Understanding Nonprofit Audits: A Beginner’s Guide

For many organizations, the idea of an audit conjures images of endless paperwork, tough questions and stress. But audits don’t have to be intimidating! In fact, they’re one of the best ways to ensure your nonprofit’s financial practices are strong, donors continue confidently supporting your work and your mission stays on track.

Every dollar counts for nonprofits, and an independent audit is the perfect opportunity to check that you’re being as efficient as possible. Plus, going through this process is great for demonstrating transparency among stakeholders.

Whether you’re preparing for your first audit or just exploring the idea, this beginner’s guide will help you understand the process, navigate each stage and use your audit results to fuel growth.

What is a nonprofit audit?

Jitasa’s guide to nonprofit audits defines an audit as “a comprehensive review of an organization’s records, reports, transactions, policies and procedures. When a nonprofit audit is conducted by an independent auditor, its goal is to assess the organization’s overall health and ensure compliance with federal, state and general financial regulations.”

It’s important to distinguish between internal reviews and formal audits conducted by third-party auditors. For an internal review, your organization’s own management or finance team evaluates your financial practices and strategy. While helpful for routine oversight, internal reviews lack the objectivity and professional validation of an external audit.

A formal audit, performed by an independent auditor, provides an impartial assessment of your financial statements and internal controls. This results in an audit opinion that can enhance credibility with donors, grantors and other stakeholders, bringing trustworthiness to your donation appeals.

With that in mind, there are a few types of nonprofit audits to know, such as:

• Independent financial audit: A third-party auditor examines your nonprofit’s financial statements, transactions and internal controls. They provide a professional opinion on your financial health.
• IRS financial audit: While nonprofits don’t pay federal taxes, the IRS may still audit them if they don’t file required forms or if they notice a reporting discrepancy.
• Internal financial audit: Your organization’s management team will examine your financial strategy, but it may be difficult to get an objective opinion.
• Compliance audit: For this type of audit, a professional will assess your nonprofit’s adherence to your bylaws as well as federal, state and local regulations.
• Operational audit: This audit reviews your nonprofit’s internal systems, staffing and management practices. They can be holistic or specific to one area of operations, such as program effectiveness or human resources.

For clarity and consistency, we’ll primarily focus on independent, external financial audits. However, the other types are also useful tools for maintaining transparency and accountability.

Does my nonprofit need to conduct an audit?

In short, it depends. Audits are great for ensuring financial transparency and complying with relevant laws and standards, but not all nonprofits are required to undergo them. If your nonprofit is required to conduct audits, it’s usually for one or more of these reasons:

• Your organization’s bylaws require regular audits to ensure financial security and transparency.
• Your nonprofit receives more than $750,000 in federal funding annually.
• In many states, state laws require nonprofits whose total annual funding exceeds a certain threshold (commonly $500,000) to conduct independent audits.
• A grantmaker or other major funder asks for an audit report before approving your grant proposal and awarding you funds.

Even if you’re not required to conduct an independent audit, you can still benefit from voluntary audits, since you’ll demonstrate to stakeholders that you take financial management seriously. An audit will also flag areas for improvement within your operations or fundraising plan, such as inefficient processes or unnecessary spending.

Also, charity watchdogs like Guidestar and Charity Navigator provide information about nonprofits to the public. Regular audits may improve your reputation and lead to higher rankings on those sites, helping more donors find your organization.

The audit process

Before committing to an audit, it’s essential to understand the process. Here’s a breakdown of the key phases and typical timelines involved in working with an independent auditor.

1. Auditor Selection

Start by picking your auditor carefully. Look for experience with nonprofits, a track record of success and CPA credentials. To find a good fit, follow these steps:

1. Search online for nonprofit auditing firms. Browse their websites for fee structures, estimated timelines and client success stories. Be sure to read online reviews from past clients, too.
2. Ask for recommendations from other nonprofits. Firsthand accounts give you an idea of what to expect when hiring a specific firm. Your nonprofit’s accountant may also provide recommendations, although they usually won’t conduct the audit themselves to prevent a conflict of interest.
3. Issue a request for proposal (RFP) to your top choices. In response, the firm will provide a tailored proposal of their qualifications, methodology, communication plan, cost estimate, client references and everything else needed to visualize how the relationship will go.

From here, you’re ready to make your final decision. From conducting initial research to receiving proposals, this stage typically takes anywhere from 4-12 weeks.

2. Internal Preparation

Your next step is to prepare your records, which takes about 2-4 weeks. Your firm will tell you how to prepare for the audit, usually in the form of a Provided by Client (PBC) list to ensure you compile all of the necessary documentation. This may include:

• Bank statements
• Investment records
• Outstanding invoices
• Documentation of donations and received grants
• Financial statements like your balance sheet, income statement, cash flow statement and functional expense report
• Payroll records and staff salary information
• List of board members and minutes from board meetings
• Relevant tax filings and forms

Beyond gathering relevant documents, you’ll need to complete other tasks like reconciling your bank accounts, addressing uncleared transactions, checking for unpaid membership dues and depositing any outstanding funds to ensure your records are as accurate as possible. We also recommend reviewing your financial records to address duplicate, missing or incorrect information.

3. Audit Fieldwork and Report

Now comes the auditor’s role! The exact timeline depends on the terms laid out in the firm’s proposal, but the auditing process typically takes between 2-4 weeks.

During their review, they’ll take actions such as:

• Assess financial records. They’ll review and verify the accuracy of your financial statements, ensuring they comply with accounting standards like the Generally Accepted Accounting Principles (GAAP) for nonprofits.
• Review internal controls. They’ll evaluate your nonprofit’s internal process for handling financial transactions, including segregation of duties, approval procedures and risk management policies to identify gaps or security risks. They may also assess technology, such as your accounting system and grant management software, to ensure proper tracking and secure access controls.
• Validate transactions. Typically using random sampling methods, your auditor will examine individual transactions for compliance with policies and accuracy. This includes verifying invoices, receipts and payroll records to confirm they are correctly recorded and consistent with the organization’s stated practices.
• Test revenue and expenses. Your auditor will review key revenue sources—such as donations, grants and earned income—to ensure they are properly recorded and categorized as restricted or unrestricted. They’ll also review expenses to confirm your spending furthers your nonprofit’s mission.
• Confirm compliance with regulations. Your auditor will check that your organization complies with legal and contractual obligations. That might include adherence to IRS requirements, grant agreements and federal or state laws.

Then, they’ll prepare an audit report, where they issue a formal opinion that reflects their findings—which could be unqualified (clean), qualified, adverse or a disclaimer. They’ll also provide recommendations for improving financial practices and addressing any issues they identify.

4. Incorporation of Audit Findings

After receiving your report, take the time to review the auditor’s suggestions carefully. Then, use their insights to improve internal controls and enhance financial reporting. As a result, your organization will become more efficient and financially healthy, empowering you to invest more in your mission.

Sharing audit outcomes with donors, grantors and board members demonstrates your commitment to accountability and good governance, too. Highlighting a clean audit or explaining the actions you’re taking to address findings can reinforce confidence in your organization’s financial stewardship.

Additionally, refining your financial processes can make your nonprofit more attractive to corporate sponsors and their workplace giving campaigns. Double the Donation’s workplace giving strategies guide explains that these programs are designed to positively impact all parties, including nonprofits, companies and their employees.

Whether through matching gifts, volunteer grants or annual giving campaigns, companies seek assurance that their contributions are managed responsibly and aligned with their goals for social impact. Sharing audit results can help here.

The sooner you can act on audit recommendations, the better! If possible, start implementing changes before you file your nonprofit’s annual tax return so your efforts will be reflected on your nonprofit’s Form 990.

A nonprofit audit is more than just numbers on a page—it’s your chance to demonstrate transparency, build credibility and identify areas for growth. By embracing the audit process, your organization can operate more efficiently and better fulfill its mission.

If your organization is required to conduct a financial audit this year or could benefit from one, start exploring firms and find the one that best fits your needs!