When best-laid plans go awry: Prepare with reserves

By Lauren Kreutzinger, supervisor, VonLehman

In any business, in any organization, even the best-laid plans can go awry.

In the nonprofit sector, this can lead to disaster.

But that doesn’t have to be the case — if you’re prepared. For example, a major grant your organization counted on could fall through. Or your facilities might require emergency repairs. And, as many nonprofits have learned in recent years, even slightly lower-than-anticipated donations can make meeting obligations difficult.

Cash reserves can help cushion the blow of unbudgeted expenses. They may also enable your nonprofit to seize growth opportunities.

Your target number

The ideal reserve depends on an organization’s unique qualities, including its operating structure, sources of funding and types of expenses. But most experts agree that a minimum of three months’ cash can help mitigate the risk of budget shortfalls and unexpected events. But some nonprofits need greater reserves and some may be safe with less.

Generally speaking, the more predictable and steady your nonprofit’s cash flow, the less you need to stash in reserves. To determine the optimal amount, however, talk to your financial advisor.

Unrestricted is best

Reserves must be easily accessible and unrestricted, if they’re to be effective in emergencies. Program-specific donations and grants aren’t much help when you need to pay your office rent or make payroll. To increase unrestricted revenue, educate donors about the inflexibility of such gifts. Although some will insist on targeting their dollars, many are likely to respond when you explain that unrestricted donations can be more valuable to your nonprofit than those with strings attached.

For their part, foundation and government grantmakers traditionally have been reluctant to give unrestricted funds to charities. But according to several recent studies, many are increasing the proportion of grant money available for general operating support. So consider asking grant providers if they can relax restrictions on funds they’re currently providing, and start looking for grants with looser restrictions.

Accessibility is just as important when you’re deciding where to store operating reserves. Avoid investments that might restrict or penalize withdrawal of funds on short notice, such as equity investments or certificates of deposit. Instead, look for the highest interest-earning checking, savings or money-market account, or possibly Treasury bills or short-term bond funds.

Justifying withdrawals

One difficult aspect of managing reserves is to know when to tap them. Using cash to address operational shortfalls or when expenses exceed income is usually justified.

Even if your nonprofit runs efficiently and typically sticks to its budget, unplanned events, such as natural disasters or economic crises, can throw a wrench in the plan. But be careful that such withdrawals don’t become routine. If you’re dipping into reserve funds every month to pay ordinary expenses, it’s time to reevaluate your budget.

Reserves aren’t just a rainy-day fund, though. Many organizations use them to seize opportunities, expand programs and services, and even improve access to credit. Prudence is essential when using reserves proactively. Your board should draw up a policy that defines reasonable uses of reserves and outlines the evaluation and approval process for specific proposals.

Too much is risky

While keeping an adequate amount of operating reserves is critical, it’s also important not to retain too much cash. Money market and other easily accessible accounts typically earn minimal interest. You can almost certainly better “invest” reserves elsewhere — for example, earning returns for your long-term endowment or helping to expand services.

What’s more, charity watchdog groups take a dim view of what they consider excessive reserves, which can negatively affect how they rate your nonprofit, and in turn, how the public perceives its effectiveness. Of course, what constitutes “excessive” depends on the organization. But several years’ worth of expenses certainly merits scrutiny.

A priority

If your nonprofit has been running lean for several years, it’s time to start fattening up your cash cushion. As the economy improves and donors increase their support, make building your operating reserves a priority.

Lauren_Graham_revLauren Kreutzinger is a supervisor at VonLehman CPA and advisory firm in Indianapolis.  Lauren focuses on audit and accounting services for nonprofit and manufacturing and distribution organizations.


For more information on this topic or many other tax, business and investment topics, contact your CPA, Business Advisor, or Lauren Graham of VonLehman at lgraham@vlcpa.com.

About VonLehman

Founded in 1946 and with offices in Kentucky, Ohio and Indiana, VonLehman is a leading full-service CPA and business advisory firm. VonLehman provides forward-thinking accounting, tax and strategic business advice to closely-held businesses, nonprofits and governmental entities throughout the Kentucky, Ohio and Indiana region. VonLehman provides clients with the depth of services and resources expected from larger national firms, but with an unmatched measure of personal care and attention. See http://www.vlcpa.com for more information.

DISCLAIMER: The technical information in this article is necessarily brief. No final conclusion on these topics should be drawn without further review and consultation. Please be advised that, based on current IRS rules and standards, the advice contained herein is not intended to be used, nor can it be used, for the avoidance of any tax penalty assessed by the IRS.

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