As stated by Alan Lakein, “failing to plan is planning to fail.” As the government continues to threaten spending cuts, it becomes increasingly important to have the discussion of whether or not your nonprofit has sufficient operating reserves and liquidity.
Operating reserve and liquidity
First, let’s discuss what an operating reserve is and how it relates to liquidity. An operating reserve is the buildup of unrestricted funds that are liquid. Liquidity is essentially how quickly assets can be turned into cash. For example, if a nonprofit used their operating reserve to invest in an expensive work of art, they would not be able to easily sell the art to cover any unexpected expenses or a loss in revenue (the government cuts funding). Without a well-funded, liquid operating reserve, a nonprofit could be defenseless to many unforeseen circumstances.
Out of business in 6 months?
In a recent survey, BDO USA reported that 40% of nonprofits have only between one and six months in operating reserves set aside for expenses during difficult times, while 13% reported to have none. That means over half of the nonprofits surveyed reported they would not be in business after six months of a major economic decline.
How much a nonprofit should have
So, how much should a nonprofit set aside? There are several opinions on how many months a nonprofit should keep in their operating reserve, but there are a lot of factors to consider. Depending on the industry and needs, each organization must decide what is best for them. Some operating costs to consider are payroll and any other fixed costs such as rent and utilities. Nonprofits must carefully balance how much of their funds are going towards expanding the mission, while ensuring they can survive an economic hardship. It is crucial for each organization to have a plan in place of how much cash and cash equivalents (highly liquid assets) should be available if needed. Having a well-funded, liquid operating reserve provides the umbrella needed to protect against the possible “rainy day” ahead.
Jared Morrison, MBA