Preparing for a successful financial due diligence by donors with practical tips

Risk-control tangle

Risk: The probability and potential impact on achievement of objectives while encountering a threat.
Risk management fundamentals-Risk Appetite is risk profile at org level (willingness to take risk to achieve objectives) and Risk Tolerance (ability or boundary to take risk/acceptable deviation from risk appetite) for activity/task. Risk appetite is about “taking risk” and risk tolerance is about “controlling risk”
Risk management approach is how to bridge the gap between risk appetite andtolerance while making informed decisions (risk capacity)
Unacceptable Risk: actions beyond the risk tolerance
Residual risk: The risk which inevitably remains after all reasonable mitigation measures have been taken

What are internal controls

Internal controls are rules, procedures and mechanisms that help mitigate risks (risk management) to an acceptable level. Internal Controls are an integral part of an NGO's planning, implementation, monitoring and achieving desired results

Internal controls help with:

Compliance: Ensuring compliance with laws
Accountability: Responsibility for outcomes/performance of organization
Fraud prevention: Preventing loss of assets
Improved Operational efficiency: streamline business processes, reduce redundancies, and optimize resource allocation
Attract capital and funds: Internal controls assures donors that their funds will be effectively utilized for the intended purpose

Examples of Internal Controls

Preventive Controls: Policies and procedures that include approvals, authorizations, verifications, reconciliations, reviews
Detective controls: Designed to identify errors after event have occurred. These include audits and reviews, account reconciliations, and physical inventorying
Corrective controls: Implemented to remedy problems that detective controls have identified
Physical controls: Involve security measures like locks and alarm systems

What donors focus while reviewing Internal controls during due diligence

Governance and delegation
Accounts and Finance
Costs, Budgets and Budgetary control
Human Resources
Procurement
Inventory and fixed asset management
Grant and Donor management
Cash and Bank
Statutory proceedings and penalties
Program and finance MIS
Record keeping and retention etc.

Governance & Delegation

Current general and governing body members-due process of appointment, change or rotation as per rules with proper documentation. Too long holding of positions is a negative
Founder as Chief functionary for long duration is evaluated against strategic contribution during such periods
Key office bearers-Chairman, Secretary and Treasurer-their association,past track record in discharging of roles and responsibilities
Direct blood relative/relative is a negative-independence of Board is questionable
Specified person as per section 13 of IT Act-transactions and benefits thereof
Any beneficial relations with other organisations
The governing body members list is duly updated with registering authority, Darpan and FCRA
Number and periodicity of Meetings of general body and governing body as per constitution documents or as per law
Attendance and Minutes of meetings maintained in minutes register and should be with CEO
Member Register
Meetings take up items of business as per roles and duties/responsibilities of the respective body laid down in constitution document

Governance & Delegation

Sub committees delegated Board responsibility should be as per constitution documents and recommendations through such delegation are duly approved by the governing body. Sub committees could be FAC, HR, Grantee selection etc
Demonstration of strategic guidance, compliance and internal controls through policies in place
Public servants on governing board/ executive committee
Political affiliations of organisation or any of its directors/ trustees
Affiliations with religious/faith based bodies/organisations
Does the organisation work attract the definition of political nature/party politics?
Does the organisation understand the boundaries if its wok relates to Advocacy, Rights C Entitlements, Activism etc

Accounts and Finance

Fund based accounting
Finance policy and systems in accounts and finance function and implementation in letter and spirit
Accounting software
Basis of accounting
Accounting records-vouchers, supporting bills/invoices for exp, PO/contract, approvals, printouts, filing
Monthly and Annual Closing of books
Delegation matrix for approvals
Maintenance of books of accounts and other records as per Rule 17AA of Income Tax Act
Qualification and vintage of accounts/finance staff
Segregation of duties/checks and balances
Separate accounting for local, FC and business incidental operations
Data security, Backup and audit trail, Rectification entries in succeeding period
Concurrent and internal audit
HO-branch accounting and reconciliation

Costs, Budgets and Budgetary Control

Understanding the concept of costs-functional and natural heads
Policy framework for budgeting costs-HR, travel, utilities mainly
Common cost apportionment as per common cost policy
Budget formulation and approval process-annual master budget including all projects
Templates may vary for donors but the basic principles of formulation are same-LOE, unit of measurement and unit cost for an activity, budget by activity and budget line
Budget monitoring process-budget vs actual derived from software
Expenditure reporting vis-à-vis budget estimates to donor-rolled up or detailed
Budgetary control process-propose action based on tolerance/variance permitted which may vary by donors

Human Resources

HR policy is a key policy that donors look for which details

Mission, Vision C Values
Org structure-updated
Processes for Recruitment, selection, engagement contract
Employee vs consultant vs contractual dilemma
Compensation and breakup-compliance with social security laws
Employee benefits-leave, insurance, gratuity
Payroll and allocation of employee costs for shared HR
Attendance records (timesheet for foreign donors) by donor projects
Performance appraisal
Disciplinary action
Employee strength currently including in finance function vs org structure

Understanding of various social security laws-central and state is essential so that policy and procedures are as per law

Team due diligence: leadership, experience, alignment with mission, vision and culture values, transparency etc

Procurement

Procurement Policy

Donors fund assets and inventory also in grant budgets
Sample procurement transactions insisted by donors to validate policy implementation
Team’s understanding and compliance of Procurement Policy for goods, services and works
Does donor insist on following its own procurement policy/Guidelines
Dedicated adman staff to handle procurement in organisation
Conflict of interest, ethics and transparency issues

Fixed asset and inventory management

Distinction between asset and inventory understood by staff
Acquiring asset and inventory following procurement process laid down in policy
Recoding, marking, issue and return, upkeep, depreciation, verification, loss, sale due to obsolescence of FA
Recording, issue and return, verification, disposal of inventory not needed/useful
Insurance of assets to cover loss
Recording of land and building in books
FA presented separately in FC audited financials and annual reporting for FC assets in FC-4

Cash and Bank

Petty cash-custody, administration and replenishment. Restrict petty cash to meet small payments not feasible using banking channels.
Reduce cash handling and transactions to bare minimum necessary as good practice
Bank:
- Provisions on banking in constitution document-at times it is only nationalised bank, SB account be insisted with Banks
- Local, FCRA accounts-do’s and don’ts
- See your member list is updated on NGO Darpan
- Dedicated bank account for grants
- Recording and treatment of interest in pool account
- Signatory to bank accounts- see constitution documents-dual signatories, signatories non-related, prefer net banking.
- Bearer payments-40A(3) provisions
- Bank reconciliation and follow-up
- Minimise visit to branch-sometime one person is engaged for banks only
- Bank statements copy for past 2 years insisted by donors to ascertain operations are using banking channels.

Grant and donor management

Current status of grant funding. Donor funding is a factor of annual budgets and spends for past few years
Besides historical audited data, donors obtain projections of grants and income in future 3 years also
Understanding the donor is essential for positioning your organisation
Understanding and internal dissemination of grant contract
Grant compliance checklist since accounting, utilisation and reporting will be different for donors-FC, CSR, others
Accounting for grant-cost centre basis with dedicated accounting staff for big ticket grants
Program C financial Reporting very crucial-template, periodicity etc for each grant contract
Timely request for course correction and revision
Community contribution, leveraging, cost matching help build your case
Communication is key

Statutory proceedings and penalties

Income Tax-assessments, proceedings
TDS deposit and return filing related
FCRA related
Social security laws-PF, ESI, PT, Gratuity
GST related
Proceedings against chief functionaries and Board members

MIS and software related

Accounting, TDS, Assets
HR-Payroll, timesheet, leave, travel etc
Audit
Program MIS
Grant Management for donor entities

Integrated MIS where all parts are on the same app.

Mandatory accounting Record and Retention

For books of accounts and other documents, there is specific law now regarding what records to maintain, in what form, where and for the period to be maintained and consequences for non compliance since August 2022 vide Rule 17AA by Income Tax Department

The specified books of accounts shall include:

cash book
ledger
journal
copies of serially numbered receipts, original copy of invoices, etc

Tips for making your organisation due diligence ready

Understand the background, focus areas and causes funded by potential/prospective donor
Donor credentials is important-PRC, sin goods etc
Develop understanding of regulatory framework applicable to donor category
Ensure all kinds of compliance we have learnt in previous sessions to maximum extent possible. This maybe done in phased manner but dedicatedly and per a plan
Continuous education of organisation key members on statutory and regulatory changes and action required
Risk management framework in place
Be proactive and manage adverse proceedings regarding organisation, staff office bearers and have latest update ready
Use technology and tools-lot of them are freely available
Spread your work through social media-low cost and high impact and reach. Show your competitive edge.
Be progressive, innovative and forward looking (latch on to new ideas and new ways) as environment is evolving)
Ensure internal controls specially key policies are actually followed and demonstrated in action and on record
Chief functionary and key staff should have clarity on vision, mission and values of the organisation and its demonstration
Be prepared upfront-Have a folder of all documents and details that are likely to be asked during org due diligence and also updating them. The folder should have different sections covering the areas that we have studied in past sessions
Use a generic checklist for org due diligence and make your folder containing sections using the generic checklist. This can be prepared basis past checklist you have received from donors.
Avoid scrambling for information during donor due diligence exercise
Reduce undue reliance on auditor or reference to auditor by donor, it adversely affects your chance to qualify.
Auditors role in due diligence in conveying a message is very crucial. Sit down and have a dialogue with your auditor-it can make or break.
Be careful in terms of your working style-while donors need you, you need to handle them and their staff with care and that understanding and skill needs to be inculcated among key staff who facilitate due diligence.
Try to build a new business development team in a gradual manner as your organisation grows. Till a team is setup, have a dedicated staff to facilitate donor due diligence. This brings focus on new business and sharpens your chance of success in fund mobilisation going forweard
If you are too small and cannot pilot/handle fund mobilisation, take help of professionals