From The Answer Desk: How Much Should My Nonprofit Have in Operating Reserves?

A: Keeping cash in reserve for a "rainy day" may seem like a luxury during an economic downturn, but maintaining a nest egg might ensure your organization's long-term financial health.

The Nonprofits Assistance Fund, a Minneapolis-based nonprofit whose mission is to build financially healthy nonprofits that foster community vitality, provides this explanation of how an operating reserve works:

[A]n unrestricted fund balance set aside to stabilize a nonprofit's finances by providing a “rainy day savings account” for unexpected cash flow shortages, expense or losses. These might be caused by delayed payments, unexpected building repairs, or economic conditions.

Reserves should not be used to make up for income shortfalls, unless the organization has a plan to replace the income or reduce expenses in the near-term future. In short, reserves should be used to solve timing problems, not deficit problems.

A commonly used reserve goal is 3-6 months' expenses. At the high end, reserves should not exceed the amount of two years' budget. At the low end, reserves should be enough to cover at least one full payroll.

However, each nonprofit should set its own reserve goal based on its cash flow and expenses. Organizations that have contracts or fees with regular and reliable payments don't need as much in cash reserves as organizations that rely on periodic grants, fundraising events or campaigns, or seasonal activities.

To be a viable operating reserve, there should be a board agreement and policy about how reserve funds can be used: When they can be used, who is authorized to use them, and how this is reported to the board.

To learn more about this topic, selected resources below may be helpful.

Web Resources

Nonprofit Operating Reserves Initiative Workgroup, NCCS: Maintaining Nonprofit Operating Reserves: An Organizational Imperative for Nonprofit Financial Stability [PDF]
This white paper contends that many nonprofits have inadequate operating reserves, argues why a reserve is vital for financial stability, and offers tips on how to start creating one.

Nonprofits Assistance Fund: The Yin and Yang of Operating Reserves: What You Need to Know [PDF]
Executive director Kate Barr advises on how large a nonprofit's operating reserve should be and how to fund it. Includes a table that aligns an organization's income characteristics with a recommended amount of reserves.

iKnow: Criteria for Nonprofits' Operating Reserves
This brief article by Thomas J. Raffa defines operating reserves and presents circumstances in which a nonprofit should plan for a larger reserve.

Nonprofits Assistance Fund: The Cash Reserves Myth
Kate Barr argues that a 3-month minimum of operating reserve may not suit all nonprofits. Instead, each nonprofit needs to analyze its cash flow, then create a workable and customized policy.

Nonprofit Times: Nonprofits and Squirrels
Richard F. Larkin, CPA, discusses how to decide on the size of your nonprofit's operating reserve.

Books & Articles

• Cash flow Strategies: Innovation in Nonprofit Financial Management by Richard Linzer and Anna Linzer (2008)
• "Improving Cash Flow Management in Challenging Times: A Primer" by Murray Dropkin, Nonprofit Quarterly vol. 10 (Summer 2003) p. 34-41.
• "Make Working Capital Work" by Susan Kenny Stevens, Foundation News & Commentary vol. 41 (July-August 2000) p. 42-5.

Do you have questions? Ask Us!

(This post is from Sandy Pon, virtual library/learning center specialist at the Foundation Center)

Comments

[Ashley Schweitzer]

Thanks for including some of our resources in this post.

I wanted to clarify that Kate Barr's article on the Yin & Yang of Operating Reserves was written for the Jan/Feb 2009 issue of Nonprofit World magazine. You can also download it at their website, www.snpo.org.

Best,
Ashley

PS. I love the Answer Desk series, it's really useful!