Reserves: What, When, and How

This conversation took off on the forums a few weeks back, and the variety and depth of responses indicated to us that there might be a lot of learning from each other and from research to be had on this topic.

How has your organization actually used its reserves (if it has used them) in the past three years?

The Financial Commons is preparing to host an online event on October 12 to discuss reserves. What does the research say about how they may be most effectively accumulated, stored, and used, and what does that look like on the ground, even for small organizations with tight margins? Is there a more productive way to consider the building of reserves when the organization is resistant?

This conversation took off on the forums a few weeks back, and the variety and depth of responses indicated to us that there might be a lot of learning from each other and from research to be had on this topic.

The thread started with this question from Kate: “We have some cash now, more than we have in the past, and are interested in how others and using their funds. Do you have a set reserve amount? I’ve heard that 3 months or 6 months expenses is the standard best practice. Who has a good policy and approach to this?”

For context, the Financial Commons has in hand a set of seven case studies from 2020 that indicate how nonprofits of various types and sizes managed their finances during that first year of the pandemic. We saw in these stories the ways in which reserves were used in the context of other capital, and the picture was not necessarily what we expected.

In the forum discussion, participants responded to Kate with strategies that ranged from simple defense against operating environment changes…

We set ours at three months of expenses. Each year when our budget increases, we set aside an additional amount to get our reserve back up to that three-month mark. We’ve discussed moving it up to six months, but with a budget of $4M, our finance committee determined they didn’t feel comfortable having that much cash sitting around unused and not going towards our mission.

Here’s our policy:

The organization aims to hold a reserve fund equal to three months of budgeted operating expenses. The amount of the reserve fund will be calculated each year after approval of the annual budget and approved by the Board of Directors. The reserve will be funded with surplus unrestricted operating cash and will be held in cash or cash equivalent funds.

The operating reserve is intended to be held as emergency savings for the organization. In the event of a shortfall where reserve funds could be used, the following steps will be followed:

1. The Executive Director, in conjunction with the Sr. Director of Administration, will identify the need for access to reserve funds. In identifying a need, staff should consider the availability of other funds and evaluation of the time period the funds will be used and replenished.

2. The request to use reserve funds will be discussed and approved by the Finance Committee.

3. The Board of Directors will approve the use of reserve funds.

4. The organization will plan to replenish the funds within one year and will report quarterly to the board on progress with repayment.

…to more complicated capital provisions for various elements of the organization.

There are at least three reserve funds for a nonprofit where I serve on the board: one reserved for the building, another a board reserve fund, and another reserved for artistic exploration. Do we need to have three separate reserve policies, or is there one policy with subsections based on who can release the reserve or what the reserved funds are for?

But, as Michael Wyland points out, the questions of what, when, and how are sometimes complicated by the irrationality and shortsightedness of some funding sources, among other variables.

I agree with the “it depends” school of thought on reserves planning. Three months is, to me, an irreducible minimum of operating reserves. My local United Way chapter mandates a maximum of three months in reserves, and many agencies find this to be a burden because other funding sources are: 1) retrospective in nature (i.e., foundations or government reimbursing for services rendered); and 2) irregular and/or occasional (e.g., semiannual) in making payments to nonprofits.

My opinion is that 6–12 months of operating reserves is the “neighborhood” most nonprofits should be living in, depending on other circumstances — like major funder restrictions.

The conversation in this thread sparked us to go to look at any available research on how nonprofits look at and actually make use of reserves, and we found some surprising information that works to reframe the issue. This is the issue we’ll be taking up in our first event of the fall of 2022: when and how reserves are useful, and what other kinds of internal funds they may need to be paired with to make good, rational, internal sense for your organization.

Takeaways: When you find that something doesn’t quite work in ways that conform to expectations, its time to look at those expectations and the ways the system works overall. This is the case for nonprofit reserves, which many nonprofits see as an unachieved goal. But even when reserves are accumulated, do they function as we think they should? Come join us at our event on October 19 as we talk about how to think both realistically and aspirationally about the issue of nonprofit reserves — for all nonprofits.