Managing an organization’s money in a fiscally responsible way is a challenging duty for nonprofit boards. How much should you spend? How much should you invest? How much should you hold on reserve for operating expenses and emergencies?
Novice board members sometimes buy into the fallacy that because nonprofit organizations exist for charitable causes, they have to deplete their bank accounts by the end of the year and show a zero balance before filing IRS Form 990.
That’s not the way it works. In fact, the federal government and nonprofit advocacy organizations encourage nonprofits to carry a continual reserve in the interest of financial security and sustainability. The question still remains, “How much reserve is enough?”
We’re providing a brief overview of how much to keep in reserve and how to build a reserve for your nonprofit.
How the Government Views Nonprofit Surplus Funds
The federal government gives nonprofits a significant tax break for the good work they do in serving the general public. That said, nonprofits have accountability to the federal government and their stakeholders for spending and managing their finances. It’s mandatory for nonprofits to use funds in accordance with their mission. Beyond that, nonprofits can spend and reserve funds as they choose.
While private foundations are also classified as nonprofit organizations, the rules that mandate them are a bit different than those for other types of nonprofits. They don’t have as much flexibility when it comes to holding a financial reserve.
The National Council of Nonprofits encourages nonprofits to set aside some amount of “rainy day” money for the purpose of ensuring longevity and sustainability. A 2018 report shows that nonprofits are largely falling short of having sufficient reserves as indicated by these stats:
- Fewer than 25% of nonprofits carry over 6 months of cash in reserve.
- Nearly 10% of nonprofits have less than 3 months of operating reserves on hand.
Overall, the federal government, the National Council of Nonprofits, and other advocacy organizations agree that if nonprofits were to spend all of their funds by the end of the year, they’d have no funds to continue operating in the coming year. Also, they’d lack the funds to survive a major catastrophe. With that settled, let’s look at how much money nonprofits should ideally reserve.
How Much Money Should Nonprofits Reserve?
In the best-case scenario, your nonprofit will have some amount of financial surplus at the end of every year that can be used to develop programs and activities in the coming year. Because nonprofits don’t have to pay income taxes (with the exception of unrelated business income, or UBI), nonprofits get to keep more of their income than for-profit corporations.
The best way to think of reserve funds is to consider redirecting the savings from income taxes into a savings account or investing them in financial products that help your money grow.
As a general rule of thumb, nonprofits should set aside at least 3-6 months of operating costs and keep the funds in reserve. Ideally, nonprofits should have up to 2 years’ worth of operating expenses in the bank. For many nonprofits, that’s just not practical. Nevertheless, it’s a goal that’s worth striving for.
What if your nonprofit experiences a deficit at the end of the year? Boards should consider this a red flag and take appropriate steps to ensure that it doesn’t become a recurring problem. Deficits can easily send stakeholders into a panic. What’s more, donors will hesitate to support a struggling nonprofit which will only make the problem worse. Also, you run the risk of draining the morale and enthusiasm of your board, staff, and volunteers.
You don’t want to put your board in the position of having to make tough decisions like laying off staff or cutting programs. One way to tackle the problem is by pulling monthly financial reports together and analyzing which months have deficits, and why they occurred. Can you reduce or eliminate expenses during months that show a deficit? Another step you can take is to step up your fundraising efforts. Create a fundraising plan that includes hosting events, gaining supporters, and applying for grants. Do what you need to do to get the organization back on track.
How to Build a Reserve for Your Nonprofit
Nonprofit board members may have different ideas about how to build a reserve and what it should be allocated for. It’s best to get the issue out on the table for discussion. Put it on your board’s agenda and consider the following questions:
- What is the purpose of the reserve funds?
- Who will have access to reserve funds?
- If there’s a need to tap into reserve funds, will it require a board vote, and what are the parameters for voting?
- What is the plan to replenish funds that have been taken out of the reserve funds?
With these and other questions answered, your board can get down to the work of drafting rules for how to handle your reserve.
Typically, nonprofit boards agree to use reserve funds for two purposes:
- To establish new programs and activities.
- To save money to be used in times of crisis or catastrophe.
Nonprofit boards that tap into their reserve funds to cover payroll expenses over the long term are likely to struggle with sustainability.
Tips for Managing Nonprofit Funds
Just as a responsible person would manage a corporate or personal budget, nonprofit boards need to take a proactive stance on money management. Here are some specific ways to manage and monitor your nonprofit’s funds:
- Bank at a credit union. They’re nonprofits too, and you’ll get lower rates, lower fees, and higher savings.
- Actively monitor your balance sheet and scrutinize it before making financial decisions.
- Invest reserve funds in a money market account or another investment vehicle to gain interest and grow funds.
- Reinvest some amount of excess funds developing programs and activities or paying down debts.
Your financial statements reflect the financial health of your nonprofit. They provide a snapshot of your assets, liabilities, net assets, and liquidity. Your board will have more flexibility in leading your nonprofit when you can show adequate reserves.
Whether you have strong reserves or no reserves, a BoardEffect board management portal is the perfect system for making your reserve plan. It’s a secure platform where your board can do committee work online or in person. With unlimited cloud storage, your financial reports are easily accessible by all board members whenever they need them.