The COVID-19 pandemic has driven home many lessons for nonprofits, perhaps none so much as the importance of operating reserves. If your nonprofit is among those organizations with dramatically depleted — or nonexistent — reserves, here are some steps you can take to remedy the situation.
1. Achieve buy-in.
It sometimes can be difficult to win support from leadership for allocating funds to build reserves that could be used for programming, especially when the demand for services is high. You might need to communicate with your board and other stakeholders about why operating reserves are essential.
Perhaps they’re already familiar with general arguments in favor of reserves. Strong reserves can empower an organization to take advantage of sudden opportunities or weather unexpected storms. If that’s not enough to convince your audience, you may want to delve into the short- and long-term risks your organization faces.
For example, maybe your nonprofit is heavily reliant on a handful of funding sources that, if cut off or reduced, would jeopardize its future. On their own, individual risks may have a low probability, but, when aggregated, the wisdom of operating reserves should become more apparent.
2. Commit (or recommit) to a formal policy.
If your organization doesn’t already have a formal written reserves policy, now is the time to develop one. And, if it does, review it to see how it holds up in light of two tumultuous and unpredictable years (with the possibility of more to come).
Among other things, your reserve policy should set the target amount to hold in a separate fund. Although no universal benchmark applies to every nonprofit, a common rule of thumb is to set aside six months of operating expenses. Your leadership’s risk appetite and your current financial position may dictate a lower or higher target. Avoid setting the target too high, though. Stakeholders generally don’t favor “stockpiling” of funds that could otherwise be used to pursue your mission.
The policy also should establish “triggers” for when your organization can dip into the fund. Note that triggers that made sense in earlier years may require adjustment at this point.
3. Develop a funding plan.
Assuming your current reserve level falls below the target, develop a plan for getting it back on track. Some organizations have reported increased donations over the past two years, which could allow them to fully fund their reserves with unrestricted net assets. Others use large bequests or unexpected windfalls.
Most organizations, however, need to include a line item for contributions to the 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. It may be necessary to cut expenses, cancel projects or divest investments to free up funds. You might need to eliminate, or at least delay, projects that aren’t helping your organization’s mission or simply come with too high a price tag for now.
Remember to leave illiquid fixed assets (buildings and equipment), endowments and temporarily restricted funds out of the equation. Similarly, budget surpluses aren’t necessarily available to fund reserves, as they might include funds already earmarked for future expenses.
4. Be realistic.
Building or replenishing operating reserves takes time and your stakeholders must understand that it’s an ongoing, long-term project. You’re typically looking at a timeline of several years to build months of reserves, and that’s if everything goes according to plan. Unfortunately, the pandemic has taught us that you may need to dip into the reserves with little warning, setting back your efforts.
That’s one reason why it makes sense to set quarterly or even annual goals, rather than monthly. It gives you greater flexibility to adjust for changed circumstances, whether it’s the traditional ebb and flow of donations over the year or crises like the pandemic. Quarterly or annual goals also reduce the risk of frustrations that can erode commitment.
Time to step up
As the economy moves into some type of new normal, guiding your organization’s financial health will be crucial. If you have questions about how to build and replenish your nonprofit’s reserves, give us a call.
Nonprofits are getting the message
A recent survey from BDO, a tax, consulting and advisory firm, suggests that nonprofit organizations have begun to prioritize operating reserves more than they have in the past. The survey defined operating reserves as liquid, unrestricted net assets not needed for current operations.
“Nonprofit Standards: A Benchmarking Survey,” conducted in June 2021, found that the number of nonprofits reporting at least four to six months of reserves ticked up, from 24% in 2020 to 28%. Organizations with more than 12 months of reserves jumped from 27% to 38%. Only 1% of nonprofits indicated they have no reserves.
Interestingly, those nonprofits with budgets under $25 million, so-called “mid-range organizations,” seem to have better liquidity than their larger counterparts. For example, 33% have reserves equal to four to six months of expenses and 42% have them for more than 12 months of expenses. By contrast, only 27% of organizations with budgets greater than $75 million have reserves for at least four to six months of expenses and 26% of them have reserves for more than a year of expenses.
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