An important part of every non-profit’s financial safety net is its operating reserve, which is an unrestricted and relatively liquid part of its net assets. Care should be taken to ensure this reserve is maintained, as it is a primary remedy in the event of an emergency or budget shortfall, and the health of your non-profit’s operational reserve can be a key indicator of the organization’s overall financial well-being. The good news is that there are some basic practices for making and keeping a healthy operating reserve, as well as non-profit accounting services available for support.
Cultivate your reserve
Cultivating an operating reserve that functions in the way your non-profit needs is a long-term, ongoing project. A solid foundation for this process begins with the Board of Directors who, based on the needs of your non-profit, may assess funding streams for the reserve and the circumstances that warrant its use. Operational reserves can be built from unrestricted contributions, investment income, and planned surpluses, such as designated fundraising initiatives like annual Giving Days. Many boards designate a portion of their organizations’ unrestricted net assets as an operating reserve. There are, however, funds that would compromise the health of your operating reserve if used for that function, like restricted funds or endowments with specific conditions on spending. Net assets tied up in illiquid fixed assets used in operations, such as your buildings and equipment, generally don’t qualify either.
Determine the right amount
The amount of funds needed for a healthy operational reserve depends on your non-profit. Some non-profits have a diverse portfolio of funders and therefore may not need a substantial reserve. On the other hand, non-profits that would benefit from a large reserve include those who rely on only a few funders or government grants, which can shift focus and spending depending on the imperatives provided by legislation and elected officials. Likewise, for non-profits with personnel costs that are a large part of part of their budget, an adequate amount of flexible funds in the operating reserve can lend a comfortable financial cushion.
Maintain a balanced minimum
As with personal finance, a reserve that can sustain the organization for three months is considered a minimum accumulation. Six months of reserves provides greater security. Maintaining a reserve somewhere in this window would allow a non-profit to keep its doors open while weathering the necessary transition in operations or funding if the situation calls for it. Or, in the worst-case scenario, it would allow for an orderly winding down of affairs.
Growing an operational reserve that is greater than six months’ worth can create more opportunities. For example, it might give your non-profit funds to pursue a new program initiative that’s not fully funded, or to leverage debt funding for needed facilities or equipment. Keep in mind, though, that accumulating more than a year’s worth of expenses in reserve could pose a problem, unless that is the intention of your board and the excess in the reserve is designated for specific purposes. Non-profit community members and supporters give money to the organization in order to see their funds make change, not to see it stockpiled.
Consider all factors
As your non-profit establishes its operating reserve, it’s important to consider all factors that affect your organization’s finances. What works for one organization might not be the right fit for yours. If you need help calculating the appropriate reserve amount for your non-profit, consider consulting with other organizations and those with expertise in the non-profit field.
Ernst Wintter & Associates LLP specializes in California non-profit audits and tax preparation. Contact us today for help with your non-profit audit or tax prep needs.