FinanceLeadership

How do you build nonprofit operating reserves?

By June 19, 2019 No Comments

Questions for Senior Leadership

By: Steve Zimmerman

“We want to build $100,000 in our operating reserves. How much do we set aside each month to make that happen?”

Much like in our personal lives, setting the goal for our savings account is the easy part of the process – the hard part is actually saving the money!  Nonprofit operating reserves are no different.  We hear this question often from nonprofit leaders with the goal of building the organization’s financial health by strengthening the reserve.  Unfortunately, the question lends itself to the annoying answer consultants tend to give: “it depends.”

While we can’t provide a specific dollar amount, we can put forth the questions your senior leadership team – board included – should consider to determine the best way to build operating reserves.

1. Over how long do you want to build the reserve?

Organizations often build reserves by waiting for windfall gifts – the unexpected bequest you received notification of or some other good fortune (at least for your mission) you may fall into. Unfortunately, if you’re trying to be more systematic, there is never an “easy” time to save money to build a reserve.  No matter the budget size, organizations can always find another project to spend resources on.  Building a reserve is about balancing program delivery, infrastructure development, and reserve investment.  Understanding your landscape and risk, as discussed more below, will help you determine the urgency at hand in building the reserve.  Asking this question, however, and making the timeline explicit upfront will help set expectations as you proceed.

2. What percent of your annual budget is the reserve?

This question goes hand-in-hand with the previous one.  What is your starting point and where do you want to get to?  The time required to build a reserve depends, in part, on how much of one you’re trying to grow.  Typically, organizations will try to add 10 to 15 days of reserve in a year.  The goal is to choose an amount that won’t have a large negative impact on operations and will still make a significant difference.  The key here is to recognize that if you’re trying to build a larger reserve, for example three months of operating expenses, it will be a multiple year endeavor.  Again, like a retirement savings plan, reserves can take a long time to build, but consistent, steady investment will set the organization on the path to achieving the goal.

3. Are there any big changes coming?

The sense of urgency for building nonprofit operating reserves and the associated timeline depends, in part, on the environment in which the organization is operating and how the organization currently generates revenue.  If there is a funding cliff on the horizon, the timeframe may change along with the amount you want to save in a year.  On the other hand, if the organization does not foresee any changes but is building a reserve to be prudent, then there might be more time.  Understanding the risks involved with the organization’s current revenue sources will greatly influence the timing.  Overall, building a reserve while you still have stable funding is always a good idea, kind of like building a boat before the flood.

4. Does your cash come in evenly?

We began this piece wondering how much to set aside each month.  The planner in all of us typically wants to save the same amount each month toward the goal.  However, that isn’t how nonprofit revenue is typically generated.  No matter the organization’s revenue mix, there are certain months where revenue generated is high – think December for individual donations – and certain months where cash flow may be tight.  Therefore, saving the same amount every month may unnecessarily exaggerate the cash flow tightness.  Rather, work to set quarterly or annual goals for money saved, providing your finance staff with the flexibility to manage cash flow while still securing the future.  A good cash flow projection can help with this process.

5. But how do you do it?

In the end, the only way to get a reserve is to have more unrestricted revenue at the end of a year than you have expenses.  Building a reserve doesn’t happen without intentionality and it is helpful as part of the budget discussion to determine what the reserve should be and in what timeframe the organization wants to achieve this goal.   The important implication is that it is alright and indeed encouraged for nonprofits to budget for a surplus when they are able and need to build their reserve.

 

It would be much easier if organizations could invest $4 a week in lottery tickets and then sit back and wait for the windfall! Instead, building nonprofit operating reserves requires strategic thinking and fiscal discipline.  But, constructing space to have open and honest conversations about finances, including reserves, is a first step in building financial strength.