April 2015
Not-for-Profit Reserve Levels:
How Much Is Enough?
A Formal Reserve Policy Can Help
Organizations Achieve Fiscal Sustainability
By Chris M. DuKate, CPA, and Cynthia A. Pierce, CPA
No matter their size,
mission, or location,
virtually all not-for-profit
organizations share a
common concern: how
to manage their operating
reserves. By definition,
operating reserves are a
portion of unrestricted net
assets that are available
for organizations to use in
financial emergencies to
sustain operations during
periods of unanticipated
declines in revenue or significant unbudgeted
expenditures.1 But how much of their unrestricted net
assets should not-for-profit organizations put aside
for such use – enough to sustain operations for three
months, six months, or more? The answer depends on
the policy the organization’s board has established after
reviewing a number of factors, including the timing and
stability of cash receipts, the timing of disbursements,
and the willingness, if any, to incur short-term financing
costs to bridge the gap between income and expenses.
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Crowe Horwath LLP
The Great Recession, which began in December 2007 and became the longest
and most significant economic downturn since World War II,2 put a spotlight on the
need to establish and manage reserves effectively. Many colleges and universities,
professional associations, foundations, and other not-for-profit organizations turned
to their reserves to help them get through the tumultuous economic period during
which tuition payments, memberships, contributions, and grants declined from
budgeted levels.
Now that the economy has begun to recover, there is a renewed focus on managing
reserves. Organizations that depleted their financial cushions during hard times will
want to review their reserve policies to re-establish financial sustainability, which begs
the question: Just how much is enough?
Three Definitions of Operating Reserves
To determine how much is enough for their reserve amounts, organizations first need
to determine what type of operating reserves they want to hold. In its “Operating
Reserve Policy Toolkit for Nonprofit Organizations,” the Nonprofit Operating
Reserves Initiative Workgroup3 identifies three definitions for operating reserves and
recommends establishing board-designated operating reserves, which address both
strategic long-term needs and operating reserves in the form of a rainy-day fund:
1.Board-Designated Operating Reserves
Reserves that are a percentage of available unrestricted net assets that an
organization’s governing body has earmarked for use in emergencies typically
are referred to as operating reserves. Available unrestricted net assets are the
difference between total unrestricted net assets and the equity that an organization
has in fixed assets, such as real estate and capital equipment. Board-designated
funds represent amounts that the board has designated for specific purposes,
such as debt-service reserves, master plan capital projects, or other strategic
initiatives, while board-designated operating reserves are used for contingencies
in operating budgets. Consider the following example from the toolkit:
Total Unrestricted Net Assets
$1,732,950
Less Equity in Fixed Assets
<$476,300>
Available Unrestricted Net Assets
$1,256,650
Less Board-Designated Funds for Specific Purposes
<$775,000>
Less Board-Designated Operating Reserves
<$350,000>
Undesignated Operating Funds
$131,6504
In this example, board-designated operating reserves are $350,000 or
approximately 20 percent of the total unrestricted net assets.
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Not-for-Profit Reserve Levels:
How Much Is Enough?
2.Undesignated Operating Reserves
The portion of available unrestricted net assets that the board does not designate
for other specific purposes is the undesignated operating reserves. This model,
which combines operating reserves with day-to-day operating funds, is common
among small and midsize organizations. Undesignated operating reserves are
calculated as follows:
Total Unrestricted Net Assets
$1,732,950
Less Equity in Fixed Assets
<$476,300>
Available Unrestricted Net Assets
$1,256,650
Less Board-Designated Funds for Specific Purposes
<$775,000>
Undesignated Operating Reserves
$481,6505
3.Available Operating Reserves
When determining operating
reserves, board members
need to remember that the
net book value of fixed assets,
such as real estate and
capital equipment, are not
included in the total available
unrestricted net assets.
These are the available portion of total unrestricted net assets when organizations
do not have any board-designated funds. This definition also combines operating
reserves with day-to-day operating funds. Available operating reserves can be
calculated as follows:
Total Unrestricted Net Assets
$1,732,950
Less Equity in Fixed Assets
<$476,300>
Available for Operating Reserves
$1,256,6506
The toolkit recommends that organizations use board-designated operating
reserves because they allow for clarity between operating reserves and day-today operating funds. Organizations that do not have the capacity to establish
board-designated operating reserves, or whose boards choose not to establish
board-designated operating reserves, may use one of the other methods.
When determining operating reserves, it is important for board members to
remember that the net book value of fixed assets, such as real estate and capital
equipment, are not included in the total available unrestricted net assets. So when
board members look at a balance sheet showing $1.7 million in unrestricted net
assets and $500,000 in the net book value of fixed assets, the starting point for
calculating operating reserves is $1.2 million.
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The Financial Accounting Standards Board (FASB), through its Financial Statements
of Not-for-Profit Entities project, is addressing the definition of unrestricted net assets
and certain other accounting concepts that apply to not-for-profit organizations. The
project seeks to re-examine existing standards for financial statement presentation
by not-for-profit organizations by improving net asset classification requirements
and information provided in financial statements and notes about liquidity, financial
performance, and cash flows. The FASB is expected to issue an exposure draft in the
first half of 2015 to solicit feedback on the proposed changes in financial reporting.
No Perfect Amount
Whichever definition of operating reserves they use – board-designated,
undesignated, or available – not-for-profit organizations should recognize that
there is no universally perfect amount when calculating operating reserves. Each
organization needs to determine what is appropriate based on its own pattern of
receipts and disbursements.
For example, colleges and universities
typically receive large influxes of
advance tuition payments in late
summer and early winter. These
receipts help fund operations in the
fall and spring. Similarly, social service
organizations might receive a boost
in December when individuals make
year-end donations for tax purposes,
creating a surplus of funds that
needs to be earmarked for operating
expenses the following calendar year.
Following are some important factors
not-for-profit organizations should
consider when determining how
much to keep in operating reserves:
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Not-for-Profit Reserve Levels:
How Much Is Enough?
Timing of cash receipts. Not-for-profit organizations should create a basic
financial analysis of their monthly receipts and disbursements for the past
two or three years to summarize historical trends in revenue that will facilitate
projecting future levels of revenue streams. Such an analysis will quickly reveal
where seasonal gaps between receipts and disbursements occur. It’s useful to
think of operating reserves as a range of funds rather than a specific amount. For
example, when cash receipts are at a low point in the year, the operating reserves
might drop to an amount equivalent to three months of operating expenses.
Conversely, when cash receipts climb to a high point, the operating reserves
might rise to an amount equivalent to nine months of operating expenses.
Stability of cash receipts. When assessing operating reserves, the
stability and dependability of cash receipts are important to consider. Some
organizations receive the bulk of their funds in the form of grants from
foundations, while others rely on pledges from individual donors who might
not follow through on their commitments. As a result, the former might be able
to put a smaller percentage of funds in their operating reserves and the latter
might need to put a larger percentage of funds in their operating reserves.
Timing of cash disbursements. The peaks and valleys of disbursements are
important factors to consider when assessing operating reserves. For most
not-for-profit organizations, payroll and payroll-related expenses account
for the majority of their disbursements, and those expenses are incurred
fairly steadily throughout the year. However, disbursements for utilities,
insurance, and other expenses might be less predictable. Operating reserves
will need to reflect the timing issues related to both types of expenses.
Willingness to borrow. Most not-for-profit organizations have revolving lines
of credit, but some organizations never use theirs. For those organizations,
their credit lines are for only the most dire of emergencies. Other organizations
tap their credit lines regularly, even if it means they have to pay interest on
the funds they borrow. Organizations need to consider their willingness or
reluctance to incur short-term financing costs when assessing their operating
reserves. Some lenders, as well as many bond underwriters, impose restrictive
covenants that might influence the level of required operating reserves.
Strategic direction. When not-for-profit organizations encounter hard
times, they might have to modify activities that further their mission. A food
bank, for example, might have to reduce the number of people it serves
if local government, facing lower tax revenues, cuts back on funding.
Organizations that anticipate such reductions in funding might increase
their operating reserves to mitigate negative effects on their programs.
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Crafting an Effective Reserve Policy
A formal policy can help not-for-profit organizations establish and maintain
adequate operating reserves. To develop a formal policy, not-for-profits
should take the following actions:
Determine what funds to include in operating reserves. Many organizations
have a variety of funds considered to be part of their operating reserves. In
addition to unrestricted net assets, organizations might consider including
temporarily restricted funds whose restrictions are programmatic in nature. The
reserve policy should define clearly the extent of the availability of such assets.
For example, an organization that has an endowment of permanently restricted
net assets will have earnings from those endowment assets. Those earnings will
be accounted for as temporarily restricted and eventually will be released into
unrestricted as expenditures for those programs are incurred. A discussion about
each component of net assets is appropriate for clarity and transparency.
The sophistication of an
organization’s accounting
system will determine
whether the organization
can commingle its operating
reserves and surplus funds
with other investments and still
account for them separately.
Decide when it’s appropriate to access the operating reserves. It’s not
uncommon for not-for-profit organizations that have predictable seasonal receipts
and disbursements to dip into their operating reserves three or four months out of
the year on a consistent basis. If the organization’s goal is to have nine months of
operating expenses in operating reserves, its policy might state that the desired
range is three to nine months. Management needs to monitor the reserves and
report to the board periodically, typically through the finance or audit committee.
Specify appropriate investment vehicles for reserve funds. It is appropriate
to invest operating reserve funds so that they grow and generate income
for the organization when they are not needed for operating expenses. It is
preferable for the organization’s investment policy to specify the investment
of operating reserves or surplus funds, which are typically invested in lowerrisk, short-term investment vehicles. The sophistication of an organization’s
accounting system will determine whether the organization can commingle
those funds with other investments and still account for them separately.
Revisit the reserve policy periodically. The reserve policy should be
viewed as a dynamic instrument, something that the board should review at
least every several years or more frequently if circumstances dictate. The
addition or loss of large donations or grants, for example, could trigger an
unscheduled review of the reserve policy as could a change in organizational
mission or some other unanticipated event. Policies are living documents
meant to be reviewed and updated. To be effective, organizations must
revisit their reserve policies and make adjustments as necessary.
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Not-for-Profit Reserve Levels:
How Much Is Enough?
Moving Ahead
Strategic planning activities
conducted by management and
the governing board should
address fiscal sustainability
in fulfilling the organization’s
mission. Establishing a policy to
manage net assets and related
operating reserves is essential
to guide day-to-day operational
decisions and help make
long-term strategic decisions
designed to further the
organization’s program goals.
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Contact Information
Chris DuKate is with Crowe Horwath LLP
in the Indianapolis office. He can
be reached at 317.208.2507 or
[email protected].
Cynthia Pierce is the Crowe
not-for-profit/higher education
services leader and is located
in the Chicago office. She can
be reached at 312.899.7019 or
[email protected].
1
“Operating Reserve Policy Toolkit for Nonprofit
Organizations,” The National Center for Charitable
Statistics, Center on Nonprofits and Philanthropy
at the Urban Institute, and United Way Worldwide,
Sept. 15, 2014, p. 14.
2
“Business Cycle Dating Committee, National
Bureau of Economic Research,” the National
Bureau of Economic Research, Sept. 20, 2010,
http://www.nber.org/cycles/sept2010.html
3
“Operating Reserve Policy Toolkit for Nonprofit
Organizations,” Nonprofit Operating Reserves
Initiative Workgroup sponsored by the National
Center for Charitable Statistics, Center on
Nonprofits and Philanthropy at the Urban Institute,
and United Way Worldwide, Sept. 15, 2010, first
edition, http://www.nccs2.org/wiki/images/d/df/
Operating_Reserves_Policy_Toolkit_1st_ED_201107-28.pdf
4
Ibid, p. 13.
5
Ibid, p. 14.
6
Ibid.
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legal advice. Please seek guidance specific to your organization from qualified advisers in your jurisdiction. © 2015 Crowe Horwath LLP
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