Board Member Perspective – Signs that the organization may be toxic

Have you ever sat at a board meeting with a feeling that the Executive Director may be exhibiting unstable behavior or may be running the organization into operational or financial instability? I’ve learned to trust those feelings and to follow them up with requests for information. You may be surprised at how many times your suspicion leads to significant findings. But how do you follow up?

From my perspective, I have seen many times how the Executive Director’s management decisions creates instability which inevitably translates to financial problems. The auditors may not include these areas in their audit and may not address practices that can lead to financial instability.

However, there are two teams within the organization that are aware of many of the unwise decisions and activities and who have a wealth of unbiased information that you can request to start gaining a more comprehensive understanding. The finance team and the HR team come in close contact with management’s thought process and decisions and to what extent they stretch the legality or ethical comfort levels. Contact both of these teams to gather information directly from them. My favorite schedule is the following:

  1. Request a detailed list of personnel changes during the year: salary increases, bonuses, hirings, and terminations (including cause). Absent a logical reason, a very active list is likely to be a sign of problems. Were these salary increases approved by the board? Is the same person receiving more than one increase in the year? Who receives a bonus and why? Repeated bonuses for one person? Why are so many staff leaving at-will or being fired? Issues with the management style of the Executive Director will first show up with constant staff turnover. If management is creating a toxic environment, people will get sick, projects will fail, the best employees will quit and the organization will suffer tremendously.
  2. Ask for the Executive Director’s timesheets or ask about his/her absenteeism, whether recorded or not. We were recently working at an organization that had a Director who would be absent without letting anyone know, call in sick for weeks at a time, leave in the middle of the day without any notice and unable to attend scheduled meetings. Not even his closest assistants knew how or where to find him. He was creating an environment of uncertainty among his team.
  3. Ask about the rotation of financial service providers or HR service providers. If these two functions are outsourced, there may be reason for concern if the Executive Director switches companies regularly or out of the blue decides that the outsourced provider needs to be changed. These are positions that deal with a lot of legal and ethical requirements. Is the Director changing these providers because he does not want to hear “that cannot be done, its not legal (or ethical)”? If there was a recent change, reach out to the provider as part of your fiduciary duty and ask what prompted this change. You may be surprised with what you hear.
  4. Visit employee review websites like Glassdoor or Indeed to check out the reviews on this employer. I was very skeptical about this review process and how it may attract only disgruntled employees. But after seeing with my own eyes the situations that were described in the commentaries, I think they need to at least be considered.

Being on the outside of an organization, providing financial services and advice, I have been in the position at times of wishing a Board member would reach out to me to ask a few questions. My concerns may not rise to level of alerting the Board of potential fraud, but if I was a Board member, I would definitely like to hear about the reckless decisions and attitude of constantly pushing the legal and ethical limits that may lead the organization to a crisis.

Board Member Perspective – Questions to Ask When Reviewing a Budget

Have you ever received a budget for approval and are not sure what you need to be looking for or what questions to ask?  We have a few questions that you can ask next time you are in that situation.

What are the programmatic priorities being set by this budget?  If this is not clear in the budget document, then ask that it be clarified.  The board sets the priorities for the organization and the buckets where the organization spends its money are reflective of its priorities.  The board should have the opportunity to discuss these priorities and make sure they agree with them.

Does the budget result in a surplus, a deficit or breakeven?  A nonprofit organization can and should operate with a surplus.  Surpluses allow the organization to plan for the future by establishing reserves.  Reserves can be used for future projects that will generate a “planned deficit” or for lean years when the funding sources are not coming through as expected.  Deficits can be approved by the board if there is enough reserves to cover it and if it advances the organization’s mission. But these results need to be clear in the budget and need to be discussed as acceptable.

What results is each type of activity generating?  We like to divide the activities of an organization into grants (you must spend every dollar received), fee-for-service (you can deliver the services at a surplus), conferences and membership (as long as you deliver, it doesn’t matter how much you spend) and internal functions (these don’t have any specific funding but are covered by unrestricted grants, indirect cost recovery or surplus from other activities).  Understanding the results of each activity allows you to see how they cover each other and whether a desired surplus can be achieved by focusing on a particular activity.

Is there a personnel budget?  Personnel costs tend to be the largest line item expense for most organizations.  This expense has to be carefully planned in terms of positions, length of time, and salary.  Ask if the positions are compensated fairly and at market rate. The success of the organization is dependent on maintaining committed and capable personnel.  Each year’s budget should consider pay increases to help with staff retention.

Does the organization have a negotiated indirect cost rate?  Recovering indirect costs is crucial for funding internal operations.  This is an area where many organizations have problems. The indirect cost rate should be reflective of the organization’s true indirect costs and the organization should always request that grants reimburse at that level.  Anything less will make the cost of running the program(s) with that grant more expensive for the organization.

Being at a board meeting while a budget is being discussed can be a very intimidating experience. But having a discussion around the questions above can help you understand better the process followed in preparing the budget and trust that the numbers reflect not only an achievable goal, but also the priorities of the board for that organization.

Board Member Perspective – Questions to Ask When Reviewing an Audit

Question of an Audit

You are presented with the financial statements prepared by auditors.  Do you know what questions to ask? What will the auditors tell you only if you ask?  The process of auditing the financial statements of an organization is quite invasive not only on the transactions and balances that make up the financial statements, but also on the processes and controls of the organization. Asking a few questions can give you valuable insight on the audit report, and on how the audit was conducted. Of course, we begin with reviewing if there is an unqualified or “clean” opinion.  Otherwise, most of your discussion with the auditors will revolve around the reason for the qualification.

On the Statement of Financial Position – Is there a liability amount that the auditors believe the board should discuss further or about which they should ask for more information?  Are there suggestions for containing or reducing some of the liabilities that management and the board should consider? Is the make up of net assets a healthy mix?  Should the organization increase the net assets without donor restrictions? Does the organization have sufficient reserves?

On the Statement of Activities – Explain the results of each column and what it tells about the operations of the organization.  Does the organization have sufficient restricted net assets for future funding based on the type of funding that the organization is reliant on?

On the Statement of Cash Flows – What does this statement tell us about the organization’s cash flow situation?  Does it appear to be generating sufficient cash flow for its operations or are there issues with collecting receivables?

On the Statement of Functional Expenses – What method is used for allocating expenses and is this a reasonable method used by other organizations?  Is the organization recovering its indirect expenses? Is the management and fundraising expense reasonable for an organization this size?  What are the programs that have the highest expenses and are these in line with the board-set priorities? If the statement does not break out the individual programs, ask why.

On the Footnotes – Are there any footnotes that are most worrisome to a reader?  Explain the footnotes that may have financial implications that are not reflected in the financial statements themselves (such as pending litigation).

On the Management Letter (even if none is presented) – Was there an item discussed with management that could have made it to the management letter, but did not?  If there is no management letter, are there areas of improvement that the auditors can suggest?

On the overall audit process – What audit adjustments did you make and did their nature and amount concern you in any way? Were there any management practices that you found unusual, but not worthy of noting in the reports?   Were there any delays in the audit caused by management?

Use these questions to guide you through the review of the audit report and you will walk away with a better understanding of the organization on which you serve.  

Board Member Perspective – Financial Information to Review

Financial Information

If you belong to more than one nonprofit board you may have noticed that each one may present a somewhat different set of financial information at board meetings.  Do you know what is the appropriate information to present and examine? In order to comply with your fiduciary duty, you should be presented with complete, accurate, and timely financial information.  But how do you know that is what you are receiving?

Timeliness – Propose to the board secretary that meetings are set after the closing of each fiscal quarter. This allows sufficient time for management to prepare a set of financial statements that reflect the activity and position through that fiscal quarter.  The board should be reviewing financial statements at least quarterly and it makes most sense to review three months at a time.

Accuracy – Are the financial statements prepared on the accrual basis of accounting?  You should request that they are since that is the most accurate representation of the organization’s activities and financial position.  Are there closings and reconciliations done for each major account in the financial statements?

Completeness – Accounting has two sides and each side needs to be presented for a complete picture.  The Statement of Financial Position (equivalent to the Balance Sheet) presents the position of assets, liabilities and net assets (equivalent to equity) of the organization.  The Statement of Activities with columns for each net assets with donor restrictions and net assets without donor restrictions should present the results of activities for the year-to-date.  Beware of Profit & Loss reports without columns for each class of net assets since it does not present a full picture. For organizations that do not have donor restrictions, the statement can contain only one column but make sure it states that it only represents net assets without donor restrictions.  If you are presented with only one of these statements, you may not have important information to discern problems present on the other side. If you are presented a Profit & Loss without these columns, you may be given a skewed view of the results of operations. For example, if the organization just booked a multi-year grant this year, the statement shows a healthy profit as a result, hiding an operational deficit.

Accountability – Insist on reviewing a budget to actual report and on having explanations for the line items with variances of over 10%.  The budget approved by the Board is the roadmap for the organization’s management and you want to monitor that this is properly followed.  

Dashboards – Dashboards can be presented, but should not be considered as replacements for the basic financial reports listed above.  They can enhance the presentation, but do not replace the breadth of information provided by a full set of financial reports.

Even if you do not fully understand the financial statements, receiving a complete set at each meeting promotes accountability and if necessary, allows you to consult with a professional for an opinion on potential issues or the general financial health of the organization for which you have a fiduciary duty.