Developing healthy reserves is a key financial milestone to building a sound, sustainable organization. It should be one of the first priorities when gaining maturity and moving past the scarcity mindset. Reserves are meant for emergencies in which expected income falls through or unexpected expenses hit.
Reserve funds can be set aside from a surplus at the end of a fiscal year, given from a donor, or accrued from the operating budget. But they should be intentionally planned for, just like you would build a savings account for your personal household. Read on to learn more about the benefits of nonprofit reserve funds.
When considering a reserve fund for your organization, there are some key points to understand. First, explore the type of reserve fund that will be the best fit. There are generally two main types of reserve funds: operational and capital. While similar, they have distinct purposes.
Operational reserves are set aside to ensure that the nonprofit can keep monthly operations going. Think payroll, program costs, and normal monthly expenses if there was a shortfall in giving or other emergency challenges (like a pandemic). Standard recommended practice is that a nonprofit should seek to have 9 -12 months of operational reserves set aside. If a nonprofit is able to save more than 12 months, then those funds can be used to start new ventures. Otherwise, use those funds to seed an endowment and create further organizational sustainability.
Capital reserves are additional funds that are saved and set aside for capital needs of a nonprofit. If you’re a nonprofit with physical assets such as vehicles, buildings, camp properties, etc, capital reserves are for you. By owning or leasing physical property and assets, you often incur capital expenses. This includes repairs and replacements of sometimes large and expensive items. Think A/C units, roofs, carpet or flooring, paint, plumbing issues, parking lot resurfacing, etc. Capital reserves help when these situations arise.
The recommended amount for these capital reserves range depending on your physical assets, but you should be able to plan and prepare for expected replacement costs as well as the unexpected. Many small and medium size nonprofits might just have one reserve fund that would include both operational and capital reserves. However, we advocate for separate funds for increased tracking, budgeting, and transparency.
Too often, nonprofits make the mistake of storing these funds in a savings account, money market, or CD. It’s often not the most prudent decision because reserves are usually held for longer periods of time. Plus, inflation can dramatically impact the buying power of your savings. People usually save for retirement not in a savings account, but a 401k because it allows them to hedge against inflation. This also allows them to make market returns that, with compound interest, set you up for long-term success. The same thought process applies to nonprofit reserves.
Banks are not meant for storing long term savings. Savings accounts and money markets average 0.06% returns each year. Inflation is currently 7%. Let’s do some quick math. $1 million in a savings account with our current inflation rate of 7% means your organization could lose $70,000 of buying power this year.
In a savings account, that money could lose up to a third of its value in just 5 years. Right in time to buy that new HVAC system, right? That’s why reserve funds set your nonprofit up for better success long-term. We recommend placing reserves in a conservative, diversified, and rebalanced portfolio of ETFs and index funds that can bring average annual returns from 5-8%.
Now that you have an idea of which type of reserve fund is best and where you should keep it, consider some best practices. It’s essential to put a policy in place so everyone is on the same page. Start by deciding how much money will be set aside in your reserve fund. Then, determine the types of circumstances that will result in assets in your reserve being used and whether there should be any limitations on how the funds are spent. Have a process for deciding if or when to dip into your reserves and when to replenish.
In addition, here are some other best practices:
Need some assistance setting up reserve funds? Infinite Giving can help. We can create multiple reserve accounts that are conservatively invested and often bring higher returns than savings, money markets, or CDs. Our asset management platform allows you to manage your reserves all in one place, easily create endowments, and receive non cash gifts. You still have complete access to your funds at any time and can easily transfer from your reserves to your checking account when needed.
To be a sustainable organization that can continue to make an impact, start today by building your reserves, hedging against inflation, and growing your giving. We can help.