Operating Reserves with Nonprofit Policy Examples
These sample nonprofit operating reserve policies are provided to get you started, but keep in mind that no example will be an exact fit for your organization. We have included some options to assist you. Be sure to review these parts carefully to create the right policy for your organization.
A nonprofit may set aside a cash reserve to provide a cushion for planned or unplanned future needs. This resource includes considerations for reserve planning and two sample policies.
An operating reserve is an unrestricted fund balance set aside to stabilize a nonprofit’s finances by providing a cushion against unexpected events, losses of income, and large unbudgeted expenses. The most common trigger for use of operating reserves is on the income side, such as when a previously reliable source is reduced or withdrawn. Since operating reserves are most valuable if they are reliable, an important factor in using reserves is also having a realistic plan to replenish them. Operating reserves should not be used to cover a long-term or permanent income shortfall. Reserves can allow an organization to weather serious bumps in the road by buying time to implement new strategies. To be prudent, reserves should be used to solve temporary problems, not structural financial problems. In the worst case scenario, reserves can be used for an orderly shut down of the organization.
Operating reserves may be a part of the organization’s unrestricted cash or working capital. Every nonprofit needs to have sufficient cash flow coming in from various income sources and going out to pay expenses and other obligations when they are due. Some organizations create reserves by setting aside cash in addition to the regular bank fund balances for use when regular cash flow is disrupted.
Reserves are also different from restricted funds. Restricted funds are grants and contributions that have been received for specific programs or projects. These funds are “restricted” for use according to the grant agreement or donor’s instructions. Sometimes this means that restricted funds sit idle in the bank for a while and the nonprofit cannot use those funds for some other purpose.
Reserves, on the other hand, are “unrestricted” funds that can be used in any way that the nonprofit’s management and board chooses.
Where do Reserves Come From?
Occasionally, a nonprofit will receive a grant or contribution to create or add to an operating reserve fund. Usually, though, reserves are built up over time by generating an unrestricted surplus and intentionally designating a portion of the excess cash as a reserve fund. Some organizations include a line item in the budget to add to reserves.
How Much Should We Have?
While there are general guidelines for setting operating reserve goals, they should always by accompanied by “it depends.” Most standards are based on a formula to have enough unrestricted cash to cover operating expenses for a number of months. A commonly used reserve goal is three to six months’ expenses. At the high end, reserves should not exceed the amount of two years’ budget. At the low end, reserves should be enough to cover at least one full payroll including taxes. Keep in mind that generic target amounts for reserves don’t take some important variables into account, such as the stability of the nonprofit’s cash receipts.
Organizations that have contracts or fees with regular and reliable payments don’t need as much in reserves as organizations that rely on periodic grants, fundraising events or campaigns, or seasonal activities. Factor in these considerations when setting an operating reserve target. The goal for operating reserves will change, too, when income or expenses become less reliable or predictable because of internal or external changes.
Why Policies Matter
To be a viable operating reserve, there should be a board agreement and policy about the purpose and use of operating reserves. The purpose of the policy is to define and set goals for reserve funds, clearly describe authorization for use of reserves, and outline requirements for reporting and monitoring. Without a policy and procedure, reserve funds tend to be gradually spent down over time and then are not available the next time the funds are really needed. When developing the policy, be sure to allow for some flexibility and ease of access. Reserves are there to help the organization operate programs and services, not to create an untouchable bank balance to admire. Two examples of policies are included at the end of this article.
Other Kinds of Reserves
This discussion has been focused on operating reserves designated to manage cash flow or short-term cash shortfalls and unexpected expenses. There are other kinds of reserve funds that can be established to build up cash balances for specific purposes such as building repair and replacement reserves, program reserves to support program continuation if income is uncertain, and opportunity reserves to allow the nonprofit to provide seed funding for a new idea or innovation. Each type of reserve needs the same kind of planning and policy as described for operating reserves.
Developing an Operating Reserve Policy
Developing and adopting a written policy regarding a nonprofit’s operating reserves is a valuable practice for any organization. The policy may be contained within the financial policies or may stand alone. Having a written and approved policy on operating reserves will help to ensure that the board of directors and staff leadership use consistent definitions and calculations and that the authority and operational guidelines for using funds in reserve are clear to all. In the absence of an adopted policy, staff and board members may have different assumptions that may or not be accurate or productive. If the idea of creating an operating reserve policy seems daunting, this basic example and guideline for policy development can be helpful.
Five Essentials for Policies
The intent of the operating reserve policy is to describe and document the purpose, goals, and mechanics for maintaining and using operating reserve funds. In order to accomplish this, the operating reserve policy needs to address five areas:
- Purpose of building and maintaining reserves
- Definitions of the types of reserves, intended use, and calculation of target amounts
- Assignment of authority for making use of each type of reserve fund, which may include delegation of some authority to staff leaders
- Responsibilities for reporting reserve fund amounts and use of reserve funds
- Any specific policies, if needed, about investment of reserve funds
Developing and Approving a Policy
This article includes two examples of reserve policies. The first is for operating reserves only and will be useful for nonprofits with a single cash reserve that is primarily used for occasional unexpected shortfalls. The second policy example expands to include other types of reserves, such as building reserves. This example requires more discussion and customization for the nonprofit’s particular situation and plans. Both of the example policies include a variety of components that may or may not fit the needs of any individual nonprofit organization. These examples are a starting point intended to help you address the essential questions and decisions. Some nonprofits develop more comprehensive and detailed policies that incorporate more specific responsibilities and add much more detail. The most important action is to create and adopt a policy that meets your organization’s needs.
Considerations When You Start with a Policy Template
We offer these example reserve policies to get you started, but keep in mind that no example will be an exact fit for your organization. Never adopt a policy without a thorough review and consideration of the risks, operations, and structure of the organization. In the example policies included here, some areas require customization. Bold, bracketed text should be customized to meet your needs. We have included some options to assist you. Be sure to review these parts carefully to create the right policy for your organization.
Download the full resources on the right for two sample reserves policies, one for operating reserves and another for multiple reserves.
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