Building Reserves in the Nonprofit World

By Laurence A. Pagnoni, MPA

Most nonprofit organizations live in a “hand-to-mouth” world where revenues are spent as they come in. It’s a dangerous way to live, because the inevitable interruptions in funding can cause an organization to fall into crisis. This includes job losses, disruptions in services, and enormous stress on the surviving staff.

Several years ago, a world financial crisis resulted in reduced funding for virtually every nonprofit. Not all of them survived. The ones that did typically had to cut, scrape, and beg.

Even in the best of times, maintaining a consistent revenue stream isn’t easy. The prudent way to operate is to build reserves that can provide a cushion in the times when funding is disrupted.

The best practices of nonprofit management dictate three to six months of cash reserves. In a $2 million organization, that’s $500,000 to $1 million. Do you have sufficient reserves?

Is it easy to build reserves? Of course not. Above all, it requires discipline in spending and commitments.

When you create your annual budget, build in a surplus. One way is to direct a target percentage of your budget toward reserves. For example, 5% of your budget in a $2 million organization would be $100,000 annually. Even if you fall short of your budget goals and break even, you’ll still be healthy. But if you set your budget goals at a break-even point and fall short, it may be crisis time. Budgeting for a surplus is simply saving for a rainy day, which is just good business.

Beyond the issue of building reserves, nonprofit managers must be more conscious of profit planning.

It’s quite common for nonprofit managers to ask for too little and spend too much of their revenues on direct program services. While it’s appropriate to be sensitive to the impact of overhead, both in terms of efficiency and public opinion, it is too often an afterthought.

A typical project funding plan will begin and end with consideration of the direct costs of executing the project. For example, if it will cost $25,000 to serve 200 constituents, the funding request will be for $25,000. That’s not enough. Even the most organized and efficient organization will devote more resources to more activity. Capacity will be strained and overhead costs will increase.

Ask for more, and pay more attention to being a business steward. If the organization is healthy, the mission will take care of itself. And, in the long run, you’ll be more effective.

We welcome your comments about this post on the LAPA blog.

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