Balancing the Mission Checkbook: Clearing Fuzzy Thinking about Nonprofit Reserves

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three-buckets

When I want to push nonprofit leaders to think about finances more comprehensively than their annual budget, I have a simple exercise that I use:

Imagine that a surprise gift arrives at your organization from a loyal and honorable donor, with no restrictions or strings attached, equal to 20 percent of your annual budget. What would you do with this windfall?

After the initial smiles and laughs about fantasyland, the answers start coming. I’ve heard a wide variety, but the most common response is: “Put it in a reserve fund.” My next question is, “Why?” These answers are often pretty vague: “In case something happens,” or, “To give me some elbow room.” I believe that fuzzy thinking about reserves is one of the barriers to building reserves. If we’re not clear about why a nonprofit needs reserves, or how reserves will be beneficial for the community, then why bother?

For most nonprofits, there are three primary purposes for having reserves:

  • Repair and replacement of fixed assets: to maintain and preserve productive long-term assets. Things break and need to be upgraded, from computer networks to furniture to roofs and heating systems. Building funds, or Repair and Replacement reserves, are a tool for accumulating cash for non-routine maintenance or replacement of fixed assets. Some of these expenditures can be prepared for by developing a systems replacement plan, while others are unexpected. Cash is needed in either case.
  • Unexpected external problems: to protect and stabilize the nonprofit in case of unexpected, often external, problems. This is the classic “rainy day fund” or operating reserve. Scenarios would include the sudden loss of a previously reliable funding source, unexpected delays in the timing of grants or revenue, or an unusual decrease in special event or earned revenue.
  • Invest for the future: to prepare for and respond to long-term changes in organizational strategy or in the community or market. Opportunity reserves allow a nonprofit to invest in program redesign or to pilot an expansion, seed fund an innovation, test out new marketing or development ideas, or bring on staff capacity that will pay off in the future. More than anything, having internal reserves for opportunities makes a nonprofit an investor in its future.

How much does an organization need in these three reserve buckets? I resist the standard rules-of-thumb metrics because I recognize the vast differences among nonprofits. Clarifying the different purposes of reserves makes the idea of a single “best practice” questionable anyway. If a nonprofit has reserves that equal 90 days of their operating budget, when and how would they use it? Organizations have different obligations and commitments. There is a spectrum of risks. Some organizations are more likely to take on a big new opportunity than others.

The first step in developing useful nonprofit reserves is to clear the fuzzy thinking and ask “why,” “when,” and “what if” questions. What buckets does your organization need, why do you need them, and how would reserves maintain, protect, stabilize, and prepare the organizations to achieve mission in the community?

If you’re ready to dig into these questions about reserves for your organization, check out this article and example policies from Nonprofits Assistance Fund’s Resource Library.

This article was posted in its original form on the Nonprofits Assistance Fund website on July 15, 2015.

  • Although I think it’s helpful to be thinking about the questions of why an organization has reserves, when looking at NFF’s 2015 State of the Nonprofit Sector report, fully 35% of nonprofits have 2 months or less of cash readily available, and 12% have under 1 month available. I think questions of “why” and “to what end” are frankly moot if you have zero tolerance for any unexpected changes. If I ran my personal finances that way (and some do), if anything unexpected happened, I’d be leaning heavily on lines of credit and paying dearly for the privilege. In nonprofits, the same consequence often occurs, and board members are often the first to be asked for “a little more to help get through a tough time.” I don’t disagree with the sentiment of the article, but I think it’s unrealistic to ignore the financial reality of most nonprofits.

    • Kate Barr

      I agree completely, Marc, and don’t intend to ignore any financial realities. I believe that nonprofits give up in defeat when they get the message that they “should” have an amount in reserves that is completely out of reach, at least in the short term. Getting very clear about why the organizations must have reserves can help deal with the objection that they should spend every dollar they have for immediate community needs. It’s such a hard decision to say “not now” to a mission need and instead put the money in the bank.

      One other comment – there is a difference between cash readily available and reserves. The highest priority for cash for nonprofits in working capital to manage the regular cash cycle of outflows and inflows. That’s a whole other critical problem.

      • Thanks for the reply, Kate – and I hear you about nonprofits giving up when they hear they “should” be saving a certain amount. Individuals (like me) react the same way! 🙂 And thanks for the distinction between cash available and reserves – it’s the closest I could get on the survey: http://survey.nonprofitfinancefund.org/

  • Paul Selden

    Agencies that depend on government contracts that reimburse the agency for services performed also need a reserve. I used to run a $4 million agency that regularly fronted $400,000 for government contracts. These, of course, showed up as receivables on the balance sheet. But their impact on day to day operations was to constantly send us to the bank to borrow money to keep the cash flowing.We finally set up a reserve of sorts to reduce the cost of borrowing. Of course the money was always out in the field so to speak, and never sitting in a reserve account. Does this still count?