The International Journal
of Not-for-Profit Law

Volume 2, Issue 3, March 2000

This paper is written from the practitioner’s viewpoint, based on daily observation and interaction with more than 300 client-nonprofit non-governmental organizations. It is intended to illustrate through actual experience the fact that existing regulations are adequate and that nonprofit organizations have already taken the initiative to implement stronger measures needed to self-regulate.

Adequate Regulation

Current and proposed accounting regulations governing nonprofit organizations (NPOs) are sufficient to provide guidelines for responsible management. Nonprofit board members and managers are realizing that if they consistently meet their responsibilities, they will effect the self-regulation that maintains public confidence and provides proper governance. On the other hand, increased government regulation contradicts the mission and purpose of these organizations. Voluntary organizations are non-governmental and should continue to function with self-regulation.

Focus on Self-Regulation

Through my presence at board meetings and my management consulting interaction with NPO executives and board members, I have had the opportunity to observe the reality of nonprofit self-regulation efforts today. It is clear to me that nonprofit non-governmental organizations have the tools necessary to effect proper self-governance and that positive steps have been taken to refocus their accountability to their “owners.” This renewed emphasis on self-regulation is being initiated voluntarily by nonprofit managers and their board members and is evidenced in several ways:

Boards are initiating top down reviews of their voluntary organizations, beginning with the close scrutiny of governing documents, including the original by-laws. By-laws establish the legal framework to be followed by NPO’s to govern the organizations. Within my client base, I have see many boards establish governance committees to review and revise existing by-laws. The trend has been to reduce the number of board members to a size that is more appropriate to govern. Boards of less than 20 members are more effective that those that exceed 50-60 members. These large boards, often made up of many community leaders and large donors, have not contributed to the effective governing of NPOs. Frequently, the Board meetings are poorly attended and effective management decisions cannot be made. By reducing the number of board members and establishing standards for attending meetings, NPOs have succeeded in bringing together a group of people who are concerned and interested in the governance of their organization.

Board committees have been scrutinized and, where appropriate, changed. New governance committees have been established. These committees have initiated ethics and conflict of interest policies to be followed by board members. The governance committee generally acts as a group to insure that board members meet their obligations to other board members and to the organization.

• Board policies are being compiled and evaluated. More organizations are revisiting the policies by which they operate. The purpose is to unify the policies and procedures adopted by prior boards into one document. This historical document basically summarizes each board member’s obligations. Expectations of and from board members are clearly defined and stated for all to see. By utilizing this document and increasing board training, board members now are more knowledgeable about their roles.
• Long range and strategic planning are reemphasizing the organizational mission and goals as originally set down. The planning process provides a framework for embracing the organizational mission and defining the goals and objectives of the NPO. When done effectively, organizational priorities are matched to the available staff and economic resources. Boards today acknowledge their responsibilities to insure that their NPOs adequately plan for the future. This has the effect of focusing the board’s attention on operational issues and defining resources needed to insure organizational effectiveness. This improved financial oversight will be discussed below.
• Boards and managers are spending more time reconciling the realities of fund raising and development with program goals. Program goals cannot be achieved without appropriate resources. Board members now understand the need to establish fund raising goals. Board members are expected to make the organizations for which they serve a priority when making financial contributions. Board responsibilities include making a financial gift to the organization, and leadership gifts if possible. There is an increased demand on board members to assist in the fund raising efforts. Board members are expected to facilitate the development efforts by identifying and meeting with potential donors. My observation has been that this effort alone has increased board member awareness of the NPO’s mission and goals. This additional understanding of purpose has improved the ability of the members to govern.
• Renewed effort is being put into ensuring that the organization’s financial resources are sufficient to meet its long-range goals. Long-term budgets are now part of the strategic plans. They identify the sources and amount of revenue needed to meet the programmatic goals detailed in the strategic plan. The budgets establish the parameters for controlling financial resources to insure they are sufficient to permit the achievement of the program goals.

Board Oversight 

As mentioned earlier, more boards have improved their financial oversight of their NPOs. Board committee structures have been changed to include audit committees and more active finance committees. This has meant more emphasis on internal controls, including improved awareness by management of fiscal oversight responsibilities. Improved oversight translates into more resources focused on program expenditures; more control over expenditures translates into more efficiency.

Following the lead of for-profit corporations, NPOs now frequently establish audit committees. These committees, made up generally of experienced financial leaders, meet with the independent auditors several times during the year. They assist in developing the audit plan and meet with the auditors at the conclusion of the audit to review the financial results. They expect the auditors not only to review the past year’s financial results, but also to discuss the trends. Part of this interaction is devoted to reviewing the auditors’ evaluation of the NPO’s accounting policies and procedures. Suggestions for improvement are an expected outcome from audit committee meetings and auditors’ comments are solicited. Additionally, audit committee members are asking the independent auditors to evaluate the qualifications of the finance staff. This evaluation is then used to assist the board in determining the reliability of the financial information received from the finance staff. This additional input from the organization’s independent accountants facilitates board members’ informed performance of their fiduciary responsibilities.

Improved understanding of their fiduciary responsibilities has also led more Boards to establish finance committees. The finance committee responsibilities include the review of the organization’s annual operating budget, cash flow forecast and capital improvement budget prior to the beginning of the fiscal year. Meeting several times a year, the finance committee sets the financial agenda for the board. This, in turn, requires management to provide accurate financial data for board review. The finance committee is also charged with the responsibility of insuring that the budget conforms to the strategic plan’s goals and objectives. Financial analyses and budget comparisons are now reviewed routinely. As a result, financial issues are identified earlier and are therefore addressed earlier. Improved information has facilitated the Board’s ability to make more accurate and timely financial decisions, which keeps the organization operating more efficiently and effectively.

Accountability to Donors

Voluntary organizations are being forced to be more accountable for the manner in which they spend their resources. Donors have become more restrictive with funding. General-purpose grants from major donors and foundations have been reduced. More grants now come with both financial and programmatic restrictions. Our recent work with clients reflects that grantors no longer appear to be willing to support the NPO’s operations. Increasingly, grants are being restricted for specific program purposes. This limits the amount that grantees can spend to support operations. Funders have also increased the reporting requirements. Grantees are more frequently asked to provide detailed financial and programmatic reviews. The financial reports are organized by budget categories thereby reducing the grantee’s ability to spend these funds on non-grant programs. These restrictions, i.e., grants that limit expense allocations, have forced voluntary organizations to be more focused on the efficiency of their operations. Overall, this improved accountability has resulted in more streamlined organizations that focus on community needs.

Grantors have also become more restrictive in limiting the overhead costs that they are willing to reimburse. NPO’s are therefore faced with the issue of controlling their indirect costs or loosing money (the difference between the rate provided by the grantor and the organization’s actual rate) on foundation grants. Given this prospect, grantees have become more diligent in controlling indirect costs.

Public Awareness

The general public has intensified its scrutiny of voluntary organizations by questioning and becoming involved in the way organizations spend their resources. Questions target topics such as overhead rates, fund raising expenses, and the portion of funds spent to achieve program results. The public has been able to obtain this information through a variety of sources. More organizations are including financial data on their web sites. New IRS regulations have made it easier to obtain financial information through requests for copies of tax returns. Other technology advances have made it possible for internet-wide dissemination of financial information concerning nonprofit organizations, i.e., Guidestar. Because of this increased exposure, voluntary organizations are taking measures to improve their control over financial activities and are strengthening their communication with the general public. This has had the effect of improved accountability and therefore better management and control over resources.

Outside Influences

To assist in the scrutinizing process, outside rating boards have been more visible. Local media has reported on intensified efforts of watchdog agencies. Oversight by the Better Business Bureau and local United Way and Combined Federal Campaigns has demanded improved accounting and reporting measures. Each NPO has published guidelines defining the limits that should be spent on fundraising and indirect costs. These limits focus NPOs on the need to spend their operating dollars efficiently and wisely. They also provide the public with an indication of the portion of their donations that will be spent for program purposes. By reviewing the actual results, donors are more likely to donate to organizations that spend the major portion of the gifts on program activities.

More NPOs are embracing the codes of ethics promolgated by organizations such as Independent Sector and other local nonprofit organizations such as the Maryland Association of Nonprofit Organizations. Organizations that have “self-certified” demonstrate their commitment to good governance and to full disclosure.

Other external factors have contributed to the clarification of financial reporting for nonprofit organizations. In the last few years, the AICPA has standardized the accounting presentation of all nonprofit organizations (FASB 116 and 117). This has created a uniform system for financial review and comparison of nonprofit organizations in spite of differences of purpose and programs. Proposed accounting rules will also remove some of the inconsistencies in recording fund raising costs. This will again improve nonprofit accountability to the public.

Conclusion

Increased government regulation can generate more rules, but the key to improved operational integrity depends on the ability of board members and managers to consistently meet their oversight responsibilities, to demand accountability from each other and to focus on the mission and purpose of the organization and the intentions of its financial supporters. I believe that organizations understand the need for transparency and self-regulation. Further regulations will not achieve additional benefits.