Nonprofit Operating Reserves – How Much is Enough? (Part 1)

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Whether you are in charge of running a nonprofit or seated on the board of one, the question of Operating Reserves and their amounts often arises.  If it doesn’t, our hope is that you will use what you learn in these next two articles to open a valuable discussion on the topic. In the first part, you will learn what a reserve is and why it is absolutely important to the financial health of a nonprofit.  In next month’s newsletter, How and When to Create a Reserve will be presented.

What is a reserve?  Basically, a reserve is a portion of assets, usually cash, which a board designates for use in emergencies to cover unexpected significant decreases in revenue or increases in expenses. An example of a significant decrease in revenue would be a consistent major donor that provides monthly contributions of 10% or more of total revenue, suddenly passes away and the customary monthly checks stop.  An example of a significant increase in expenses might be the need to hire an employment attorney because an ex-employee is suing your organization for some type of labor issue. While these two examples suggest an emergency with a negative perspective, there are positive situations that can exist that also require the need for a reserve. Having a reserve will also expand an organization’s ability to take advantage of opportunities, like starting a new program, changing focus, or even purchasing a building. The main purpose of a reserve is to smooth out erratic timing situations, which will enable an organization to survive operating shortfalls caused by economic conditions or management error. Yes, bad decisions can create economic hardship and some management errors are not covered by insurance.

Why does a Nonprofit need a reserve? There are at least 8 main reasons for a nonprofit to have a reserve.  For ease of recall, you can remember them by the acrostic    R E S E R V E S:

  • R-Resilience- The ability to bounce back from an unforeseen financial event
  • E-Enhanced flexibility to develop new programs or redirect focus
  • S-Survive operating shortfalls or seasonality of cash flow
  • E-Expand credit opportunities & permit favorable financing for expansion
  • R-Replacement of capital assets
  • V-Vulnerability to high long term debt, payables, and deferred income
  • E-End game-Winding down of a program
  • S-Sustainability-Having the necessary resources to fulfill its mission

Come back next month to learn How and When to Create a Reserve as well as some final thoughts on the importance of a reserve for nonprofits.

Whether just starting a nonprofit, or needing a peek under the hood of an existing nonprofit, Pro Back Office has the expertise and history to help your nonprofit build capacity to continue your mission into the future.  We are ready to help you review best practices from all aspects of accounting and human resources.