A guide to setting up, registering and governing an NGO
Finance
Guide To Financial Management
What are Audited Financial Statements?
Audited Financial Statements vs Management Accounting Records
There are several things that you should know about the preparation of Annual Audited Financial Statements, or Audits. The first is that an Audit is performed by an independent audit firm, i.e. someone outside of the organisation. An Audit is, therefore, different from the monthly account statements that your accounting officer or bookkeeper (often an internal person) will/should be producing, and which keeps track of all daily transactions against the organisation’s funds.
These monthly accounting records are often referred to as Management Accounts because they provide the management of the organisation with a regular update on the organisation’s finances. It is important that this information is kept up-to-date, as it is used to inform important management decisions on what is available to cover the organisation’s monthly operating expenses.
An Audit involves performing certain procedures to obtain audit evidence related to the amounts and disclosures that are made in the organisation’s official financial statements. It is important to understand that the specific procedures selected will depend on the auditor’s judgement which includes his/her assessment of the risks of any material misstatement in the financial statement, whether due to error or fraud. In making those risk assessments, the auditor considers internal controls relevant to the preparation and presentation of the financial statements and will design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of internal controls.
An audit also includes evaluating the appropriateness of accounting policies used in the organisation as well as the reasonableness of any accounting estimates made by the trustees/directors of the organisation.
In summary, an auditor provides an independent judgement on the validity, accuracy or completeness of the information contained within the Annual Financial Statements.
Note: It is the role of the Board to appoint auditors and sign off on the audit.
Useful Resources
Guide to Accounting Officer Engagements for NPOs
https://www.npoassist.co.za/downloads/NPO-Guide.pdf
How to evaluate your external auditor
https://hashtagnonprofit.org/features-and-resources/finance/how-to-evaluate-your-external-auditor
What does it mean to raise unrestricted funds?
Unrestricted funding (general purposes funding) can be raised from donors who support a particular cause and have great confidence in the organisation. Advantages of unrestricted funding are that the organisation can use them as they see fit. Whilst it is common for donors to only fund the direct costs of a project or programme, increasing numbers of donors are recognising that funds for organisational overheads such as staff, rental, maintenance, stationery, insurance and utilities are essential to programmatic success.
In order to ensure that overheads are covered, it is important to budget the exact cost of a programme including all overheads (i.e. the percentage of all staff time and percentage of all overheads) so that the organisation has a good understanding of what the programme actually costs. For example, a percentage of the CEO’s time should be in the budget as, although the CEO may not personally be involved in the delivery of the programme, he/she is accountable, undertakes on-going monitoring of the programme, ensures the funds are spent appropriately and produces reports. These all take time and the programme costs need to cover that time.
A key principle of budgeting should be that every programme must pay its way in the organisation and contribute to its share of the overheads. If the full budget is not met by donor funds, then the organisation can make a strategic decision to either seek an additional donor and delay the project, use any unrestricted funding available or to spend some of its reserves.
Useful Resources
Budgeting for Sustainability | |
What Public Benefit Organisations should know about Value Added Tax (VAT) | https://dgmt-commons.co.za/files/2014/06/DGMT-What-organisations-should-know-about-VAT.pdf |
How to Manage your Cash Flow effectively | https://www.accountability.co.za/news/how-to-manage-your-cash-flow-effectively |
What are an organisation’s reserves?
General financial reserves are an organisation’s savings. It is extremely important to understand that general reserves are built up from unspent, unrestricted funding. So, to be clear, unspent money from a ‘restricted project’ (i.e. where funds were awarded to an organisation to be spent on a specific programme or organisational costs) may not be used to cover other costs, as it is not unrestricted funding.
Reserves take a long time to build up!
Often, organisations set target levels for their reserves and work hard at reaching this target. In such instances, building reserves (or savings) is seen as an important part of the organisation’s financial planning. Reserves are built up with the intention of providing some cushion should the organisation experience some financial strain, or in the event of the organisation closing down when other costs might need to be covered, such as paying retrenchment packages, terminating lease agreements etc. It is considered good practice for Board members to determine (or designate) how and under what circumstances reserves may be spent.
As a general rule, it is a good idea to keep general reserve funds in a separate bank account so that they can be monitored, guarded and not spent.
It is extremely difficult to raise funds for reserves. Donors do not like seeing an underspend on their donations (savings) and it is difficult to use this as a way of building reserves. However, if donors pay their grants upfront, these can be invested in high interest-bearing savings accounts and funds are only drawn down into the organisation’s current account as required. The interest can be put into reserve unless the donor has indicated that it can only be used for the purpose outlined in the contract.
Once reserves have accumulated enough, a non-profit can purchase shares on the stock exchange that should increase in value over time and dividends can be reinvested to grow the reserves. A financial advisor can manage this on the organisation’s behalf.
Another source of income for reserves is services rendered that are paid for by a client or customer, such as training fees or consultancy work (income generation). These fees are not taxable if the work is in line with the purpose and objectives in the organisation’s founding document.
Some organisations have established for-profit entities and the after-tax profits are re-invested into the non-profit. This carries a great deal of risk and it should be carefully considered whether the organisation has the seed funding required, the skills to implement and the time required to run and administer a for-profit entity.
Useful resources
Operating Reserves with Non-profit policy examples | https://www.propelnonprofits.org/resources/nonprofit-operating-reserves-policy-examples/ |
5 Reasons your Nonprofit Needs an Operating Reserve | https://blog.blackbaud.com/5_reasons_your_nonprofit_needs_an_operating_reserve/ |
Can PBOs buy shares in companies and get dividends? | https://hashtagnonprofit.org/features-and-resources/legal/can-pbos-buy-shares-in-companies-to-get-dividends |
What is meant by cash flow, liabilities and commitments?
A lack of cash flow can cause short-term financial difficulties for organisations, especially when salaries need to be paid and when not all of the organisation’s costs are covered by ‘restricted project’ funds (i.e. funds awarded to an organisation to be spent on a specific programme or organisational costs). Such difficulties are often compounded when other liabilities and commitments – which may be in the form of overdrafts, loans, the need to service debts, or mortgages – also need to be met.
For all organisations, it is critically important that management establish financial management systems that allow for accurate forecasting of the organisation’s cash flow situation through efficient monitoring of the organisation’s monthly operating expenses. It is good practice to try to ensure that committed/regular payments are matched to committed/regular income on a month-by-month basis.
Working with cash
It is often the case that community-based organisations operate in an environment where they are required to work with cash. Some organisations might be able to collect money for membership fees or they receive donations from members in the community. It is important to recognise that working with cash-based transactions comes with costs (such as bank charges, which the organisation will have to carry) and often with some very real risks. Cash is vulnerable to theft and there is often a temptation to use available cash to pay for emergency expenses.
It is extremely important, therefore, that organisational management ensures that:
- only one person has access to petty cash;
- petty cash is kept in a locked box and then locked in a safe;
- an efficient record-keeping system (paper trail) is established that will allow you to account for all cash income and expenditure;
- the cash and receipts signed for withdrawals should always equal the total funds in the general ledger;
- all records are kept up to date and are regularly checked by an independent person; and
- petty cash should not be used to provide taxi fare or other assistance to employees as loans.
Why do organisations need to diversify their funding?
Diversification means accessing funding from a variety of funders and sources so that the NPO is not dependent on only one donor. Some donors only provide an annual grant, whilst others are prepared to commit for the longer term such as three to five years. Whilst that provides for an element of predictability, it is useful to generate diverse sources of income.
Diversity of income includes:
- A diversity of donors including corporate social investment, individuals, international aid and private philanthropy.
- Income generation through fees for services that are aligned to your purpose and objectives.
- Annual fees from membership.
- Crowd funding opportunities and events.
- Interest from high interest-bearing accounts where donor income is invested and which provide interest.
- Government subsidies and tenders when appropriate.
- Income from other agencies such as the Lotteries.
Useful resources
Public Finance Management Act 1999 |
Guides to help your NGO thrive
Navigating the technicalities of establishing, registering and running an NGO can be intimidating. We provide free guides to help your organisation grow and thrive. With easy-to-follow instructions on important topics from how to establish an NGO to governance, monitoring and evaluation, as well as useful tools and templates, we’re here to help you!
Are you looking to establish a non-governmental organisation (NGO) or searching for resources to strengthen your pre-existing organisation? We’ve curated a guide that will help you think through the legal, financial and technical questions associated with setting up and governing an NGO in South Africa.
Monitoring and evaluation (M&E) is essential for NGOs to determine how effective the work they’re doing is and identify areas of improvement. We’ve put together an easy-to-follow guide for all levels of experience including tips, tools and advice from experts.
Many NGOs may feel intimidated by the Protection of Personal Information Act (POPI Act or POPIA). To assist you, we have compiled a guideline that unpacks, in simple language, the most essential aspects of the Act that NGOs need to know and understand in order to take the first steps towards becoming compliant.
