Five Minutes for Finance - Segregation of Duties
In the previous article on Internal Controls, I listed several types of control activities to mitigate risks and ensure that management directives are carried out. These activities include approvals, authorizations, verifications, reconciliations, and segregation of duties (SoD). For nonprofit organizations, where trust and accountability are paramount, implementing effective SoD can safeguard assets and enhance operational integrity.
What is Segregation of Duties?
Segregation of duties involves dividing responsibilities among different individuals to reduce the risk of error or inappropriate actions. By ensuring that no single individual has control over all aspects of any significant transaction, organizations can create a system of checks and balances. This principle is particularly crucial in financial management, where the potential for misappropriation of funds is heightened.
Importance of Segregation of Duties in Nonprofits
Fraud Prevention: Nonprofits are often seen as easy targets for fraud due a culture of trust among like-minded staff and/or a lack of financial expertise. SoD helps minimize opportunities for dishonest behavior by requiring multiple approvals and oversight.
Error Reduction: With multiple individuals involved in financial processes, the likelihood of mistakes decreases. Checks and balances ensure that transactions are reviewed and verified before they are finalized.
Enhanced Accountability: By assigning distinct roles and responsibilities, nonprofits can create a culture of accountability. Each employee knows their specific duties and can be held responsible for their part in the organization’s financial processes.
Regulatory Compliance: Many nonprofit organizations are subject to regulations that require strict adherence to internal controls. Implementing SoD can help ensure compliance with these legal obligations.
Key Areas for Segregation of Duties
Financial Management: The most critical area for SoD is financial management, including functions like accounts payable, payroll, and cash management. For example:
One person should be responsible for initiating payments, while another approves them.
Separate individuals should handle bookkeeping and reconciliation tasks.
Fundraising and Donations: The processes surrounding fundraising should also be segregated:
Different individuals should manage fundraising activities and record the donations received.
This separation helps ensure that fundraising revenues are accurately reported and properly managed.
Grant Management: When managing grants, it is essential to segregate duties related to application, approval, and reporting. This prevents any one individual from having complete control over the entire process.
Board Oversight: Board members should have distinct roles in governance and oversight, ensuring that financial decisions are reviewed and approved independently of the operational team.
Challenges in Implementing SoD
While SoD is vital, implementing it can be challenging, especially in smaller nonprofits with limited staff. Some common challenges include:
Limited Resources: Smaller organizations may struggle to assign different individuals to every function, making it hard to implement strict segregation. It may require assigning certain financial tasks or roles to staff from non-financial (program) departments (making bank deposits, opening and logging incoming payments) and/or Board members (approving expenses, signing large checks)..
Overlapping Roles: In many nonprofits, staff may wear multiple hats, leading to potential conflicts of interest. It is important to clearly understand and document workflows and individual responsibilities to identify any potential overlaps or gaps that would compromise security.
Staff Training: Ensuring that all staff understand the importance of SoD and are trained in their specific roles can require significant effort. This is especially true if the organization experiences high levels of turnover.
Best Practices for Nonprofits
Assess Current Practices: Conduct a thorough review of existing processes to identify areas where SoD can be improved.
Define Roles Clearly: Establish clear job descriptions that delineate responsibilities and reporting structures.
Implement Technology Solutions: Utilize accounting software that can help enforce SoD by requiring approvals and tracking changes.
Regular Audits: Conduct regular internal and external audits to evaluate compliance with SoD and identify areas for improvement.
Foster a Culture of Transparency: Encourage open communication about financial practices and promote a culture where staff feel comfortable reporting concerns.
Conclusion
Segregation of duties is a fundamental principle that nonprofits must embrace to enhance accountability, prevent fraud, and ensure compliance. By thoughtfully implementing SoD practices, organizations can build a strong foundation of trust and integrity, ultimately supporting their mission and fostering confidence among donors and stakeholders. As nonprofits strive to operate efficiently and ethically, the commitment to segregation of duties will remain an essential aspect of their governance framework.
About this Series
Subsequent articles in this series will cover other topics related to nonprofit financial management. Here is a list of, with links to, previous articles:
About the Author
For over 30 years, Robert Pascual has been a leader in nonprofit financial management as a CFO, consultant, conference speaker and educator. He holds an MBA from the Haas School of Business at the University of California and is the founder and principal of Robert Pascual, MBA LLC. He has worked with small, mid-size, and large nonprofit organizations spanning the fields of education, workforce development, housing, health, philanthropy, social services, media, fiscal sponsorship, nature, and the environment. Each of these organizations has faced both unique and common challenges, some of which are probably similar to ones that you wrestle with.