Just like it’s a smart idea to have a personal “rainy day” fund just in case of an emergency home repair, surgery, or other unexpected large costs, the same goes for a nonprofit organization. Even nonprofits with solid income streams can be hit with unanticipated events, income, and unbudgeted expenses. In these situations, it’s vital to have that financial cushion in the form of operating reserves so the organization doesn’t suffer long-term, negative consequences from temporary dilemmas. Concurrently, it’s essential to have the board adopt and adhere to a policy outlining the details of the reserve.
A common scenario where operating reserves may be prompted can be when a source of a reliable income is withdrawn or reduced without expectation.
Important Elements of an Operating Reserve Policy
Every organization’s policy is going to look different, but there are a few general areas that should be addressed.
- Purpose– Why is it important for the organization to build and maintain reserves?
- Definitions- How are the types of reserves, calculation of targeted amounts, and intended use defined?
- How the reserve is funded– An operating reserve is only as valuable as its reliability. The policy should set out a practical plan for replenishment to the targeted amounts. Often, a worthy reserve goal is about three to six months of expenses. At the very least, on the low end, reserves should cover one full round of payroll.
- When the reserve can be used– The plan should layout when the reserves can be tapped when unexpected shortfalls hit. The reserves should not be used to address foundational finance issues. In a “last straw” scenario, operating reserves can be used to close down the organization.
- Classify the operating reserve as unrestricted– Unlike restricted funds that are marked for specific programs and projects, the operating reserve should be set as unrestricted so that the board and management can employ as they choose when the crisis calls for it.
That’s Not All
Because each nonprofit is unique, each nonprofit is going to need policies and procedures tailored to their specific operations. That said, generally, there are at least 10 policies most nonprofits need to be prepared to address on the annual information filing, Form 990. Check out my free guide to nonprofit policies and procedures.
Additionally, keep in mind that an operating reserves policy should be written to correspond with any other financial-specific policies, like an investment policy.
Want to discuss your nonprofit’s policy needs? Don’t hesitate to contact me at 515-371-6077 or firstname.lastname@example.org. I’m based in Cedar Rapids, Iowa but will travel to meet with nonprofit pros all across the state.