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Apr 27 2021

Nonprofit Operating Reserves: How to Plan for Emergencies

Nonprofit operating reserves is revenue set aside for future use. Planning for this ensures long-term financial heath. Where does this money come from and how can nonprofits plan for the future?

Nonprofit Operating Reserves: How to Plan for Emergencies - araize.com

Establishing nonprofit cash reserves

Nonprofit operating reserves are unrestricted cash set aside for unexpected financial emergencies. Like any business, unplanned events can cause a finance crisis. Keep in mind, reserves are not intended to solve low revenue problems. Cash reserves are for when unforeseen circumstances cause cash flow problems. A good example of this is the Covid-19 pandemic.

Operating reserves ratio

Reserves set aside money for emergencies. A good reserve goal is 3 to 6 months of expenses. A good operating reserve ratio is about 25%, which is about 3 months of the annual expense budget. Cash reserves should not be more than two years of the budget. At the very least, reserves need to cover at least one full payroll. Ideally, this task is handled by a skilled nonprofit accountant.

An operating reserves formula calculates the time it can operate before it runs out of funds. There are many operating reserve calculations. Here are three methods:

  • Percentage basis: Divide operating reserves by yearly working cost. Use the previous year’s real costs or current year’s planned costs.
  • Number of months Basis: Take the total annual expenses divided by one-twelfth. For example, if the annual expenses is $600.000, divide this by 12 which equals $50,000. This leaves a ratio of 1.5 or one and a half months.
  • Set the target: To arrive at a target of 25% or 3 months, multiply the annual expenses by 25% (.25).

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Developing a cash reserves strategy

Reserves can build up over time. Using excess cash and adding it to the reserve much like putting money in a savings account for a rainy day. Put into practice by including a line item to the budget.

The best strategy is to use your budget and raise funds for your operating reserve. Here are some suggestions:

  • Include a budget line for contributions to reserve.
  • Fund non-cash depreciation expenses with cash income.
  • Include multi-year capital budgets.
  • Build reserves into capital campaigns.
  • Include planned giving campaigns.
  • Include board contributions.
  • Factor in employee reduction savings.
  • Add windfalls such as specific grants, gifts, etc.
  • Assign a percentage of unrestricted gifts to build the reserve fund.
  • Use diversified revenue streams to add to cash reserves.

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When to access operating reserves

The important thing to know is when to access the reserve fund and when not to use it. In other words, you’re either financially savvy or guilty of poor stewardship of funds. Use cash reserves for emergencies only, not to supplement spending. Reserve funds are for temporary use and replenished once cash flow improves. Your cash flow report can help with this analysis.


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The Bottom Line

For cash reserves to work best, your board of directors need to be onboard with an agreement and policy. Includes when to use and who may allow access to funds. Put in place a procedure for annual reviews. This protects your nonprofit from the unexpected going forward.

Want to read more? Check out these insightful articles:

  • Nonprofit Accounting: Guide to Financial Statements Management
  • Functional Accounting: Guide to Classifying Expenses
  • Criteria for Hiring a Skilled Nonprofit Accountant
  • Nonprofit Accounting Course: Essential Skills Training
  • Surviving COVID-19: Nonprofit Sustainability Plan
  • Nonprofit Cash Flow Forecasts: How To Avoid Deficits
  • Investing In Nonprofit Overhead Reaps Rewards

Did you find this article useful? We welcome your thoughts and comments.

Written by Joseph Scarano · Categorized: Accounting for Nonprofits · Tagged: cash reserves, nonprofit operating costs, nonprofit reserves, operating reserves

About the Author

Joseph Scarano is the CEO of Araize, Inc., developers of cloud-based FastFund Online Nonprofit accounting, fundraising and payroll software solutions to help your nonprofit become more transparent, accountable and sustainable.

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