What Is Financial Due Diligence Really All About?

Carol Cantwell, founder of Fun With Financials, works with nonprofits and foundations to build financial literacy and align philanthropy with true financial health. We spoke with her about her Financial Health Assessment Tool designed to dig into grantees’ financial health without requiring budgets, and about ways foundations can let go of preconceptions when they approach financial due diligence. Follow Carol on Twitter @FunFinancials.

Andy: The challenges of financial due diligence on nonprofits are many, for a variety of reasons. Some foundation board members and staff lack the necessary skills, but maybe a bigger reason is a lack of clarity among foundations about what they are looking for, and why. 

Carol: You’ve hit the nail on the head here. I’d say this isn’t unique to small-staffed foundations either. I’ve always thought it was unfair to expect that foundation staff or board members will just magically know how to understand financial information. Funders can’t ask for better information until they know what that would actually look like.

I’ve also found, in my work in philanthropy, that there’s an inertia around financial due diligence. Everyone has a vague idea that it’s a good thing to do but not many people are asking the questions about what it is really for. So most of my work with foundations is creating a space for people to ask this question and figure out an answer that matches their organizational values and capacity. The capacity piece is especially important for small-staffed foundations. It doesn’t make a whole lot of sense to spend precious grantee time or foundation staff time requesting budgets and financials that don’t get used in a meaningful way.

Andy: Some funders are searching for signs of financial weakness, because they want to fund only “strong” organizations. But others understand that a group that does excellent work in its mission area may have some financial weaknesses; these funders want to help the nonprofit become stronger. Would you say that your financial analysis tool is really intended for the latter type of funder?

Carol: My approach is all about creating financial health, especially in the social justice sector, so I absolutely didn’t want to create something that could be used punitively. I want funders to really think hard about letting go of the notion of “strong” organizations and use financial information as a relationship builder, not as decision-making criteria.

I have lots of strategic reasons for this but also a very practical one. I think the big fear among funders is that they’ll fund an organization that goes out of business, has some kind of scandal, or . The truth is there’s a real chance that something unfortunate will happen over the life of a funder. But I’d much rather we ask if we should be designing all our processes to decrease this remote potential, even if it means extra work on everyone, or should we just get comfortable that bad things will occasionally happen and design our systems for the vast majority of times when good things happen.

Also, financial strength is somewhat of an illusion. An organization can have fantastic management practices and be very effective in its mission but have really weak financial performance because of larger economic or funder cycles. Should they be further punished or helped back to health? Or maybe a financially strong organization is strong because it doesn’t really spend its funds to increase its impact but just to maintain strong financial performance. Should they be rewarded?

There must be a bigger conversation about what we as funders are trying to achieve with our resources and which organizations are best able to help us achieve that. I realize there’s not necessarily a simple answer, but it is how I approach the conversation.

Andy: Say more about the relationship-building goal.

Carol: If funders use their inherent power with grantees to ask for information that’s more relevant to actual grantee financial health instead of a fake funder budget, that’s a step in the right direction. My dream is that grantees could be really honest—that they could actually say that what we really need to be more effective and have a bigger impact is new office space, upgraded computers, a full-time office manager, reserves to ride out the ups and downs in funding, or any of the other unsexy items that are so necessary but never make it into actual grant proposals. I would like to see funders engaging grantees more around what they really need to perform and be strong, and investing more in their long-term financial health.

Related resources

• What Makes an Effective Nonprofit
• Understanding Nonprofit Financials
• Red Flags in Nonprofit Financials
• How to Read Potential Grantees’ Financial Statements
• Streamlining Your Financial Due Diligence

Senior Program Director Andy Carroll writes resources, designs workshops, and facilitates seminars for funders. Andy also dedicates a significant portion of his time to managing our Leadership Initiative that defines, validates, nurtures, and celebrates the many ways philanthropists lead. Andy has 25 years of experience in nonprofit organizations, and he enjoys talking with funders about their questions, interests, passions, and plans for making a difference.