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The Importance of Non-Profit Operating Reserves: A Roadmap for Financial Sustainability

Published on by Rachael Cruse in Not-for-Profit

The Importance of Non-Profit Operating Reserves: A Roadmap for Financial Sustainability

For many non-profit organizations, financial efficiency often plays a secondary role to fulfilling the mission of the organization. However, financial sustainability is a crucial element that determines long-term success. While grants and fundraising play a significant role in garnering resources, comprehensive financial management, particularly the development and management of operating reserves, is equally critical. So, let’s shed light on the importance of operating reserves and provide a strategic guide for non-profit leaders to build and manage these funds effectively.

What are operating reserves?

When non-profits have operating reserves, they are often referred to as a “rainy-day fund,” or unrestricted funds that are set aside from the organization’s regular financial operations. These funds serve as a financial safety net, enabling the organization to continue its operations during unexpected financial challenges. These could include a sudden drop in income or unanticipated expenses.

Establishing and managing operating reserves isn’t a ‘set it and forget it’ task; it requires strategic planning and regular review by the board, organization leadership, and a trusted financial advisor. Nor is the amount to be set aside for operating reserves a one-size-fits-all solution. While it is generally recommended that non-profits aim to have sufficient reserves to cover 6-12 months of operating expenses, the actual amount should be carefully assessed based on the organization’s unique financial situation.

Operating reserves versus restricted funds and endowments

Non-profit organizations should also understand the difference between operating reserves and other funds like endowments or restricted funds. While operating reserves are unrestricted funds, endowments are typically subject to stringent restrictions regarding their use and are intended for long-term financial stability. Conversely, restricted funds are subject to rules about their use, set either by the organization itself or as a condition of a donation.

The types of reserve funds should be carefully chosen based on the organization’s specific needs. Operational reserves aim to cover daily operational costs in case of a financial shortfall, while capital reserves are meant for capital needs of non-profits with physical assets, such as buildings or vehicles. Alternatively, project reserves may be required if the organization is preparing for a significant future project.

Strategies for operating reserves

Storing reserve funds in traditional bank accounts can limit their growth potential and put them at risk. Therefore, non-profits should aim to store their reserves in FDIC-Insured accounts, ensuring government protection should the bank fail. Placing reserves in a brokerage account with a sweep program can also be beneficial, as it allows non-profits to access more FDIC coverage, make low-risk investments, and accept stock donations.

Creating a clear reserves fund policy is vital for effective management of these funds. The policy should outline how much money will be set aside, the circumstances that warrant using the reserves, limitations on fund usage, and the process for replenishing the reserves. Thus, it provides a solid framework for the fiscal governance of the organization.

Non-profits also need to calculate their operating reserve ratio, which is a key measure of financial stability. It can be calculated on a percentage basis (total operating reserves divided by annual operating expenses), or a number-of-months basis (total operating reserves divided by 1/12 of annual operating expenses). Several factors, such as cash flow cycles, revenue volatility, spending flexibility, and the organization’s life cycle stage, can impact the appropriate operating reserve ratio.

Lastly, budgeting and raising funds for reserves is an ongoing process. Including a “contribution to reserve” line item in the budget, designating board contributions, and including reserves in multi-year capital budgets or capital campaigns are some strategies that can be employed to build the reserve fund.

Bringing it all together

The establishment and management of non-profit operating reserves are integral to the forward-thinking financial stewardship of any non-profit organization. These funds not only enhance an organization’s financial resiliency but also fortify their financial position, contributing to their long-term success and ability to serve their communities effectively. A well-planned, regular review, and effective management strategy can help non-profits build healthy reserves, ensuring they are always prepared for the unexpected. Contact one of our dedicated non-profit accounting pros to see where you could start building your operating reserves, or to talk about what you could be doing with your existing reserves.

More resources for non-profits

If you want to learn more, check out these posts on the sweeping revisions to OMB’s federal financial assistance guidancewhen non-profits should consider fractional resources, or explore our Thrive video series, now available on-demand.

Do you have other questions or challenges facing your organization? Contact one of our non-profit pros for a free consultation. We’re here to help.


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