Many people don’t think nonprofits are vulnerable to fraud or embezzlement, but it is more common than you think. Internal audits catch only 25% of fraud, with most incidents only caught by accident or via tips from other employees.
Fraud is often committed by trusted employees or volunteers that you may never expect. Many people who commit fraud may also feel motivated to continue doing so due to a lack of consequences or detection.
Fraud or corruption usually takes place through:
- Embezzlement
- Kickbacks
- Bribes
- Rewards
- Extortion
- Conflicts of interest
It’s crucial to ensure that these types of fraud and theft do not go undetected in your nonprofit. Here are some ways you can identify and prevent fraudulent activities:
1. Team members
Most volunteers and employees working for a nonprofit are driven to accomplish the organization’s mission. But, some take opportunities to financially benefit themselves. Organizations should be on the lookout for the Fraud Risk Triangle:
- Pressure: Extra stress put on employees to meet unrealistic demands and performance standards may result in motivation to commit fraud. Personal problems may also contribute to this pressure.
- Opportunity: A lack of internal controls, such as proper monitoring and oversight, might incentivize employees to steal or commit fraud.
- Rationalization: Someone who can justify the personal rewards for fraud over the possibility of getting caught may be likely to commit fraud. These justifications can relate to job dissatisfaction or entitlement. For example, if an employee feels underpaid, they may justify the fraud as just getting even.
While identifying these risk factors can be difficult, your organization must take extra precautions against fraud.
When hiring or recruiting volunteers, it’s reasonable to ask for references and implement accurate, efficient background checks for all employees.
Providing clear rules and guidelines for ethical behavior in your charity or nonprofit organization is essential to set the tone for all employees or volunteers. Explicitly communicate that the organization will not tolerate dishonest or unethical behavior. Managers and directors should also publicly promote the stipulation that all employees may face the same consequences regardless of their position within the organization.
2. Management practices
Lack of internal control or supervision may increase the likelihood of fraud. Some of the most common nonprofit shortfalls include:
- Inefficient management: An unqualified board of executives or managers may not monitor nonprofit operations accurately.
- Pressure and responsibility: Executives taking on excessive workloads may become burnt out and be less likely to catch fraud.
- A shortage of employee development programs: Fewer incentives to work efficiently, such as promotional opportunities, for undertrained and unhappy employees can increase the possibility of fraud.
- Hasty approval of executive decisions: Considering all possible questions and options can help reduce rushed choices that may lead to fraud.
Respecting and appreciating your employees may reduce their motivation or incentive to commit fraud. Employees who feel ignored or mistreated may be more likely to engage in fraudulent activities. Employees or volunteers may also be less willing to report fraud committed by another staff member if they feel undervalued.
You can improve transparency and accountability within your organization with active engagement from managers, directors, and supervisors. Proper leadership and oversight may boost effective collaboration between all members of a charity and inspire social support and teamwork.
3. Implement internal controls
Nonprofits have an effective tool to fight fraud through internal controls or policies and regulations that prevent misuse and misappropriation of assets. From customizable user controls to auditable transaction ledgers, internal controls safeguard your organization’s financials.
Your finance team plays a key role in fraud prevention. Your organization’s financial statements are critical to determine if your charity is experiencing fraud. Some examples of falsifying financial documents in nonprofit organizations include:
- Overstatement of revenue
- Inappropriate asset valuation
- Absence of disclosure
Ensuring that no one person has complete control over your charity’s funds and financial access by separating all necessary tasks is a great way to execute nonprofit fraud prevention.
Additionally, you can implement proactive measures like these to prevent fraud:
- Delegate separate functions to different employees
- Require employees and volunteers to submit all receipts
- Monitor financial activity periodically
- Compare revenue, donations, and expenses
- Require an explanation of any significant changes in expenses
- Examine bank statements and canceled checks
- Separate those who handle receipts and deposits from those who are responsible for record-keeping
- Limit employee access to funds
Implementing internal controls and systems that prevent fraud positions your organization for success.
A more secure future
Fraud prevention is an ongoing effort that requires vigilance, transparency, and strong internal controls. By fostering a culture of accountability, ensuring proper oversight, and implementing proactive financial safeguards, your organization can significantly reduce the risk of fraud.
By implementing these steps, nonprofits can protect their mission, maintain donor confidence, and ensure resources are used to create a lasting impact in their communities.
Fraud is just one part of the picture. To improve nonprofit operations, read the Go-to Nonprofit Accounting Guide.
