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Friday, June 15, 2012

Nonprofit Operating Reserves: Checking Your Safety Net


During the last recession many nonprofits turned to their operating reserves to keep from going under. As your nonprofit prepares for those inevitable hard times in the future, you need to be clear about which — and how many — assets you can peg as operating reserves.

Know the Boundaries
An operating reserve is the unrestricted and relatively liquid portion of your nonprofit’s net assets. Operating reserves don’t include only cash or cash equivalents, because that would make it a working capital reserve, which is created to ease routine cash flow swings. Operating reserves are for emergencies.

Endowments and temporarily restricted funds shouldn’t be viewed as operating reserves — nor should net assets tied up in illiquid fixed assets used in your operations, such as buildings and equipment.

An operating reserve is more long-term in nature. It generally spans a period of years and comes from operations that create a surplus, such as unrestricted contributions, investment income and a budget surplus.

Customize the Size
Nonprofits with diverse funding can typically maintain smaller operating reserves — say for less than three months of expenses. But for most nonprofits, three to six months of operating expense can be viewed as a “safe harbor.” This would enable the organization to continue as usual during a brief transition in operations or funding, or, in the worst-case scenario, allow for an orderly winding up of affairs.

An operating reserve of more than six months of expenses provides greater flexibility. It might give the organization, for example, funds to pursue a new program initiative that’s not fully funded.

It all Depends
How much you should keep as operating reserves depends on your organization. Generally, if your nonprofit depends heavily on only a few funders or government grants, you’d benefit from a larger reserve. Likewise, if personnel costs make up a significant part of your expenses, you should build a heftier reserve. But if these factors don’t apply, a smaller reserve would likely suffice.

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