Operating Reserves and the Not-for-Profit Organization's Budget (article)
Organizations evolve. Operating environments change, and not-for-profit organizations can expect to feel a financial impact from the new tax legislation. Looking at your budget and operating reserves now can help your organization be prepared for what comes next. There are plenty of factors that weigh in on your bottom line, but the need for adequate operating reserves is a significant factor in maintaining financial stability.
How Much Should My Not-For-Profit Have in Operating Reserves?
How much a not-for-profit organization has in reserves will depend on the unique needs of the organization. In general, a good starting point is to have enough in unrestricted net assets to cover three months of annual expenses. Factors that might increase that level include day-to-day fluctuations in income and expenses, types of revenues streams (by reimbursement), the desire to take advantage of opportunities to grow the organization or the inability to forecast future revenues. Factors that might allow a smaller reserve might be a lack of unexpected fluctuations or perhaps a culture of wanting to use all of the resources available for the organization’s mission.
If it looks like the organization needs more in reserve than what it has currently or needs alternative sources of funding to be funneled into unrestricted net assets, the organization will likely need to update its reserve policy. Putting a policy in place helps make it clear why a specific level of reserves is needed and provides insight to the organization’s board and other external parties about how reserves are used.
Look for Components of Unrestricted Net Assets
Closely related to a not-for-profit’s operating reserves are its unrestricted net assets. Components of unrestricted net assets are important. Net assets attributed to investments in property and equipment do not contribute to operating reserves. Ideally, an operating reserve should be composed of cash on hand (to deal with day-to-day operations) and savings to be used for unexpected situations.
When evaluating your budget, look at past years’ net assets and how they’ve changed. If patterns indicate a trend, your organization should take a close look at its other expenses and financial ratios, such as program and fundraising efficiency. It may be that certain activities are consuming too many valuable resources and need to be reworked to keep the organization on solid financial ground.
Analyze and Adjust
Budget time is a good opportunity for a financial health check-in. If during your reviews, your organization finds any indicator that its current operating plan is not putting the organization in a strong financial position, your organization may want to enlist the help of an accounting provider to create a budgetary plan to get your organization back on track. Periodically checking in with your financial ratios can also help you monitor the progress of any changes made as part of efforts to improve your financial performance.
For more information about budgeting and financial performance monitoring, please contact us.
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