Even the best-laid plans can go awry. A major grant your organization counted on could fall through. Or your facilities might require emergency repairs. And, as many nonprofits have learned in recent years, even slightly lower-than-anticipated donations can make meeting obligations difficult. Cash reserves can help cushion the blow of unbudgeted expenses. They may also enable your nonprofit to seize growth opportunities.
Your Target Number
The ideal reserve depends on an organization’s unique qualities, including its operating structure, sources of funding and types of expenses. But most experts agree that a minimum of three months’ cash can help mitigate the risk of budget shortfalls and unexpected events.
Some nonprofits need greater reserves — say six months’ or one year’s worth — and some may be safe with less. Generally speaking, the more predictable and steady your nonprofit’s cash flow, the less you need to stash in reserves. To determine the optimal amount, however, talk to your financial advisor.
Unrestricted Is Best
Reserves must be easily accessible and unrestricted if they’re to be effective in emergencies. Program-specific donations and grants aren’t much help when you need to pay your office rent or make payroll. To increase unrestricted revenue, educate donors about the inflexibility of such gifts. Although some will insist on targeting their dollars, many are likely to respond when you explain that unrestricted donations can be more valuable to your nonprofit than those with strings attached.
For their part, foundation and government grantmakers traditionally have been reluctant to give unrestricted funds to charities. But according to several recent studies, many are increasing the proportion of grant money available for general operating support. So consider asking grant providers if they can relax restrictions on funds they’re currently providing, and start looking for grants with looser restrictions.
Accessibility is just as important when you’re deciding where to store operating reserves. Avoid investments that might restrict or penalize withdrawal of funds on short notice, such as equity investments or certificates of deposit. Instead, look for the highest interest-earning checking, savings or money-market account, or possibly Treasury bills or short-term bond funds.
One difficult aspect of managing reserves is knowing when you need to tap them. Using cash to address operational shortfalls, or when expenses exceed income, is usually justified. Even if your nonprofit runs efficiently and typically sticks to its budget, unplanned events, such as natural disasters or economic crises, can throw a wrench in the works. But take care that such withdrawals don’t become routine. If you’re dipping into reserve funds every month to pay ordinary expenses, it’s time to reevaluate your budget.
Reserves aren’t just a rainy day fund, though. Many organizations use them to seize opportunities, expand programs and services, and even improve access to credit. Prudence is essential when using reserves proactively. Your board should draw up a policy that defines reasonable uses of reserves and outlines the evaluation and approval process for specific proposals.
Too Much Is Risky
While keeping an adequate amount of operating reserves is critical, it’s also important not to retain too much cash. Money market and other easily accessible accounts typically earn minimal interest. You can almost certainly better “invest” reserves elsewhere — for example, earning returns for your long-term endowment or helping to expand services.
What’s more, charity watchdog groups take a dim view of what they consider excessive reserves, which can negatively affect how they rate your nonprofit, and, in turn, how the public perceives its effectiveness. Of course, what constitutes “excessive” depends on the organization. But several years’ worth of expenses certainly merits scrutiny.
If your nonprofit has been running lean for several years, it’s time to start fattening up your cash cushion. As the economy improves and donors increase their support, make building your operating reserves a priority. Contact MFA's Nonprofit Team to learn more.