First, the COVID-19 pandemic wreaked havoc on not-for-profit finances and operations. Now, many organizations are worried about how high inflation and a possible recession might interfere with their plans. To help prevent service disruptions and other negative outcomes, focus on building up operating reserves. Even if you can afford to divert only a small amount to reserves right now, should your organization need it, you’ll be grateful for the cushion.
A policy to help weather storms
Strong reserves can help nonprofits survive unexpected financial blows (or, in better times, take advantage of sudden opportunities). Review the short- and long-term risks your organization faces. For example, is it heavily reliant on a handful of funding sources that, if cut off or reduced, would jeopardize its future?
If your organization doesn’t already have a formal written reserves policy, develop one now. And, if it does, review the policy to see how it holds up in light of the past three tumultuous years.
Among other things, your policy should set the target amount to hold in a separate fund. Although no universal benchmark applies, most organizations should set aside six months of operating expenses. Your leadership’s risk appetite and your current financial position may dictate a lower or higher target. Avoid setting the target too high, though. Donors and grantmakers generally don’t favor stockpiling of funds that could otherwise be used to pursue your mission. Your policy also should establish triggers for when your organization can dip into reserves.
A plan for funding
Assuming your current reserve level falls below the target, develop a plan for getting it back on track. 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. Or use large bequests or unexpected windfalls.
Most nonprofits, however, need to include a line item for contributions to the 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. Similarly, budget surpluses aren’t necessarily available to fund reserves because they might include funds already earmarked for future expenses.
Building or replenishing operating reserves takes time and your stakeholders must understand that it’s an ongoing, long-term project. In general, it takes several years to build months of reserves, and that’s if everything goes according to plan. Make sure to partner with a trusted accounting advisor to properly document operating reserves and to maintain accurate financials. Knowing your financial situation will allow nonprofit leaders to make sound financial decisions. For information on how Cordia can help improve the efficiency of your accounting team, contact us now.