Safety net essentials
Now more than ever, you need operating reserves
Too few nonprofits keep healthy operating reserves. A study of charities in the Washington, D.C., area, for instance, found that 57% of the organizations had insufficient operating reserves to cover three months of expenses — the minimum level many experts consider necessary to maintain financial stability.
Forgoing reserves leaves your nonprofit vulnerable to rapid or unexpected drops in revenue or jumps in expenses. You may regard such funds as optional or a luxury, but that’s just not the case these days.
What are operating reserves?
The Nonprofit Operating Reserves Initiative Workgroup defines “operating reserves” as the portion of unrestricted net assets that nonprofits designate to sustain financial operations. The assets would be tapped in the event of significant unbudgeted increases in operating expenses or losses in operating revenues. Reserves also should be liquid, or easily converted to cash.
Note that operating reserves and cash on hand are not the same. Cash is often restricted for specific purposes, such as future projects or programs, and is therefore unavailable for other uses, unlike reserves.
Operating reserves also are distinct from endowments. Endowments are restricted, as well, and the organization can typically spend only the interest generated by the principal funds, making that money unavailable for daily operations.
Why do we need reserves?
The times are turbulent, and even when the economy gets solidly back on its feet, it won’t stay that way indefinitely. Operating reserves can help nonprofits bridge the gap when revenue streams or donations fall off because of a wobbly economy.
Robust reserves also allow organizations to seize unexpected opportunities, set aside funds for long-term goals and plans, and cover increased expenses after a natural disaster or other emergency hits.
You also can tap reserves to ramp up your staff and deliver services under federal contracts that don’t provide payment for 30 to 60 days. Reserves will come in handy, too, if grants fail to come through, or major fundraising events are delayed or canceled.
How much do we need?
There’s no universal operating reserves benchmark that applies to every organization, and the question of an appropriate operating reserves amount can raise some thorny issues among stakeholders. Some may argue, for example, that the nonprofit has an ethical obligation to devote as much of its available resources as possible to carrying out its mission. Others might worry about the appearance or difficulty of soliciting additional donations while sitting on significant reserves.
Reserves, however, aren’t about accumulating wealth. They’re about securing the financial stability necessary to function effectively for the long run.
According to the Workgroup, you need to consider several questions when setting the goal amount, including:
- Are your revenue sources subject to large unexpected negative fluctuations?
- Are your resources subject to sudden increases in demand?
- Are your income and expenses subject to significant day-to-day fluctuations?
- Have your planning and budgeting processes been historically accurate in forecasting financial results?
- Are adequate backup resources likely to be available?
- Is the governing body trying to expand the organization?
The Workgroup recommends a minimum reserves level of 25% or three months of your nonprofit’s annual expense budget. The adequacy of reserves beyond that amount will depend on specific circumstances.
You can’t afford not to
Organizations without sufficient operating reserves can run into trouble meeting payrolls, paying bills, providing services and retaining qualified staff. Your CPA can help you determine the amount of reserves you need to minimize such risks.
