Factors for Consideration when Crafting Reserve Policies for Non-Profit Organizations

Factors for Consideration when Crafting Reserve Policies

Organizational policies regarding operating reserves are crafted around many considerations. Often much weight is given to statutory requirements set by governmental rulemaking bodies, however the uniqueness of every business is a more appropriate guide to setting a suitable reserve policy. Where the operating reserve is used or replenished lies in the budget, namely the excess or deficit produced by the difference between program revenues and expenses. One rule-of-thumb in the non-profit industry is to maintain a reserve account equal to 3 months of operating expenses . This method serves as a solid guideline in beginning to form any reserve policy.

In constructing a policy, a nonprofit must first consider the nature of its own business. Of particular importance is the level of risk or variability associated with planned revenues and budgeted expenses. Businesses that are more susceptible to funding issues may wish to build a larger reserve while economic circumstances permit. The reserve must be adequate enough to allow the organization to withstand economic hurdles, but not too big that it drags on fiscal practicality. Some revenue streams like annual dues and an annual charity auction can provide reasonably estimable cash flows for an organization, while dependence on charitable donations during the holidays could very easily underfund an organization during a harsher economic climate. A plethora of factors contribute to how an organization should form, fund, and maintain its operating reserve. A survey of these factors follows:

• Cash flow timing
• Predictability of expenses
• Reliability of revenues and external financing
• The presence of opportunities
• Governmentally set policies
• Preferential accounting and tax treatment
• Implications for legal structure
• Overall economic environment

An appropriately crafted reserve policy clearly defines sources of funding for the reserve, and suitable uses for reserve funds. Also included are details regarding authorized users, guidelines for ideal funding levels, and instructions for implementation of the policy. It is common for non-profits to invest their cash operating reserves in short-term investments. This strategy retains the liquidity of the reserve while putting to use the economic value of the assets contained therein. A single size fits all approach to operating reserves, for example the 3 months of expenses rule, is a good starting point for non-profits wishing to establish or better manage their reserve. The fact remains, however, that organizations are too diverse to all comply with this rule regardless of their circumstances. As presented, numerous factors merit consideration in the crafting of a reliable and practical reserve policy, most notably the nature of the non-profit’s operations, and the present and anticipated future economic environment.


Reference #1: Operating Reserve Policy Toolkit for Nonprofit Organizations, 2010