You never know when your not-for-profit might experience a financial crisis. With the current efforts in Washington to slash expenses, some nonprofits have already lost federal funding, and more may lose it in the near future. But that’s not the only risk. A significant grant from a foundation or state government might not be renewed, or a major donor could decide to stop supporting your organization. If such uncertainty has ever forced you to suspend services and scramble to implement Plan B, you probably understand how important operating reserves can be.
This financial cushion can help you manage shortfalls that can lead to a financial crisis. If your nonprofit’s operating reserves are low or nonexistent, start looking for ways to build them.
Written Reserves Policy
A formal written reserves policy is a crucial first step. Among other things, your policy should set the target amount to hold in a separate fund. Although no universal benchmark applies, six months of operating expenses is usually sufficient for many organizations. Incorporate your risk appetite and current financial position into the target calculation. In general, greater risk calls for higher reserves. So, for example, if your organization heavily relies on a handful of funding sources, assess the shortfall if one or more sources were to disappear overnight.
Avoid setting your reserves target too high, though. Donors and grant-makers generally don’t favor stockpiling when funds might otherwise be used to pursue your mission. Your policy also should establish triggers for when your organization can dip into its reserves.
Windfalls and Budget Items
Next, consider how you’ll reach — and maintain — your target amount. If you’ve received increased donations over the past couple of years, you might be able to fully fund your reserves with unrestricted net assets. Other sources include unexpected windfalls such as large bequests.
Most nonprofits, however, need to include a line item for reserves in their budgets. This amount shouldn’t hinder day-to-day operations, but it will help you begin to make real progress toward your reserves goal. If a financial crisis hits, it may be necessary to cut expenses, cancel projects or divest investments to free up funds.
Remember to leave illiquid fixed assets (buildings and equipment), endowments and temporarily restricted funds out of the equation. Keep in mind that budget surpluses aren’t necessarily available to fund reserves because they might include funds already earmarked for future expenses.
Enlist Support
How long it will take to build your nonprofit’s reserves depends on your goals and resources. But it’s critical to enlist the support of your board and leadership team so that contributions to the reserves fund become a priority. Our Not-for-Profit team can help educate decision-makers, as well as advise your organization on an effective operating reserves policy.