Reserves - What Kind and How Much?

Each month, Nonprofits Assistance Fund hosts the Financial Management Network.  These free, informal gatherings are opportunities for members of the nonprofit community to get together to discuss different financial topics and network with peers. Key takeaways from these discussions will be posted and form an archive to help promote healthy financial practices.

Notes from Reserves - What Kind and How Much? (Nov 19, 2008)

A cash reserve can provide organizations with cash in an emergency. Reserves can also give organization leaders opportunities to grow and expand programming. A group of nonprofit leaders met to ask questions and discuss reserves and reserve policies.

Three Broad Questions

  • How can we build a reserve?
  • How much cash should we have in reserve?
  • How should we manage our reserve?

How to Build a Reserve

  • Always aim for a year-end surplus.
    • Overcome an organizational culture of "zero balance" in order to address future growth and cash flow issues.
    • Revenue from a profitable fee-based program can often help create a surplus.
  • Look for opportunities to move contributions into a reserve fund.
    • Unexpected, unbudgeted grants or bequests may be good possibilities.
    • It may be possible to create a policy that 3% (for example) of certain types of income will be transferred to your reserve.
    • Note: many contributions carry restrictions, and must be spent on a certain program or during a certain period of time.
  • Fund depreciation:
    • Build the cost of future acquisitions of capital assets into your budget by expensing a portion of the initial purchase price each year. Achieving a surplus, while accounting for this depreciation expense, puts an organization in a stronger cash position. It makes them more able to afford replacing assets when necessary.
    • This is common for many organizations that require extensive equipment or facilities.
  • Raise money specifically for the reserve, possibly through a capital campaign.
  • For additional ideas, see "Budgeting for a Surplus" from our notes on Annual Budget Planning

How Much?

  • How much cash should an organization have on hand?
    • People in the nonprofit sector often cite the three month rule that says organizations should have three months of operating expenses on hand. 
  • Depends on the size of the organization. How much is "3 months" for you?
  • Depends on monthly expenses. For example, if staff is the primary expense, it may be desirable to have a larger reserve to provide security for staff.
  • Depending on cash flow needs, reserve funds can cover cash flow gaps.
    • An organization with a highly fluctuating cash flow might want a larger reserve
    • Use our template to project your organization's cash flow
  • Depends on revenue stream. Organizations with dependable sources of income may choose to keep a smaller reserve. If income is less reliable, reserve funds can cover uncertainty.
  • Depends on purpose. Have a discussion at the board level to determine reserve philosophy and policy.
    • What is the reserve for?
    • How will it be used?
    • How difficult will it be to access?
    • How fill funds be replenished?
  • Choose to have multiple, separate reserve funds. Examples include:
    • An operating reserve to cover cash flow.
    • A building reserve to finance costs associated with owning a property.
    • A board-designated reserve to cover longer-term market downturns or other future financial concerns. Specify the purpose in an organizational policy.
    • Set different policies for each reserve. For example, an operating reserve can be easy for staff to access on a monthly basis, while a board-designated reserve can be more restricted.
  • Remember, it might take longer to replenish a reserve than to spend it!

Communicating Your Reserve(s)

  • Do reserve funds impact funding requests?
    • Depends on the donor or foundation. Some prefer to help the neediest organizations that do not have their own source of capital. However, many will only fund organizations that are financially stable and are planning for the future.
  • Transparency is always key. Explain the purpose of any reserve to funders, board members, and staff.
  • Example: organizations with a major project (capital expansion, construction) may need to raise a large sum over multiple years. If these funds are not designated, it could appear that the organization is hoarding. Reserves can be identified on financial statements:

 Unrestricted Net Assets
  1,000,000
   
Board Designated for Building Expansion  400,000
Operating
 
Repair
  
Program Seed Fund
  
Undesignated  600,000

 

Reserve Management

  • Keep or invest funds in an appropriate place:
    • One option is to put cash into a Certificate of Deposit (CD), so it is available, but not too accessible.
    • Money market funds may be an option. A money market account will typically earn more interest that a traditional savings or checking account.
    • Consider Federal Deposit Insurance Corporation (FDIC) rules and regulations carefully, especially in this climate
      • FDIC insurance covers: funds in deposit accounts, including checking and savings accounts, money market deposit accounts and CDs.
      • FDIC insurance does not insure other financial products and services that insured banks may offer, such as stocks, bonds, mutual fund shares, life insurance policies, annuities or municipal securities.
      • Currently the FDIC covers up to $250,000 (please note that this is a temporary increase from $100,000)
    • CDARS: the Certificate of Deposit Account Registry Service
      • CDARS is useful if your total funds are greater than the FDIC insurance limit
      • A CDARS account allows you to invest funds in multiple CD accounts with one financial institution, ensuring that your total deposits are insured by the FDIC (up to $50 million)
  • Consider the pros and cons of utilizing reserves versus a line of credit
  • Evaluate reserve policy and ensure that staff and board are on the same page.
    • It is important that everyone understands the purpose of the reserve.
    • It is not just about a dollar amount or a number of months.
    • Find reserve policies that work, and make sure the board is providing strategic guidance to staff.

Interested in Learning More?

View our Resource Collection or check out the Discussion Archive for notes from other Financial Management Networks.

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