Armanino Blog

Nonprofits, I’m Looking Through You

by Tom Schulte
July 17, 2012

The results of the most over-used business word of the year are in and the winner is “innovate.” I would have guessed that winner would have been “transparency,” which would have made for an ideal segue for this article about… transparency.

So I will have to work at being innovative regarding the topic of transparency as it relates to the nonprofit world before another “paradigm shift” (2nd place winner) occurs.

But in the nonprofit industry, the “t“ word has probably earned its place at the top of the list. To most nonprofits the term connotes the need to make financial statements more readily understandable, and suggests being open about all aspects of their operations. Since the IRS revised Form 990 over four years ago to require the disclosure of a gamut of information, transparency has taken center stage with not-for-profits.

So, is transparency actually a good thing? Is too much transparency a bad thing? And how does any organization reveal its inner workings without inviting misunderstanding or drawing criticism?

Why Embrace Transparency?
We say it all the time. Your nonprofit’s reputation is its most important asset. With today’s immediate and widespread access to information on the Internet, a positive image can turn negative overnight. Major funders and individual contributors will run from a not-for-profit with a less than stellar reputation while the bloggers and press will besiege it. Transparency helps you protect your organization from a public perception that you have something to hide. A nonprofit that discloses its financial facts and other information about its governance is less likely to attract criticism and media scrutiny. And potential donors will be put at ease by learning that your organization is well managed with strong oversight.

Your Website:  A Good Place to Start
Think of it as a key transparency tool. Post the organization’s annual audited financial statements on your website as soon as they’re approved by the board of directors. This action boldly states “we have nothing to hide—look. And we even get our statements audited by an outside firm.” The audit process might entail a four-to six-month lag between the end of the year and final board approval but such a delay is less than the length of time typically needed for nonprofits to complete and file their Form 990 and then have it posted on GuideStar, an online site that, among other things, facilitates research on not-for-profits by providing information to the public.

Posting the audited financial statement on your own website (or elsewhere) doesn’t guarantee that the public will understand it. Consider using tools such as financial pie charts, Frequently Asked Questions (FAQs), third-party testimonials and informational brochures to make the numbers digestible. Translating financial results into program outcomes can be particularly effective.

Also post on your website any of the board’s policies and procedures that demonstrate strong governance. This includes your nonprofit’s conflict of interest statement, whistleblower policy and political activities policy.

Approaching Form 990
When addressing transparency, disclosing salaries of the nonprofit’s highest-paid employees—a Form 990 requirement—is often the first thing that comes to mind. Salary and benefits information can be sensitive material that may draw public scrutiny and criticism.

Often, you can prevent salary-related criticism by explaining how salaries at your organization are set. Schedule O, “Supplemental Information to Form 990 or 990-EZ,” provides space to explain any of your answers, making it an ideal place to describe the steps taken to determine key individuals’ salaries. Your not-for-profit, for example, may have conducted an areawide or national salary survey of similar positions at like-size organizations. As a California nonprofit such steps are required for both the CEO and CFO position—but there is no downside to re-emphasizing the steps you took.

Form 990 also requires nonprofits to disclose the nonmonetary benefits it provides to key individuals—for instance, free housing or a free car for a university chancellor. In the “age of transparency,” nonprofits need to be aware that such “perks” might draw public ire.

Even if a compensation package is deemed appropriate by the board after it performs the required due diligence, it’s important to consider how a potential contributor or funding source might view it. Funding has been pulled from some organizations because the funding sources disagreed on appropriate compensation levels. A preventive measure might be to offer a rational explanation on Schedule O of why the benefit was provided — or to eliminate the benefit altogether.

It’s important to remember that your Form 990 will be freely available to the public on GuideStar and that your audited financial statements (for many organizations) are required to be furnished upon request. These days, potential donors and other interested parties (again—media, bloggers, unhappy former boardmembers and employees) are frequent GuideStar users and more organizations are taking advantage of access to the audited financial statements.

When Explanations are a Must
Sometimes explanations to Form 990 answers aren’t only desirable, they’re necessary. For example, a question in the form’s Governing Body and Management section asks if the organization has become aware of a significant diversion of assets, which includes embezzlement or theft. If you answered “yes” to this question, you need to explain this event and describe the steps you’ve taken to prevent such frauds from occurring again.

Also, Form 990 asks several questions about having particular policies in place, even though there’s no legal or IRS requirement to have them. Such disclosures make it apparent what the IRS believes ‘best practices” should contain but in some cases, there may be a sound reason why your nonprofit lacks a certain policy. A not-for-profit with a union, for instance, would follow federal laws regarding conflicts of interest rather than have its own conflict-of-interest policy.

Transparency is here to Stay
With intense competition for the donated dollar and a more scrupulous public with a voracious appetite for knowledge, all signs are that the “t” word is not going away and instead there may be calls for even greater transparency in the future. Smart organizations may consider adopting a “management discussion and analysis” section (like that required by public companies) in their financial statements (a requirement currently being considered by the accounting profession for non-public companies as well).

Such information may include new programs or funding sources. They might want to offer explanations of operational changes—for example, hiring 10 employees or opening a new location. The explanations can help to explain fluctuations in account balances from one year to the next. Annual reports can be used not only as a tool for donor acknowledgment, but also to provide details on the organization’s financial position.

Seize the Day
Transparency as the norm, rather than the exception, presents some challenges including making the information your nonprofit presents accurate, understandable and consistent. But transparency also is an opportunity to “differentiate” (#4 on list) your organization in an “apples to apples” (#6) comparison so that in a “consumer-driven” (#9) economy your organization is seen as “best of breed” (#12).

July 17, 2012

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