Understanding Nonprofit Audits: Which Type Do You Need?

Jackie McLaughlin

Nonprofits like yours must gain public trust to garner the support needed to fulfill their missions. After all, trust is the foundational factor that compels supporters to get behind charitable causes and contribute in various ways.

Transparency and accountability are the pillars of trustworthiness, meaning your nonprofit must demonstrate its commitment to responsible and effective resource management to secure public support. Engaging a CPA firm to conduct an audit can ensure your nonprofit’s finances are accurate and orderly to reassure stakeholders and fuel your fundraising efforts, marketing strategy, and other mission-centric activities.

There are several different types of audits, and your team should understand each of them to create a plan for monitoring its resource management.

What is a nonprofit audit?

Chazin & Company defines a nonprofit audit as “an independent examination of an organization’s financial records, internal controls, and adherence to legal and ethical standards.” While the term is usually used in a financial context, the process entails:

Testing financial data: Audits are designed to test the material correctness of financial data and to ensure that the financial statements are presented fairly and in compliance with Generally Accepted Accounting Principles (GAAP).
Verifying compliance: A nonprofit’s activity in relation to grant agreements, donor restrictions, and state and federal regulations may be tested to verify compliance.
Evaluating internal control processes: Internal controls and procedures, particularly those involving the recording of financial transactions might be reviewed in audits to identify areas of potential risk and to recommend improvements.

With a comprehensive view of its financial activity and internal processes, your nonprofit can instill confidence in stakeholders, donors, and the general public that your organization is effectively using its resources to fulfill its mission. Additionally, the insights gleaned from audits may help leaders determine ways to improve financial management so that monthly financials are more accurate and conducive to better decision-making. For example, this overview may help your nonprofit’s team adjust its strategic plan or bookkeeping strategies so that its resource allocation better supports its overall goals.

What type of audit does your nonprofit need?

The term “audit” is frequently associated with financial statements. However, your nonprofit can use audits to analyze everything from HR activity to your marketing plan. The following categories of audit types are among the most common, and likely the ones your organization should consider conducting.

Financial audits

Financial audits are in-depth examinations of your nonprofit’s financial activity, including its financial statements, internal controls, and reporting processes.

Your state may mandate this as part of its charitable solicitation license requirements. Or, your bylaws may require it.

When you conduct a financial audit, there are several ways you might go about it:

Internal: Your nonprofit’s management team can conduct audits to analyze your current financial performance and consider any potential areas for improvement.
Independent: A third-party auditor or auditing firm may evaluate your nonprofit’s financial documents and activities to provide objective insights into your nonprofit’s financial health. This is the type that will be required by the state’s charitable solicitation license regulations.
IRS: In the rare case that a reporting discrepancy is discovered or a nonprofit fails to file required forms, the IRS may audit your organization.

When an independent audit is planned and scheduled the auditor will provide a list of items they will need. This is called a PBC (prepared by client) checklist. They will also work with you to establish a reasonable timeline based on any relevant your organization may have.

Compliance audits

A compliance audit reviews your nonprofit’s adherence to laws, regulations, policies, and procedures that govern its operations. This may include:

Regulatory compliance: Adherence to federal, state, and local laws is reviewed. For example, the audit may check whether your nonprofit filed Form 990 accurately and on time.
Grant compliance: This type of audit ensures your nonprofit meets specific requirements laid out by the grantor in any grant agreements you’ve been awarded. Keep in mind that some grants may ask for a financial audit report, so grant compliance can actually include multiple types of audits.
Internal control compliance: Internal control audits may check to ensure that your nonprofit adheres to its own internal procedures for recording financial transactions or following policies such as conflict of interest or gift acceptance.

Operational audits

An operational audit analyzes your nonprofit’s internal processes to determine whether they align with its mission and goals. The goal is to assess how efficiently your nonprofit’s operations support its objectives, as well as highlight any potential for improvement.

The key areas reviewed in an operational audit include:

Workflows and procedures across various departments
Performance metrics and KPIs
Internal control procedures
Stakeholder engagement

After an operational audit tests your nonprofit’s activities and strategic plan, you can use this evaluation to identify areas of improvement. NXUnite provides this example: If your nonprofit struggles to raise enough funds for its programs, your strategic plan may need an improved approach to fundraising. This might involve creating specific and actionable marketing strategies or putting more effort into donor acquisition and stewardship.

Regular audits are essential to ensure your nonprofit consistently meets its financial and operational requirements. The best way to make sure your organization is prepared is to enlist the help of an accounting professional. An expert in nonprofit accounting can not only help your organization prepare for a financial audit when the time comes but also consistently manage your nonprofit’s finances to ensure you’re always audit-ready.