A "rainy day" fund provides financial stability for nonprofits and charities
An operating reserve (also known as a general or unrestricted reserve) provides a financial cushion in case of unforeseen operational needs or sudden loss of revenue. Maintaining an adequate operating reserve is a powerful — but often overlooked — way to help ensure your organization's long-term well-being.
What's the value of a reserve fund?
Imagine an unusual dip in donations, delayed payment from a funding agency or the need for a major building repair. Any of these scenarios could impede your ability to cover payroll and other operating expenses. That's when a reserve fund comes into play.
With an adequate operating reserve in place, you can:
- Focus on delivering high-quality services and programs
- Act on unanticipated opportunities, such as the ability to make a key hire or purchase
- Minimize short-term, crisis-based decisions
- Demonstrate the kind of financial stability that instills donor confidence
How much should be set aside?
Although guidelines vary, an operating reserve large enough to cover three to six months' worth of expenses is a common goal. That said, no single standard applies. How much you should set aside depends on the nature of your nonprofit and factors such as expenses and normal cash flow.
If you receive regular funding from a government agency, for example, you might not need as much in reserve as a nonprofit that depends largely on seasonal fundraising campaigns. Similarly, if you run a well-established arts organization, you might need less in reserve than an organization that tends to run lean and mean, such as a neighborhood food shelf. That said, every organization should prepare for the possibility of regular funding not being renewed.
In the end, it's generally up to the board of directors or trustees to make the final call on a financial goal for the operating reserve — after careful consideration of the risks of going either too high (and tying up cash unnecessarily) or too low (and risking inability to weather a financial crisis).
Whatever your goal, the statistics are sobering. The National Council for Voluntary Organisations (NCVO), revealed that 37 percent of charities are running with little or no operating reserve at all. A 2018 report from the Nonprofit Finance Fund revealed that more than half of American nonprofits had fewer than three months of operating reserves available while still others had only one month of reserve funds.
What are some strategies for establishing — and replenishing — a reserve fund?
Board participation is essential here. Executive leaders and the board should work together to:
- Establish a financial goal for the reserve fund. The goal should take into account seasonal factors, predictability in cash flow, and realistic financial projections for the coming year.
- Implement an operating reserves policy. The policy should specify when operating reserves can be used and who's authorized to spend the funds. Make sure the policy aligns with your strategic and financial plans and is regularly reviewed and updated as needed. The policy should be made available to donors, and you might also explain what you're holding (or not) in your annual report.
- Identify viable ways to build the reserve fund. You might set aside a percentage of the surplus in any given month until the goal is reached, or consider seeking donor support as needed. While this may not be as tangible or glamorous as other ways of providing support, chances are you'll find more than one donor willing to help your nonprofit reach this worthy goal.
- Clarify what's off limits. Operating reserves are typically made of cash or investments that can quickly be converted to cash and aren't designated for another purpose. Typically, this excludes real estate, lines of credit, and cash with restrictions or cash earmarked for specific projects, initiatives or essential future spending. Endowment funds are generally off limits, too, unless specifically designated for operating funds — and even then, typically only investment income may be tapped for use.
Some nonprofits downplay the value of operating reserves, instead putting any available cash toward programs and services. Others fear donors may think money isn't needed if financial reserves of any amount are readily available.
However, lack of a financial safety net places nonprofits in a vulnerable position. Worst case, a significant financial blow could crumble the organization. In contrast, an adequate operating reserve has the opposite effect — helping avert crisis and ensuring sustainability when cash flow is less than ideal. The closure of both BeatBullying and Kids Company in the U.K. were at least partly a result of a lack of sufficient operating reserves: when funding slowed down, the organizations were unable to continue while seeking additional funding.
Reserves can also offer an opportunity to be more ambitious. Although a certain amount of caution is wise, the Charity Finance Group encourages nonprofit leaders to take a more commercial view of operating reserves. You might consider operating reserves as drivers for change — to increase fundraising activity or to support your organization's strategic aims through program-related investment, for example.
This article draws on the expertise of Andy Nash Accounting & Consultancy. Based in Cardiff, Wales, the firm offers specialized accounting and financial consultancy services to small and medium sized nonprofits.