Cash reserves are key for nonprofit survival. They are essential for assessing and ensuring the long-term sustainability of a nonprofit. The Board is responsible for agreeing a reserve amount and including it in the financial policies. Tracking where the organization is in relation to the funds can literally mean the difference between catching financial crisis before it is too late and failure. We invited nonprofit operations consultant Sean Hale to share his thoughts on how best to address this important issue.
Building & Maintaining Cash Reserves (protect your nonprofit from the next storm)
Healthy reserves can help your nonprofit in weathering a storm or making the most of an opportunity. But how do you get from here to there? Once you take the first steps, it gets easier.
Case in point
Once upon a time I got to work with a great nonprofit. Good people, exciting mission, changing lives. I’d only been involved a few days, though, before discovering a big weakness: no cash reserves. What does that mean? In their case, they were about two weeks away from running out of money.
- Phone calls got made.
- Hands got wrung.
- Teeth got gnashed.
- Credit card balances got very, very big.
- Board members and a couple of big donors came through with a generous mix of gifts and loans and thus they averted disaster.
Most people find this a stressful and unpleasant way to live (personally or professionally). However, just in case you thrive by living on the edge and flying by the seat of your pants, let’s dig into why this ultimately hurts your organization’s mission and long-term success.
Having no reserves costs much more
A nonprofit without cash reserves costs more to operate, just like it does for a person.
For a person, that extra expense sometimes takes the form of a payday loan or big credit card balances. Or it might mean that they spend a lot of time juggling debt from one credit card to another, begging loans from family and friends, or losing significant time and opportunities because they can only ride the bus.
For a nonprofit, the lack of cash reserves can impact the whole organization and distract it from its mission. Some of these may appear small on the surface, and they would be if they were one-time occurrences, but over time they add up like death by a thousand cuts.
- Accounting staff spend more time watching the daily cash balance.
- Program staff have to count every nickel and dime, and maybe need permission before making even small purchases.
- The board, instead of maximizing their impact as proud ambassadors of the organization:
- Spend their time worrying about money
- Get tempted to micromanage
- Feel shame that they have to beg their friends to keep the organization afloat rather than pride at asking the friends to invest in a thriving mission
- Loyal donors might give once or twice to rescue your organization. However, very few will do it long-term because they feel more confidence in those organizations that have financial stability.
Remember: every minute that creative energy goes into managing low cash distracts from the mission. Even worse, it can undermine morale:
- The best staff will likely seek new (more stable) jobs
- It becomes harder to recruit new board members (because who wants to join a sinking ship?)
- Donors want to invest in a brighter future, not helping a nonprofit limp from one emergency to the next
How do we get cash reserves?
Your nonprofit can build up cash reserves much like the way you would eat an elephant: one bite at a time. This is a slow but steady process. One week, one month, and one year at a time.
Pro Tip: By working smarter, rather than harder, you can find more money to save without tightening the belt or painful cuts. Check out the strategies below.
Strategy 1: Transforming Inertia Into Action
Many organizations have opportunities to cut unnecessary expenses. Running a nonprofit day to day can be more than a full-time job, meaning that sometimes we put something off for so long that we forget about it.
- Sometimes it’s the fax line that you stopped using years ago but are still paying the phone company for every month.
- Sometimes it’s signing the paperwork to change to a new vendor that costs half as much and has better customer service.
- Or maybe it is making sure routine maintenance happens so that you don’t have to replace your vehicles every three years.
Read more about this strategy, and how to apply it, here.
Strategy 2: Return to Mission and Values
Many nonprofits, even small ones, have multiple programs. When an organization has more programs, it becomes more difficult to run them with a high level of excellence and efficiency.
By way of analogy, imagine you’re craving a hamburger and have your choice of two restaurants. One place does burgers, pizza, Chinese, sushi, Mexican, salads, smoothies, sandwiches, and barbeque. The other only does burgers and fries. Which one would you bet on for a good burger?
For your nonprofit, do you have multiple programs? Is each functioning at high levels of efficiency? Or might staff’s attention be divided so that they’re doing simply an okay job on 3 or 4 programs?
In organizations that have multiple programs, inevitably some programs have stronger alignment with the mission and values. So, take a good look at your mission and values because they can help you get clarity about where to focus your energy.
Read more about this strategy, and how to apply it, here.
And also see the Matrix Map, here, to help you figure out which programs to focus on without playing favorites.
Strategy 3: Using the right tool for the job
When the day-to-day routine of running a nonprofit and its programs represents more than a full-time job, that makes it hard for staff to stay up to date on the latest trends and technology. Top of the line software from 2010 might be an inefficient and unsafe dinosaur today.
Read more about this strategy, and how to apply it, here.
How much reserves do we need?
Different organizations will have different targets based on their needs, dynamics, and more.
You need at least enough reserves to cover your annual cash flow ups and downs. Many nonprofits have seasonal highs and lows in revenue and expenses: big annual grants that get paid all at one time, a summer dip in staffing, holiday gift giving, and the like.
To get started, calculate the difference between your annual high and low point. Having that much cash on hand will make it easier to get through the lean months without the risk of running out of money. Every nonprofit should have this level of cash reserve, at a minimum.
Next, calculate how much cash you need to cover your expenses on an average month (take annual expenses and divide by 12). Having enough cash to cover one or two months can go a long way towards allowing your nonprofit to handle a surprise or two.
Many nonprofits like to, over time, build up reserves of 3 to 6 months. Reserves this size will allow your nonprofit to:
- Respond carefully to surprises: taking time to breathe and think carefully rather than being forced by a lack of cash to take flash decisions.
- Make strategic investments: to support long-term growth, strength, and impact. Certain staff positions, like professional fundraisers, can take months or longer to pay for themselves.
- Try something new: Many nonprofits find it difficult to try something new because they cannot cover the cost of that new technology or initiative. Even when they know that the way they’ve always done things hasn’t kept up with the times, if they don’t have the time and money to explore and carefully consider the new ways, how will they make that transition?
- Weather a rainy day: Whether its repairing flood damage or doing a national search for a new rock star executive director, reserves can cover those big expenses that you know will happen sooner or later, but you frequently can’t predict.
How do we get from here to there?
The same way you eat an elephant: one bite at a time.
Instead of aiming for a balanced budget next year, aim for a budget surplus. A surplus of just two week’s expenses every year will become a source of meaningful stability and strength over time.
Let’s say a $1 million dollar nonprofit follows this recommendation for 10 years. That means that they:
- Will have a $38,000 budget surplus every year (roughly 4% of the overall budget)
- Will build a reserve of nearly $400,000
- Will have a reserve that can cover 5 months of expenses
Pro tip: a reserve is not sacred and it is not a discretionary fund
I’ve seen too many good nonprofits treat a reserve as something so sacred that they could never spend it. If you point out to them that half the building has burned down, they’ll respond “well we need these savings in case the whole building burns down.”
Other nonprofits treat it as a discretionary fund, available for whims and unsustainable spending. They might use such funds to add a new staff position with no plan for how to continue paying for it in year 2.
Instead of these extremes, spell out clearly, in your board policies or bylaws, all the key considerations for your reserves. For example:
- Why the nonprofit has set up a reserve fund.
- Target annual additions and target final balance, including relevant calculations.
- Under what circumstances can the reserve be spent (and not be spent).
- Who has the authority to access the reserve?
Conclusion
You and your nonprofit can do this, one step at a time. You’ll find each step, each year, gets easier than the one before it. Then, before you know it, you’ve established a habit that will make your nonprofit stronger, more focused, more resilient, and more impactful.
About the author
Sean Hale, of Sean Hale Consulting, has served nonprofits for more than twenty years. Most recently, as Mission Capital’s Chief Financial & Operations Officer, he made improvements that reduced waste, generated new revenue, boosted staff productivity and morale, grew financial transparency, and shrank risk. Over his career, he’s also helped boards and management to navigate complex situations and consistently left the organizations stronger and ready for their next stage of growth. Sean is also the co-founder of Philanthroforce, a comprehensive guide to consultants in the nonprofit sector.