Operating reserves — unrestricted assets you can readily access — are often called “rainy day funds.” However, stable reserves are critical for more pressing reasons than for occasional financial setbacks. Some nonprofits, for example, have drawn heavily on their operating reserves due to economic challenges. If possible, now’s the time to replenish your reserves.
Reserves are essential for stability
Solid operating reserves demonstrate responsible financial stewardship and increase your organization’s self-sufficiency. They also protect against unexpected revenue shifts, investment fluctuations and unplanned expenses. Reserves can also be used to prevent cuts in programs and staffing levels, making you more nimble to take advantage of unforeseen opportunities.
In the most dire scenario, a financial cushion can help you wind down operations in an orderly fashion. But remember, reserves are best suited for timing gaps, not ongoing deficits. Resist the urge to use them routinely to cover income shortfalls unless you have a replenishment plan.
Avoid rule-of-thumb thinking
Each nonprofit’s circumstances differ, so don’t base your reserve level on rigid benchmarks. At a minimum, strive for enough reserves to cover six months of operations, including payroll, fixed costs and other necessary expenses.
Also, consider organization-specific factors. If you depend heavily on factors vulnerable to economic or political shifts, you might need a more robust reserve. Conversely, organizations with diverse revenue streams may require less.
Estimate your target
To determine an appropriate reserve level:
Review your long-term financial forecast, strategic plan, and budget to project revenue and expenses. Is any revenue stream in jeopardy or uncertain? Is a new program launch expected to boost certain costs? For how long?
Don’t limit your financial forecast to a single year. A longer view — say, five years — will help reveal trends that a shorter view might miss.
Calculate risks. Assess your risks by considering your mission, sector, geographic location, as well as macroeconomic conditions and factors such as pending litigation.
Assess the likelihood of each risk, its potential negative financial impact, and the appropriate reserve amounts to manage each risk.
Don’t set aside too much. Reserves are crucial but stockpiling too much can backfire. If your reserves appear too large, supporters may assume you don’t need additional contributions.
Finally, a formal operating reserve policy must be established. Your policy should address several issues, including the reserve minimum level. The plan for funding reserves might include budget surpluses, investment income, unrestricted contributions, and even contributions solicited specifically to establish a reserve fund. Your Hood & Strong team can advise you on other factors that should be included.
