Generally speaking, operating reserves are your organization’s “rainy day fund.” Why are they important?
For starters, an organization’s rainy day fund is there to protect against the unexpected. Those of us who have worked in or with the nonprofit industry for a long enough time know not to take anything for granted. Regular contribution sources can dry up or disappear with little to no lead time, and short-term reputation damages can scare away funders and take years to rebuild confidence. These situations can be devastating to operations, which is why it’s important to have reserves to keep the organization afloat.
The other benefit of reserves is that they allow for flexibility and opportunity. Having the ability to invest in a new program, event, partnership or service can sometimes be the difference-maker in diversifying revenue sources and expanding the footprint of your organization.
With the adoption of ASU 2016-14, the new nonprofit reporting standards, potential donors will be even more informed about how nonprofits manage their resources and liquidity to meet cash needs. Those organizations that have been able to build strong cash positions will be able to stand out from other nonprofits by emphasizing their track record of strong management and effective use of resources. Therefore, now is as good a time as any to start putting your organization’s operating reserves front and center or revisiting your current policies.
Adoption of an operating reserve policy is an excellent starting point. An organization’s board should be responsible for adopting the policy. The policy should address:
- the purpose of the reserves
- a calculation of the target amount (for example, one year of operating expenses)
- the intended use of the reserves
- who has authority over the reserves and who monitors the use of the reserves
- a plan for replenishing the reserve balance
Finally, it is not required that the reserves be set aside in a separate bank account; however, if a short-term intended use has not been determined, it may be wise to explore potential investment vehicles for those funds to maximize their impact for the organization.