The COVID-19 pandemic taught us several valuable lessons. For many nonprofit organizations, the most important lesson concerned the need to establish a rainy day fund to address emergency financial needs, such as when donations dry up and/or operating expenses soar through the proverbial roof. Since the pandemic has waned in intensity, most nonprofits have started to experience a return to pre-pandemic levels of donations, but the expenses side of the accounting equation has emerged as the new threat to financial solvency.
Nonprofit organizations operate on tight budgets and for 2023 and beyond, that appears to be a serious issue as rapidly increasing prices coupled with the prospect of a prolonged bout with a recession drains budgets faster than the water drains through a newly installed kitchen sink. The focus on building operating reserves to cushion financial blows such as the negative economic impacts of high inflation and a deep recession has never been more of a critically important financial goal for nonprofit organizations.
Propel Nonprofits, which is a Minneapolis nonprofit organization that helps foster the growth of financially healthy nonprofit organizations, defines how operating reserves should work.
“An operating reserve is an unrestricted fund balance set aside to stabilize a nonprofit’s finances by providing a rainy day savings account for unexpected cash flow shortages, expenses or losses. These might be caused by delayed payments, unexpected building repairs, or economic conditions. A commonly used reserve goal is 3-6 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.”
Develop a Formal Policy to Help Ride Out Financial Storms
Although building a healthy operating reserve is one of the most common financial goals nonprofits share, achieving the often-elusive goal is difficult to do. Your nonprofit organization cannot expect to increase operating reserves to cushion financial blows unless it creates a policy to accomplish this all-important financial objective.
If your nonprofit has not established a formal written policy on how to build cash reserves, the time is now to develop one to increase its financial viability. Even if your nonprofit organization has created a formal written policy to bolster its financial reserves, revisit the policy to improve the short and long-term goals of accomplishing this goal.
What Your Nonprofit’s Operating Reserve Policy Should Include
Establishing an operating reserve policy is a good start on the road to developing a strong fiscal game plan for your nonprofit organization. However, your nonprofit should follow a template for achieving the goal of building a stronger rainy day fund that addresses both donation shortfalls and substantial increases in operating expenses.
First, decide the minimum value of what your nonprofit organization should set aside at all times. Even during periods when your cash flow is healthy, your nonprofit needs to follow a guideline to maintain a minimum value for cash reserves. Second, clearly define the economic circumstances that require dipping into your nonprofit organization’s rainy day fund. Third, designate the decision-makers who determine when the time is right to access operating reserves to account for revenue decreases and/or sharp spikes in operating expenses. Fourth, include a provision in the operating reserves policy that defines the process and the timeframe for replenishing your nonprofit’s operating reserve. Finally, implement a measure that determines how your nonprofit should spend its rainy day fund.
The Bottom Line: Be Patient
Creating or enriching an operating reserve represents a sound fiscal policy that helps your nonprofit weather the worst financial crisis. However, the leaders in charge of maintaining a healthy operating reserve must be patient by understanding that saving for a rainy day is a long-term project.