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How Much Should My Nonprofit Have in its Operating Reserve?

October 13, 2022

An operating reserve provides a cushion against large unbudgeted expenses, loss of income and unexpected events. Does your nonprofit organization have a big enough reserve? Find out here.

Does your nonprofit have an operating reserve? Wondering if your operating reserve is enough to cover unexpected cash shortages?

What is an operating reserve?

An operating reserve is like an internal line of credit or “rainy day fund”. The reserve is a balance without restrictions set aside to provide a cushion against large unbudgeted expenses, losses of income and unexpected events. The practice of setting aside funds for an operating reserve strengthens an organization financial and liquidity position.

When is the operating reserve used?

The operating reserve is established by a board vote which includes a formal policy or plan to establish, maintain, utilize and replenish the reserve, utilizing it and replenishing it.

Typically, the reserve is only used as a short-term solution and not used to cover long-term income deficits. The operating reserve allows a nonprofit to absorb the costs of unexpected obstacles to allow the organization to continue fulfilling the mission with less worries about their financial health. Chronic cash shortages can distract an organization from long-term goals and new opportunities.

Given operating reserves are funds without donor restrictions, they can be used based on how management and the board vote. This differs from donor restricted funds, which are grants or contributions that have been restricted for a specific purpose designated by a grantor or donor.

Where do Reserve Funds Come From?

From time to time, a nonprofit may receive a contribution for the purpose of establishing and adding to an operating fund. In most cases, reserves are developed over time by generating an unrestricted surplus and intentionally moving a portion of that cash into a reserve fund. You can see why it is critical to have a formal policy for the operating reserve fund which will dictate how to build and maintain the reserve over time.

How much should my nonprofit have in its operating reserve?

An ideal reserve goal is six months or more of annual operating expenses, but most organizations establish a reserve starting at 25% or three months of annual operating expenses.

However, it is important to take the knowledge and experience of the organization into account. Variables will differ from one organization to the next so understanding your organization’s cash needs will assist in refining the reserve total.

Picture this: One organization has reliable contracts and consistent receipt of payments as opposed to another organization that relies on fundraising events, campaigns, or a limited donor base. The latter may need to have more than the general three months of annual operating expenses to be prepared for more frequent cash shortages.

The reserve and the policy established should be reviewed at least annually. Given economic conditions change overtime, so might the specific needs of the reserve. Management and the board should schedule an annual review of the operating reserve during the budgeting process to set the organization up for success.

Questions on your operating reserve? We are here to help.

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