5 Keys to Develop Your Operating Reserve Policy
Every nonprofit needs to have sufficient cash flow to meet obligations. Setting aside an operating reserve is a smart practice as it provides a cushion against unexpected events that could temporarily impact the cash flow.
Following are five best practices to follow when establishing your operating reserve policy. These steps will help you standardize your practices and ensure that the operating reserve is available when needed.
- Create a written and approved policy
It is not enough to simply have an operating reserve. Developing and adopting a written policy is a valuable process that helps ensure the board of directors and leadership team are aligned on definitions, calculations, and procedures.
- Clarify the purpose and mechanics
Make sure that your operating reserve policy includes not only the high-level purpose and goals of the reserve, but also the mechanics of how it will be maintained. At a minimum, the policy should cover:
- Purpose of building and maintaining reserves
- Definitions of the types of reserve(s), intended use, and calculation of target amounts
- Assignment of authority for making use of each type of reserve fund which may include delegation of some authority to staff leaders
- Responsibilities for reporting reserve fund amounts and use of reserve funds
- Any specific policies, if needed, about investment of reserve funds
- Identify the funding source
Operating reserve funds can come from a variety of sources. Sometimes one or more grants or donations can be used to establish the fund. At other times, the reserve is built gradually, whenever there is an unrestricted surplus.
Make sure your policy details how you will fund your operating reserve. If it will be created via surpluses, clarify what portion of excess cash will be placed in the reserve fund. You might also want to include a line item in the budget for adding cash to the reserve.
- Set limits
Your policy should also establish how large your operating reserve needs to be. Typically, the reserve should cover three to six months of expenses, but that figure can vary greatly depending on the specifics of your organization. For example, if you have long-term contracts that provide reliable funding for the foreseeable future, you probably do not need as much in reserve.
If your nonprofit relies on periodic grants, fundraising events, or seasonal programs, you will probably want to set a higher operating reserve goal. Your policy can also provide for periodic reviews to assess whether your goals are appropriate given any changes in funding.
- Decide how to handle other types of reserves
If you decide to create additional reserves, such as a “Capital Reserve,” you will want to create separate policies for each of those reserves. Each policy should be customized to address essential components of the different reserves—do not assume that a single policy can or should apply to all types of reserves.