, high reliance on debt, not only causes the organization to pay interest and fees that could otherwise be spent on programming but can put the organization into a cycle that is often times difficult to get out.  It is also more difficult to attract donors that are willing to contribute to your organization’s debt than to current operations and programming.  If your organization has a high debt balance, consider implementing a plan to pay off the debt in a timely manner.

Negative Restricted Net Assets

Contributions to nonprofits can either be restricted or unrestricted by donors.  Restricted contributions have to be used for a specific purpose or period of time as noted by the donor.  Unrestricted contributions can be used for whatever the organization deems necessary.  Sometimes if an organization receives too many restricted gifts or doesn’t have enough unrestricted funds, it “borrows” from its restricted funds to pay for unrestricted purposes (operations).  This can create a negative restricted net asset balance.  This is a significant cause for concern because it means the organization has used contributions restricted for a specific purpose by a donor for something other than the specific purpose.  This not only can cause issues with donors but is also a sign that the organization does not have enough funding to support its everyday operations.

Failure to File Form 990

As a tax-exempt organization, nonprofits do not pay income taxes but they still must file an annual information return (Form 990) with the IRS.  Failure to file the return for 3 consecutive years, will result in the loss of tax-exempt status.  An organization that hasn’t filed its tax return, even for just 1 year, is cause for concern.  Why wasn’t the return filed?  Who is responsible for ensuring the organization meet its compliance requirements?  What other requirements or forms have not been filed? 

No Accountant

An organization that does not have an accountant or bookkeeper likely (1) does not have anyone reconciling the bank accounts and maintaining the financial activity consistently or (2) has an individual responsible for other roles and is not properly trained in accounting.  It is important to have a dedicated individual, whether internally or contracted, to maintain your accounting.  The person should be knowledgeable of nonprofit accounting so that they can properly report your organization’s activities.  Management and the board of directors needs to have timely, accurate financial statements to make decisions. 

Inactive Board

Your board of directors is ultimately responsible for your organization.  The IRS believes that an active and engaged board is important to the success of the organization and is more likely to comply with tax law requirements.  The board should consist of individuals that are informed and active in overseeing the organization’s operations and finances.  If your organization has difficulty getting quorum at board meetings, you should ask why.  Do you have the right people on your board?  If your board does not have robust discussions about topics before making decisions and simply rubber stamps everything, the board is not doing its job. 

If your organization can identify any of these issues, make sure you address them head on before they lead to larger problems. 

Contributed by: Carrie Minnich, MAcct, CPA | Partner | DWD CPAs & Advisors

Posted in Mission Minded Nonprofits

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