Preparing for a Nonprofit Financial Audit: 4 Essential Steps

Although the IRS occasionally audits exempt organizations, most nonprofit financial audits are conducted independently. During an independent audit, your organization contracts a private auditor to review your financial records and management practices, and they create a list of recommendations to improve your nonprofit’s efficiency, effectiveness, and compliance.

Preparing well beforehand is essential to make the most of your nonprofit’s financial audit experience. Let’s review four steps for doing just that!

1. Determine Why and When You’re Conducting Your Audit

There are two main reasons why your nonprofit might conduct a financial audit: Either you’re choosing to do so to gain insight into the strengths and weaknesses of your management system, or it’s a requirement for your organization. Jitasa’s nonprofit audit guide explains four situations in which your organization might need to undergo a financial audit:

• Your nonprofit’s founders included a clause about recurring audits in its bylaws.
• You receive more than $750,000 in federal funding per year.
• Your organization’s total revenue exceeds your state government’s audit threshold (usually $500,000).
• You’re applying for a grant that asks you to submit an audit report with your application.

If you’re conducting your audit for a government or grant-related reason, schedule it so you’ll receive your report at least a month before the state’s or funder’s deadline. Your timeline is more flexible if you’re auditing by choice or because of your nonprofit’s bylaws. However, it’s best to complete your audit before you file your annual tax return so you can report that it took place and you’ve started implementing the recommendations.

2. Select a Nonprofit Auditor

Choosing a nonprofit financial auditor is similar to hiring any other consultant or contracted professional. Your auditor should understand your organization’s unique needs, have experience working with nonprofit finances, and offer pricing plans that align with your budget constraints.

To find an auditor that meets these qualifications, follow these steps:

• Start your research online. A simple Google search for “nonprofit financial auditors near me” or “nonprofit financial auditing firms in [city name]” is a surprisingly effective way to start the hiring process. Browse various auditors’ websites, note their fee structure and their estimated time to complete audits, and read reviews from past clients.
• Ask for recommendations. Supplement your online research by contacting other nonprofit professionals in your network to see if they’ve conducted independent financial audits at their organizations and, if so, what they thought of their auditors. Additionally, while your accountant typically won’t audit your nonprofit themselves to avoid a conflict of interest, they may be able to recommend auditors they’re familiar with.

• • Issue a Request for Proposal (RFP). According to Cornershop Creative, an RFP is “a formal document that outlines the requirements, specifications, and criteria of a project or service. It serves as an invitation for qualified vendors or partners to submit bids.” Create one specific to your audit and send it to your top two or three candidates so you can easily compare their approach, timeline, pricing, and references.

• Make your final decision. Once you’ve settled on your top-choice financial auditor, meet with them to hammer out the final details of your partnership. Then, develop and sign a contract to formally select them for your audit.

The entire hiring process often takes two to three months, so keep this in mind as you create a calendar for your audit—we recommend beginning your research as early as possible!

3. Pull Required Documentation

After your auditor signs your contract, they’ll send you a Provided by Client (PBC) list that details all of the documentation they’ll need access to for the audit. Most PBC lists include some combination of the following resources:

• Recent tax forms, including Form 990s, separate state filings if applicable, and employment-related tax forms like W-2s and 1099s

• Copies of your core nonprofit financial statements—income statement, balance sheet, cash flow statement, and functional expense report
• Details of major donations and grants received
• Investment statements
• Unpaid invoices
• Bank account statements and deposit slips
• Payroll and staff compensation plans
• Board membership list, meeting minutes, and treasurer reports
• Fiscal policies and procedures handbook

Your auditor will use these documents to assess your organization’s financial situation, so gathering them in advance will streamline the process. Organize them in a single digital folder to share with the auditor for easy access.

4. Clean up Your Financial Data

In addition to collecting everything on the PBC list, consider the general state of your nonprofit’s accounting system before your audit. Show your auditor that you’re practicing good data hygiene and make it easy for your auditor to find any additional information they may need by:

• Reconciling your bank statements to find and fix any discrepancies between them and your internal records.
• Identifying any uncleared transactions, determining why they occurred, and addressing their effects on your cash balance.

• Evaluating your nonprofit’s vendors and removing any inactive ones from the list.

• Checking for unpaid membership dues if your organization has a membership program.

• Depositing any undeposited funds so your cash availability is accurately accounted for.

• Looking for coding errors such as duplicated, missing, or incorrect data entries.

• Verifying your capitalization to ensure you’ve correctly categorized your nonprofit’s assets.

• Reviewing your accounts receivable and payable to confirm all outstanding financial obligations.

Ask your organization’s accountant or bookkeeper if you need any help with this process. They’re likely more familiar with your accounting system than anyone else at your organization, and they’ll let you know the reasons behind any discrepancies and work to resolve them.

Once you’ve determined your timeline and auditor, pulled everything on the PBC list, and cleaned up your accounting system, your next step is simply to wait while the auditor does their work. This process usually takes two to four weeks. When they finish and present your audit results, sit down with your nonprofit’s finance team, board, and leadership to create a plan for incorporating the recommendations into your strategy.

Especially if this is your organization’s first time undergoing a financial audit, your results likely won’t be perfect—which is totally fine! Treat your audit as a learning experience and promptly implement your auditor’s recommendations, and you’ll put your nonprofit in an even better position for its next audit and for better financial management going forward.