Board members come to the board table with a variety of perceptions about reserves. Some are directly contradictory, and likely not best practices.
Here are some common misconceptions:
- We are nonprofit and are required by law not to have any reserves.
- We need to focus on continuing to grow our reserves. There is no such thing as too much in reserves.
- We should keep all our reserves in the bank in a checking account because that is guaranteed by FDIC. The stock market is too risky.
- Reserves should just be used for a rainy day.
- It is OK to spend down reserves if you need the money to operate.
- It is too risky to use reserves to take advantage of new opportunities.
None of the above are good practices. Here’s why.
Nonprofits are required by law not to have any reserves.
This is a common misconception and one that is tightly held. Part of being a good fiduciary means ensuring that the organization has the funds that it needs to fulfill the mission if anything goes wrong, and the organization runs out of money, then it will close. That is irresponsible for board leadership.
We need to focus on continuing to grow our reserves. There is no such thing as too much in reserves.
It is possible for an organization to fail to serve its mission or does not take important proactive measures to benefit the membership and trade for growing the reserves. Most experts say that organizations need between six months and a year of operating funds.
We should keep all our reserves in the bank in a checking account because that is guaranteed by FDIC. The stock market is too risky.
The interest return is almost nonexistent on FDIC insured money market accounts. It is possible to work with an investment advisor and come up with a very conservative and diversified strategy that will ensure the safety of the reserves.
Reserves should just be used for a rainy day.
Well, it is important to have reserves for a rainy day. It’s also important to use them strategically to grow and support the organization. A one time expense for reserves is a reasonable thing to do. Another reasonable thing to do is to use the interest from the reserves in the following year, but it is important to remember that there could be a year where there are losses. In that case, the board will need to decide if it wants to continue to draw down reserves or could curtail some aspect of operations.
It is OK to spend down reserve funds if you need the money to operate.
In general, this is a bad idea. While it makes sense to take funds from reserves for a one-time opportunity or to solve a problem, this makes no sense over the long haul.
It is too risky to use reserves to take advantage of new opportunities.
It is true that not every opportunity pans out. There are times, however, when taking advantage of opportunities is crucial. Do not allocate for new projects without a solid plan that has been reviewed and approved by the board.
Sometimes an organization is dependent on one source of revenue. If that one source dries up there will be severe consequences for the organization. In those situations, the need for reserves may be exponentially higher as the organization may have to live off the returns from their investments.
It is tricky to figure out just how much money should be left in the checking account to cover cash flow versus in the reserve account. Some organizations have essentially steady monthly income, while others see huge variations over the course of a year. When determining how much money to put into reserves, it is important to look at the cash flow patterns. This is particularly true if you’re using CDs. If much of the money comes in early in the year, there is a temptation to put much of it into an investment account. If you do that, you may well find that you are out of cash. A request to release funds from reserves can then raise an unnecessary red flag for the board. It is best to calculate to have enough cash to cover the full year cycle. Some groups opt to have CDs for short-term investments. Others go with high yield savings accounts to allow quicker transfers (These are hard to find for nonprofits.)
Most nonprofits work with the service financial planners, fiduciaries, to manage their accounts. The service includes making investments in accordance with the organization’s investment policy, ensuring you are nonprofit, gets reports on a regular basis and meets with the board once or twice a year to review the investments.
Nonprofits with smaller amounts of money (less than $250k) to invest may find CDs are a good option. There are also companies that specialize in accounts that are managed electronically.
Sidebar
Any organization with a significant amount of money to invest should have an investment policy. There are plenty of samples out there and often your investment firm will have some recommendations. Most nonprofits lean towards being fiscally conservative, but they try to balance that with a decent return on investment.
