3 Audit Pitfalls Nonprofits Should Avoid
Preparing for an audit isn’t just about closing your books once a year. It’s about cultivating healthy, sustainable financial practices that support your nonprofit’s long-term mission. At Smith Marion, we’ve worked with nonprofit leaders for decades and seen firsthand the patterns that separate well-prepared organizations from those that struggle during audit season.
In a recent webinar, Kendra Dockham, CPA and Audit Principal at Smith Marion, shared her experience from over a decade of auditing nonprofits, from churches and social justice organizations to health benefit funds and California special districts. In this article, we’ll explore the three most common audit pitfalls Kendra has observed and provide actionable steps your organization can take to avoid them.
Why Audit Preparation Matters
Audits don’t have to be intimidating. With the right systems in place, they can provide valuable insights and strengthen your organization’s financial credibility. As Kendra emphasized, the organizations that perform best in audits are the ones that prepare all year long not just at year-end.
Let’s look at the three most common issues and how you can avoid them.
Audit Pitfall #1: Inadequate Documentation Practices
Why Documentation Is Essential
“If you didn’t document it, it didn’t happen.” This foundational principle should guide every nonprofit’s operations. Inadequate or hard-to-access documentation slows audits, creates confusion, and increases the risk of material misstatements.
Kendra explains that documentation isn’t just about storing receipts. It involves capturing every financial and operational agreement including grant contracts, HR paperwork, board meeting minutes, and donor restrictions and organizing them in a retrievable system.
“We’re looking at how do we capture it, how do we retain it, and how do we recall it.” — Kendra Dockham, CPA.
The Need for Centralized Systems
Many organizations struggle with where and how documentation is stored. Between email, Microsoft Teams, and cloud drives, there’s often no single source of truth. This becomes especially problematic when staff members leave or are out sick.
To reduce risk and improve audit readiness, every organization needs:
- A clear documentation retention policy
- Defined storage locations (with secure, shared access)
- Version control and naming conventions
- Backup systems (preferably cloud-based)
Tracking Restricted Net Assets
Nonprofits often face a unique challenge in tracking restricted donations. Accounting systems may fail to capture donor restrictions and monitor the release of funds throughout the year.
“We want to make sure we’re tracking what were the exact donor restrictions on these funds and how have we released them during the year.” — Kendra Dockham, CPA.
Using tools like a P&L by class and maintaining a monthly reconciliation log of restricted funds can streamline this process and avoid issues during audit testing.
Audit Pitfall #2: Outdated or Weak Internal Controls
What Internal Controls Should Achieve
Internal controls aren’t just checkboxes for auditors they’re your first line of defense against errors or fraud. As Kendra puts it:
“Internal controls can’t prevent everything, but they should allow us to detect problems in a timely manner.” — Kendra Dockham, CPA.
They should be tailored to your organization’s size and structure. Even with limited staff, controls like approvals, monthly reconciliations, and segregation of duties can be implemented effectively.
Keep Policies Aligned With Modern Workflows
One of the most overlooked issues is outdated procedures. Many nonprofits still operate under legacy policies designed for paper-based processes, even though most transactions today are electronic.
Kendra explains how organizations inadvertently trip themselves up by not updating policies:
“When we’re doing the testing, we’re looking for what your policy says you’ll do. If your policy still says ‘manual timesheets’ but you’re using software, that’s a problem.“
Policies should be reviewed and updated regularly, especially after operational changes like remote work, electronic payments, or subscription billing.
Accountability and Communication
Once updated, policies must be clearly communicated and enforced across the team. Everyone responsible should understand their role in maintaining internal controls.
“It may be we’ve not allowed them adequate time or space to follow procedures. So we want to make sure we’re giving them what they need to succeed.“
Audit Pitfall #3: Weak Governance and Oversight
The Board’s Fiduciary Responsibility
Nonprofit boards play a critical role in overseeing the organization’s financial health. Yet, many board members don’t fully understand their responsibilities.
“Board members are often highly engaged and care deeply but they may not have a fiscal background,” Kendra explains.
This is where ongoing board training and financial literacy sessions become invaluable. Board members should review financial statements regularly and ask informed questions.
Oversight of the Executive Director
A recurring issue is the lack of formal oversight for the executive director’s role and compensation. Many organizations don’t conduct annual reviews or benchmarking studies, leaving gaps in accountability.
“If there’s no performance review, then how can we expect the executive director to be reaching for those big goals?” — Kendra Dockham, CPA.
Kendra encourages nonprofits to:
- Maintain employment agreements
- Benchmark compensation packages
- Set measurable goals aligned with the strategic plan
- Conduct regular performance evaluations
Governance Documentation Essentials
To avoid audit flags, nonprofits should keep:
- Current board rosters and minutes
- Committee charters
- Signed compensation agreements
- Documentation of board approvals and votes
Practical Tools for Better Audit Readiness
Tools and habits to support a smoother audit process:
Document Management Policy
- Define what to keep, how long to keep it, and where to store it
- Monitor digital backups and ensure secure cloud storage
- Assign document responsibility to your finance lead
Internal Review Checklists
- Use pre-audit checklists more than once a year
- Ensure trial balances, payroll files, and reconciliations are reviewed monthly
- Confirm all contracts and compliance documentation are up to date
Restricted Fund Tracking Log
- Document donor restrictions and expenditures monthly
- Reconcile with your P&L by class
- Ensure consistency in grant reporting and fund releases
What Healthy Nonprofits Do Differently
Healthy organizations don’t treat audits as a once-a-year event—they embed audit readiness into their culture. They value transparency, maintain consistent documentation, and adapt their internal controls as their operations evolve.
“When you find a problem midyear, it doesn’t mean something’s wrong—it means your system is working.” — Kendra Dockham, CPA.
Conclusion
Addressing these three common audit pitfalls- documentation gaps, internal control weaknesses, and governance oversight can improve your organization’s preparation, efficiency, and transparency. The goal isn’t perfection; it’s progress, consistency, and accountability.
If your nonprofit wants to improve its audit readiness or needs help reviewing internal systems, our team at Smith Marion is here to help.
Let’s Strengthen Your Nonprofit’s Financial Foundation
At Smith Marion, we’re proud to partner with mission-driven organizations across the country. Our team brings deep nonprofit expertise and personalized guidance to help you prepare, plan, and thrive—before, during, and after your audit.
Schedule a consultation today to learn how our audit and assurance services can support your goals.