This article is the first in a series describing how your Board of Directors can use internal controls to improve the financial efficiency of your childcare centre. Over the next few months we will be looking at a variety of ways to make the most of your financial resources.

The financial management framework

First it is helpful to put financial management into a framework. There are four main components in the financial management cycle:

• setting overall objectives
• establishing budgets
• regular monitoring of your financial position
• comparing where you are financially with where you want to be and adjusting appropriately.

A useful analogy for the financial management of a not-for-profit organization is that of taking a voyage. The first step is to figure out where you want to go (clearly setting out your objectives). If you don't know where you want to go you will likely spend a great deal of time going nowhere. These objectives must be established by the Board and management of your organization and are commonly created through a strategic planning process. A common objective for childcare centres is that of providing affordable high quality childcare. Articulation of objectives can be a long and complicated process. However, it is critical that the organization spend the time and go through the process periodically to ensure a common focus and direction. It is also critical that overall objectives be documented, especially if there is little continuity of Board members from year to year.  

Once you have decided where you are going you must chart your preferred course as there are usually several ways to reach an objective. To use the trip analogy again, you have to determine whether you want to take the scenic route, and perhaps run out of funds, or take the most economical route possible. Your centre should prepare a budget of financial resources estimating what you will need to spend to reach your objectives and, as importantly, how you expect to obtain the resources to get there. This could take the form of both an annual budget and a monthly cash flow forecast.

The next step is to periodically monitor where you are on the voyage. In the context of the financial management of an organization, this entails having an accounting system which permits you to determine where you are financially at regular (monthly) intervals. You may also need to obtain information such as current and estimated future enrolment levels to help you determine whether your budget is still a reasonable one.

Now that you know where you are and where you want to be you have to compare the two and change course as needed to reach your destination. For your childcare centre this involves comparing your actual financial position with that previously budgeted. Changes to revenue and expense patterns can then be made to help you work towards attaining your financial objectives at the end of your reporting period. 

Increasing efficiency and effectiveness

We all know that there are more and less efficient ways of achieving objectives. Good control over the financial management framework can help you achieve your objectives with as little effort as possible. Failure to tend to the financial management process can result in your getting lost (going broke) along the way. Designing sensible internal financial controls helps to make the process as efficient and effective as possible.

What is internal control?

Internal control is the term used to describe policies and procedures designed by the Board and management to help ensure that the organization's objectives are achieved. In a childcare setting internal controls include the policies and procedures developed to ensure that high quality care is delivered at the most affordable cost possible. Two signatures on each cheque, review of monthly bank reconciliations, preparation of an annual budget and presentation of a monthly financial report at each Board meeting are examples of internal control procedures designed to help a Board know whether finances are being efficiently managed. Establishment of a finance committee and monthly reports at Board meetings to discuss areas such as child development, upcoming meal plans and finances are examples of internal controls designed to provide the Board with information required to assess the quality of care being delivered.

Internal controls go beyond accounting and financial systems. Appropriate internal controls are essential if a Board is to monitor all facets of an operation including quality-of-care issues such as personnel management, child behavior management and program development. While our newsletter will focus on the financial aspect of controls, non-financial internal controls are just as critical for a Board to efficiently achieve its objectives (delivery of services).

Internal controls should be creative and need to be applied in the context of an organization's culture. For example, some Boards may feel more comfortable with extensive and formal documentation of all aspects of policies and procedures. A voluminous manual may suit the culture of the organization. In other organizations such a manual may be seen as unnecessary and a less formal policy and procedure document may suffice. No single set of controls can be designed and applied to every organization. It is up to your organization to determine what is appropriate for its specific needs.

The Board of Directors sets the tone of internal control at the organization. If your organization wants to maintain a set of internal controls to keep financial management effective then the Board must be prepared to follow-up on a regular basis to ensure that the policies and procedures are being followed. Strong support at the Board level for appropriate controls generally results in effective financial management.

Limitations of internal control

There are inherent limitations to internal control and its ability to ensure that corporate objectives are met:

• Good financial management and internal controls are not possible if an organization does not have a clear idea of what it is attempting to achieve. Imagine trying to design an efficient vehicle not knowing what a journey involves. You may design an all-terrain vehicle when what you really need is a school bus. Once your organization has clearly articulated its purpose and goals then you can begin to design appropriate internal controls.

• Internal controls cannot prevent an organization from making operational and/or strategic errors and mistakes. They are designed to ensure that actions taken or not taken by management are followed up and reported to the Board. Internal controls are not designed to manage the organization. People manage.

• Internal controls can help minimize errors and irregularities but cannot eliminate them. Internal controls may cease to function as a result of human error. A purchase in excess of an amount budgeted may be made and not caught by an organization's internal controls. Also, two or more people can deliberately decide to override controls.

• An organization must take into account the costs of implementing internal controls and compare the costs with the benefits. Costs include volunteer time. As internal controls can never provide absolute assurance that policies and procedures will be followed the Board must determine what constitutes an acceptable risk and controls must be designed accordingly. Once again, this requires judgment on the part of the Board and must take into account the culture of the organization.

Control systems

Internal controls can be classified into two broad categories or systems. The first category includes controls designed to collect, record and process financial data and prepare timely reports. People often do not think of data collection, processing and reporting as part of their organization's internal control system. However, if you do not have an effective information collection, processing and reporting process then all the controls designed to ensure accuracy won't be worth implementing. Controls in this category include:

• Assigning responsibility for various tasks such as the centre's bookkeeping.
• Creating reports to be understood by Board members and management. Overly complex or simplistic reports will result in poor communication of financial data.
• Designing an appropriate attendance system to make staff aware of when children arrive and when they depart.
• Designing systems to ensure that data such as supplier invoices and accounts receivable are recorded accurately and on a timely basis.

The second category of internal controls includes those designed to enhance the reliability of the data reported. These procedures and policies include:

• proper authorization of transactions (prior authorization of major expenditures)
• adequate segregation of duties
• establishment of a finance committee
• proper controls over petty cash
• designing of appropriate forms
• controls to safeguard assets (two signatures required for all cheques)
• controls to verify financial records (monthly reviews and annual audits)

We have enclosed a financial management checklist with this newsletter for your information. You might find it useful to review the items listed and determine whether you feel there are areas in which your centre could do with improved controls. The next few newsletters will go into each of the areas in more detail.

Making internal controls work

We conclude our overview with a brief discussion of some of the factors that can enhance the effectiveness of internal controls in place at your centre. Again, we will be going into this area in more detail in subsequent editions.

Good control factors include:

• Establishment of a finance committee of the Board to spearhead planning and monitoring of financial activities and reporting. The finance committee would report to the Board and take primary responsibility for managing financial resources throughout the year.

• Design of an effective organizational structure (i.e. who does what, who is responsible for what and to whom). An organizational structure with clear reporting responsibilities that take into account the culture of the organization is critical for effective financial management. A poor organizational structure with unclear reporting responsibilities will invariably result in controls being missed, misapplied or misinterpreted.

• Effective assigning of responsibilities. This includes clear articulation and documentation of job descriptions. This would also include articulation and clear documentation of responsibilities of various committees of the Board and the Board itself.

• Effective management controls including methods of financial planning and budgeting, reporting of actual results to the Board and follow-up of variances between budgeted and actual amounts.