3,400 nonprofit leaders across the U.S. responded to a 2018 survey conducted by the Nonprofit Finance Fund, and 69% reported having at least 3, and up to more than 6 months’ worth of operating expenses in their reserve funds. A number that is now likely less as many organizations have had to either pause or significantly overhaul operations in light of COVID-19.
It would be hard to make the argument for not having any reserve cash. Similarly to your personal savings, a nonprofit reserve fund acts as a “rainy day” fund for the organization, and this pandemic serves as a stark reminder of how reserve funds are a bedrock to nonprofit sustainability during tough times or hardship.
1. So, how much cash does your nonprofit really need in its reserves?
In all honesty, there’s no magic number. Not what you came here for, huh? We know! The real answer is that there is no such thing as a “one-size-fits-all” reserve recommendation, and an appropriate goal depends entirely on your organization. A common standard is 3-6 months operating expenses.
Here are some guidelines that will help you determine a reasonable amount for your organization’s reserve funds and develop an appropriate reserves policy:
2. Know the basics!
Start by calculating a three-month reserve as a baseline. Add your total monthly operating expenditures (rent, payroll, utilities, program expenses, administrative expenses, etc) and then multiply that by 3 (three month reserve). What are all the absolute costs of your nonprofit’s monthly operations?
3. Consider the varied and unexpected!
So now you have a better understanding of your monthly operating costs. Simple enough, right? Not so fast. You must also consider unforeseen changes to your funding streams! Organizations who lack diversified funding sources struggle the most in this area but the current pandemic or the loss of a major donor are also both obvious examples, and there are many other factors that could contribute to unexpected expenses. Additionally, you must also consider variable expenses – those that may change or vary depending on need or market prices.
4. Prepare for the worst!
Okay, this might be a little dramatic, but this is what we want you to consider: if your reserve funds are intended to protect against unexpected financial consequences, getting an idea of the potential consequences you aim to protect your organization from will help you better determine how much should actually be in your reserve fund.
We recommend you start by conducting a risk management assessment of your organization. Realistically identify your funding threats, then identify how much you would need in order to continue your operations in the short-term while you adjust.
5. Develop a Cash Reserves Policy!
Reserve funds for your organization differ from an endowment in that there are not typically restrictions on the spending of the reserve funds. However, development and implementation of a reserves policy will help improve stakeholder support, keep the board of directors and key management up to speed on intended spending, and allow them to make more informed decisions on the allocation of funds – going both in and out of the reserve account.
Much like the total amount in your reserves, reserve policies will also vary from organization to organization. Regardless of what your final policy looks like, be sure to include the following core elements in your reserves policy:
Purpose – What is the main reason for establishing a reserve fund? (TIP: maintaining operations is an appropriate reason!) In addition to the general purpose of the fund, detailed objectives may also be included.
Definition + Goals – Include pertinent reserve information including target minimum and maximum balances; departments, individuals, or teams that will have oversight of the funds; and details on the calculations that comprised your baseline or reserve target, including both variable and fixed expenses.
Funding Reserves – Here, you’re going to outline your plan for establishing the fund. This should include any money designated to establishing the fund, funding strategies that will be used to raise the remaining fund money, how frequently the fund will be replenished, how changes or progress will be tracked and reported to the board, and how shortfalls will be handled and rectified.
Investing Reserves – Where will your reserve funds be housed? Will they be readily available as cash, co-mingling with your organization’s general cash accounts? Or will the funds be kept in a separate bank or investment account? Outline your investment plans and fund accessibility in this section of your reserve policy.
Using Reserves – This section of your reserves policy focuses on two important elements: management’s decision to use reserve funds, and authorization and monitoring from the board. Again, this may look different for your organization, but the goal for this section of your policy is to communicate very clear guidelines and accompanying processes for identifying usage opportunities for reserve funds and how that usage is monitored.
Review of Policy – Last but not least, it’s important to establish guidelines for the review of your reserves policy, including specific process and frequency. This will help ensure that your reserve policy stays relevant and aligned to the evolving goals of your organization.
If your organization is considering establishing a reserve fund, or reviewing existing reserve fund policies, keeping these guidelines in mind will help you do so most effectively.
Still unsure of where to start? Let’s talk! Schedule a free 30-minute consultation today!