Lessons Learned from COVID-19: The Importance of Operating Reserves for Nonprofits

As we start to see COVID-19’s grip on our communities loosen, many employees are returning to work and assessing how the pandemic has impacted their organizations. For nonprofit organizations, having adequate operating reserves on hand was crucial as they continued to serve their clients and communities.

Operating reserves provide a cushion against unexpected events like COVID-19, losses of income, large unbudgeted expenses, or when funding partners become slow to pay. 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 challenges, not structural financial problems. Entities without adequate reserves are left scrambling when there is an unexpected event or cash flow crunch.

If your organization is in a position where operating reserves aren’t meeting your needs or maybe don’t have an operating reserve at all, there are initial steps you can take to start to build up your reserves:

  • Step 1: Consider a board/management strategy session to discuss importance of reserves. Strategize on what ideal goals might be, and how you might get there. Other considerations might be whether you want the funds deposited into a separate bank account, and how the money will be deposited or withdrawn in the event of need.
  • Step 2: Draft a reserve policy that is agreed upon by the board. The policy should include the purpose and use of the operating reserves, including how it will be replenished if it is needed for operating.
  • Step 3: Develop a plan to start saving. While a common goal is to get to 3-6 months of expenses, that doesn’t happen overnight. Reserves are generally built up over time by generating an unrestricted surplus and intentionally designating a portion of excess cash as a reserve fund. Some organizations include a line item in the budget to add to reserves. It might be as little as a $1000/month or could be a percent of net income.

While COVID-19 has brought this need for operating reserves to the surface, nonprofits have been dealing with this issue for many years. More than a decade ago, The Nonprofit Operating Reserves Initiative Workgroup released a whitepaper, Maintaining Nonprofit Operating Reserves, which has many important points that are relevant today for determining your ideal operating reserve level.

In addition to providing advice on how to formulate your policy and defining your operating reserve ratio, the white paper also addresses the “it depends” factor. No two organizations are identical in how operating reserve totals are determined. The white paper outlines many different factors to be considered in deciding what amount of reserves an organization will need to maintain.

Factors that indicate your organization should maintain a higher level of reserves include:

  • High risk of there being significant unpredictable demands on your resources
  • Regular day‐to‐day fluctuations in income and expenses are significant
  • There is a high likelihood that unexpected opportunities will come your way, requiring additional (available) resources to take advantage of these opportunities

Factors that indicate your organization should maintain a lower level of reserves include:

  • Your main sources of revenue are generally not subject to large unexpected negative fluctuations.
  • The governing board is generally willing to live ‘day‐to-day’ and trust that resources will be available when needed.
  • Your planning and budgeting processes have historically proved to be fairly accurate in forecasting financial results.

Just like personal savings, there is never a perfect time to put more away. However, starting small and building over time will leave the nonprofit with the long-term sustainability it needs to survive through uncertain times. At BerganKDV, we have a team who can help you assess your current situation and offer potential solutions to ensure you are positioned well to handle any unforeseen financial shortages. Start here.

CATEGORIES: COVID-19 | Nonprofit | Tax, Audit & Accounting

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