Wake up: Is your nonprofit board prepared?

By Samuel Bertagnole

Financial accountability is one of the primary responsibilities of any nonprofit board; however, with a slow economy and the government cutting back on money for non-profit organizations, financial planning is more crucial than ever.

Wake-up call

The collapse of the 123 year Hull House should have been a wake up call to all nonprofit organizations. The Hull House, started in 1889 by Jane Addams, provided various services to thousands of people in Chicago. The “challenging economy” with increased demand and decreased support was blamed for the failure. While the economy contributed to the failure, the non-profit’s tax information suggests the organization was in trouble even before the economic downturn.

The Nonprofit Operating Reserves Initiative Workgroup believes that thousands of nonprofits are threatened with closure.

The Nonprofits Assistance Fund states that economic troubles are not limited to small organizations; larger groups are even less likely to have adequate finances.

What can your nonprofit board do to avoid financial problems? 

The Nonprofit Operating Reserve Initiative Workgroup believes that organizations with adequate operating reserves will “emerge from this current economic crisis in a stronger financial position, positioned to withstand the next challenge that arises.”

A study by the Urban Institute found that 57% of the Washington region nonprofits had too little reserve and 28% did not have any operating reserves.

What your board should know about operating reserves?

Operating reserves are unrestricted assets that can be used to support the organization during times of emergency. According to grantspace.org, reserves can be used to “stabilize a nonprofit’s finances” during times of low cash flow due to delayed payments and unexpected repairs. However, they caution against using operating reserves to replace income. “Reserves should be used to solve timing problems, not deficit problems.”

Rick Moyers wrote an excellent series of blogs describing what nonprofit boards need to know about operating reserves. One entitled What Operating Reserves Are and Why They Matter includes a great explanation of what an operating reserve is and what it is not.

With economic uncertainty regarding sources of income, operating reserves are essential to an organizations ability to function. In addition, they allow organizations to respond quickly to unanticipated opportunities.

Common myths about operating reserves

In another blog post entitled There’s No Penalty for Having Reserves, Moyers discusses two common myths that board members associate with cash reserves.

• First – Nonprofits cannot operate at a profit
• Second – Accumulating reserves makes a nonprofit appear less deserving of funds

According to Moyers, both these ideas imply that there is a penalty for building operating reserves. However, that is not the case. He points out that

• Nonprofits can legally have an operating reserve that equals less than three years of their current operating costs
• Most people would prefer to support a well-managed organization rather than one in financial crisis.
  

 

How much money is needed? It depends

There are many guidelines that suggest nonprofit boards have a minimum reserve that equals 1 month of operating expenses, but no more than 2 years of reserve. Most suggest that board members maintain between 3 and 6 months worth of operating expenses in reserve.

In an article entitled The Yin and Yang of Operating Reserves: What You Need to Know, Kate Barr suggests that board members take a closer look at these numbers. She states that “standard calculations don’t take some important variables into account, like the stability of the nonprofit’s cash receipts.” Her article contains a table that allows board members to set an operating reserve based on their specific income characteristics.

The board’s role in creating and maintaining an operating reserve

While some organizations wait until they need to use the reserve to discuss how it will be managed, the Nonprofits Assistance Fund suggests that board members create a specific reserve policy first. They state that this policy should guide staff and board members in planning and decision making.

The Nonprofit Assistance Fund recommends that an operating reserve policy should consist of the following:

• Purpose and size of reserve
• How the reserve will be built
• How the money will be used
• Who has the authority to use the reserve
• How the reserve will be replenished

Pat Hanley with the Social & Civic Institute states that such policies help boards avoid future confusion about financial reserves.

In her article, Kate Barr says that, “Without such a policy, reserve funds tend to be gradually spent down over time, and aren’t available when they’re really needed.” She also warns nonprofits that reserves should be used to help an organization provide services, and that it should not “create an untouchable bank balance to admire.”

Boards need to move their priority from financial accountability to financial planning if they wish to survive difficult economic times. Constance Woloschuk in an article entitled Commitment of Nonprofit Board to Financial Sustainability suggests that in addition to financial accountability, nonprofit board members need to integrate financial planning into their planning. She offers several suggestions to help boards make this transition.

Call to action

The Nonprofit Operating Reserves Initiative Workgroup states “If your organization doesn’t have a policy, establish one. If your organization has a policy but has not reviewed it in the last three years, pull it out and evaluate it.”