How Much Should a Nonprofit Have in Reserves?

Should a nonprofit have a reserve?

That’s the question I get asked the most. More often than any other question, I hear, “Should a nonprofit have cash reserves?”  Well, the short answer to this question is… “Yes!” A good rule of thumb is to set aside at least two months of operating expenses. That number comes from a ratio within the nonprofit industry known as “days cash on hand”. The most common industry recommendation is 60 days of cash on hand, which is also what I recommend to my clients. 

Exceptions to the Two Month Rule

As with any rule, there are, of course, some exceptions. There are some specific situations in which you’ll want to grow your reserves to more than two months of operating expenses. Here a just a few examples to get you thinking about what’s best in your own situation: 

•  Concentrated Funding-  This applies to your organization if you have a particular concentration in your funding sources. In this case, a certain individual may provide the funding for a significant portion of your programs or operations. For instance, let’s say your total budget is $120,000 but you have one donor who contributes a third or a fourth of your entire budget. Well, that's a pretty large concentration of risk in one particular relationship. In this case, I’d recommend increasing your reserves by the percentage of that particular donor’s contribution as it relates to your overall budget. So if that one person represents 25% of your budget, then you would want an additional 25% of your budget in operating reserves. 
•  Grant Funding- Another example would be if you receive grant funding that typically has a lag associated with it or there's potential for a timing issue. Do you have a fee for service arrangement with a grant source where you provide services and then you bill in arrears for those services? If so, you can often be found waiting two, three, or even six months to get that reimbursement. A situation like this could really affect your cash flow, in which case, I’d recommend that you increase your cash reserves  to align with any potential delays in collecting those revenues.
•  Capital Campaigns- Finally, if you're raising capital, getting ready to do a building project, or you’re currently building, keep in mind that these situations are extremely delicate times for a nonprofit. Just know, there is a lot of disequilibrium that can happen in the finances during those times. So before going into such an unpredictable season, it's really important to be prepared. I would say doubling your reserves is a good place to start. If you typically keep two months of cash on hand, then increase that amount to four months of expenses. There are even some circumstances that actually warrant strengthening your position further by  tripling your typical cash on hand. For example, if your building project is being funded largely by donor pledges  (future contributions that are expected but not guaranteed) it may be wise to keep six months of cash on hand.

What if your nonprofit doesn’t have any cash reserves? 

 OK. So if you're reading this and you're thinking, “2, 4, 6- What if I have zero?” Take a breath. Yes, what’s true about planting trees is also true here as well- the best time to start was 20 years ago, but the second best time to start is today. My advice to you is to just get started! The most practical way to reach any savings goal is to make it a part of your budget. Let's just say that you want to budget to set aside one month’s expenses. If your annual budget is $120,000, then you’d budget to put away $10,000 this year. So you'd want to  operate your ministry on 90% and the other 10% would fall to the bottom line and be tucked away as reserves, which usually leads to another question… 

How do nonprofits account for their cash reserves? 

 When we talk about reserves, most people are thinking about the actual physical cash. They focus on putting this money in a separate bank account or separating it in a way that indicates its purpose  as emergency reserves in the nonprofit’s assets, or cash side of the balance sheet. That's valuable and important because those funds are long term and you may be able to invest them and get a return on your money, but it also needs to be reflected in the net asset section of your balance sheet. (In nonprofits this is called a Statement of Financial Position.) This  is because your net asset section of your financials conveys very important info and you want these reserves to show up in your net assets as designated for “cash reserves” or “emergency funds”. You can pick the term that your board would recognize. You should also have a conversation with the board about the  “why” behind the reserve policy. Having a clear discussion about why you need to set aside cash will help bring clarity to your financial statements and explain why you are choosing to accumulate cash and what it's for. If you’d like to learn more about net assets and how they relate to your nonprofit, I’ve written another blog specifically about that here.