When I was managing a public radio station, I had a staff member question why at the end of the year, the organization had cash left over. Her thought was that as a nonprofit, we should spend out what we raised in a given year. I think she was hoping for more money for her department. I needed to explain that even nonprofits need cash flow. I think she was much happier when in 2009, as the economy went into recession, we could weather the storm without any layoffs until economic conditions improved. She is not the only one. I had one persistent donor tell me that “nonprofits are prohibited by law from making a “profit,” and that extra money must be put into current programs.”
That’s also not true.
In a 2011 article, The Chronicle of Philanthropy noted, “The U.S. Better Business Bureau’s Wise Giving Alliance, which assesses whether national organizations are in compliance with its Standards for Charity Accountability states charities should ‘avoid accumulating funds that could be used for current program activities.'”
My approach was to plan to end each year in the black and putting any unspent cash at the end of the year to the station’s reserve account.
You especially appreciate a strategy like this when you face a recession or even a pandemic and fundraising declines.
I’m pretty fiscally conservative, so while I have heard that a benchmark is to have three to six months in reserves, my approach was always to have at least a full year worth of cash in the bank. That means we could raise money for next year’s expenses during the current year.
I had an auditor tell me that nonprofits should not have more than three years of current operating expenses on hand. But, I can’t think of too many nonprofits with the possible exception of hospitals that come even close to that threshold.
When the subject comes up, I explain the need for reserves by suggesting that they try to do at work what they do at home. Hopefully, they have a rainy day fund in case the furnace or air conditioning unit goes out.
Nonprofit organizations need to repair and replace fixed assets. They have unexpected expenses that could not have been predicted when the budget was drafted. And, they need to have cash should an unexpected opportunity arise.
It is up to the Board of Directors to establish a financial plan for how these funds will be saved and invested. If 100% of funds are invested, they won’t be available for short term needs. The stock market can also be risky with funds that are needed in the short term. The Board needs to adopt an investment policy, so that is clear how the money is being saved.
In all the years of working with grant-making foundations, I can tell you that no one has ever questioned why we had reserves. On the other hand, I know a colleague who tells the story of being turned down because their nonprofit didn’t have sufficient cash on hand.
While some struggle with the concept of cash reserves, nonprofit leadership always appreciates forward thinking during a time of crisis.