2020 has put a dent into the reserves of many nonprofits. If your nonprofit was affected, you might have tapped into reserves to buy protective equipment or pay staffers’ salaries when your budget didn’t prove adequate. As COVID wanes and the economy improves, your nonprofit needs to strategize how it will rebuild devastated operating reserves.
Return to steady ground
It takes time to assemble an adequate operating reserve, and doing so is a continuous project. It’s nearly impossible to grow reserves when you’re under financial stress, but once your nonprofit is on steadier ground, your board of directors should determine your target amount and how to reach it. Also review the circumstances under which you can draw on reserves. Now that you’ve been through a major economic event, you can make educated changes to your operations.
Reserve funds can come from multiple places: unrestricted contributions, investment income, and planned surpluses. Some boards also designate a portion of unrestricted net assets as an operating reserve. However, funds that shouldn’t be part of an operating reserve include endowments, temporarily restricted funds, and net assets tied up in illiquid fixed assets used in operations (e.g. buildings and equipment).
Be protected and flexible
The size of your operating reserve depends on how your organization operates. If you depend heavily on only a few funders or grants, your nonprofit will benefit from a larger reserve. Likewise, if staff costs are high, your nonprofit could use a thick reserve cushion.
Typically, three months of reserves is considered a minimum accumulation, but six months of reserves provides greater security. A three-to-six-month reserve should enable your nonprofit to continue operating for a brief transition in operations or funding. In the worst-case scenario, such a reserve would allow for affairs to be wound up.
If a global event like COVID happens again, an operating reserve of more than six months would be needed. A bigger reserve can also give more financial flexibility in difficult times. For example, you’d have funds to pursue a new program initiative, or to leverage debt funding for needed facilities or equipment.
But don’t hoard your reserves
It’s generally not a good idea to put aside more than 12 months of expenses. Donors want to see your nonprofit put funds to work, not hoard them. Contact Ernst Wintter & Associates LLP for more information about operating reserves and setting the appropriate policies for your California nonprofit.