Prepare for Financial Uncertainty with your Operating Reserves

You never know when your nonprofit might face a financial setback. With ongoing efforts in Washington to cut expenses, some nonprofits have already lost federal funding, and more may face similar challenges soon. But that's not the only risk. A significant grant from a foundation or state government might not be renewed, or a major donor could decide to stop supporting your organization. If such uncertainty has ever forced you to suspend services and scramble to implement Plan B, you probably understand how crucial operating reserves can be.

Operating reserves act as a financial cushion to help you manage acute shortfalls. If your nonprofit’s operating reserves are low or nonexistent, it’s time to start building them up.

Establish a Written Reserves Policy

A formal written reserves policy is a crucial first step. Your policy should set a target amount to hold in a separate fund. Although no universal benchmark applies, six months of operating expenses will be sufficient for many organizations. Incorporate your risk appetite and current financial position into the target calculation. Generally, greater risk calls for higher reserves. For example, if your organization heavily relies on a handful of funding sources, assess the shortfall if one or more sources were to disappear overnight.

reserves target too high, though. Donors and grant-makers generally don’t favor stockpiling when funds might otherwise be used to pursue your mission. Your policy should also establish triggers for when your organization can dip into its reserves.

Identify Windfalls and Budget Items

Next, consider how you’ll reach and maintain your target amount. If you’ve received increased donations over the past couple of years, you might be able to fully fund your reserves with unrestricted net assets. Other sources include unexpected windfalls such as large bequests.

Most nonprofits, however, need to include a line item for 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.

Remember to leave illiquid fixed assets (buildings and equipment), endowments, and temporarily restricted funds out of the equation. Keep in mind that budget surpluses aren’t necessarily available to fund reserves because they might include funds already earmarked for future expenses.

Enlist Support

How long it will take to build your nonprofit’s reserves depends on your goals and resources. But it’s critical to enlist the support of your board and leadership team so that contributions to the reserves fund become a priority. We can help educate decision-makers and advise your organization on an effective operating reserves policy.