The Importance for Nonprofits in Having Operating Reserves – Brian C

Every organization should have financial statements and an annual financial report. This is a proper measure of financial accountability. Many organizations are required to have an annual audit of their financial statements. All publicly traded companies and all governmental entities must have an annual audit. This audit provides certain assurances that the organization is managing its resources effectively. It also provides a third party view to protect the stakeholders from any significant financial malfeasance. The interesting part is there is usually little interest from the board of directors of the organization in the financial report. There are usually three very important items that the board of directors will look at: cash, net income/loss, and net assets. They want to know that the organization is liquid, that it is operating at a profit or surplus, and that there are reserves in place if they have to use them in an emergency. I found it interesting in a recent article where the Meyer Foundation conducted a study of the levels of operating reserves among nonprofits and found that sixty percent had reserves totaling less than three months’ worth of operating expenses. Twenty-eight percent of nonprofits said they had no reserves at all (Moyers). I found this interesting since research from Bart and Deal says that financial measures were the top ranked information that boards received from their staff for for-profit and nonprofit organizations (p. 8). Clearly, there were not enough conversations about operating reserves when reviewing these financial measures. As the recent economic downturn has reminded us, it is imperative that an organization have a healthy operating reserve. The important clarification is an “operating” reserve. This means the reserve funds must be liquid such as cash or investments that can be accessed quickly to assist with cash flow problems.

If almost one third of nonprofits have no operating reserves at all, there is clearly a misunderstanding from boards and executives alike as to the importance of having them. Maybe many nonprofits are simply wary of building a reserve because of the implication of being a nonprofit. If you have enough surplus money to build an operating reserve, then you are making a profit. That is a valid point, but I think a sensible argument would be to break it down to no more than a savings account analogy. All individuals have, or should have, savings accounts to assist with unexpected expenses. The for-profit and public sectors have them as well. They may go by various names, but the use is the same. Once board members and executives have been educated about the importance of an operating reserve, then they must go about building that reserve. That can be easier said than done in the nonprofit world. Many sources of funds coming from grants and other donations come with restrictions. These funds could not be used for an operating reserve. The nonprofit would need to secure unrestricted funds to be able to build an operating reserve. This will depend heavily on the operating model of the organization. Also, nonprofits must resist the urge to use any surplus funds to put back into programs. Nonprofits exist to provide services that accomplish their mission and provide a benefit to their communities. It can be difficult to set aside funds for a reserve when there are many competing needs for that funding. The recession has definitely opened some eyes that it is absolutely necessary to have these reserves. It is better to spend a little less on programs with proper planning to build a reserve than to be forced to spend less on programs based on insolvency. Nonprofits have been hit hard in this recession with reduced funding and an increased demand for services. Hopefully, a valuable lesson has been learned and nonprofits will emerge with a better understanding of what a proper operating reserve encompasses and what it will take to get there.

References

Moyers, R. (2011). Four Things Boards Should Understand About Operating Reserves.

The Chronicle of Philanthropy. Retrieved June 11, 2011, from http://www.philanthropy.com/blogs/against-the-grain/four-things-boards-should-understand-about-operating-reserves/27728.html

Bart, C. and Deal, K. (2006). The governance role of the board; in corporate strategy: a

comparison of board practices in ‘for profit’ and ‘not for profit’ organisations. Int. J. Business Governance and Ethics, Vol. 2, Nos. ½ 2006, 2-22.