Why is Operating Reserve Important for Nonprofit Organization?
Business worldwide has suffered negative impacts due to the pandemic crisis, and nonprofit organizations are no exception. Faced with so many difficulties, several organizations are clinging to life as there is a considerable dip in contributions. Organizations that carefully planned their operational reserves had the lifeline during this crisis and have proven to be an essential factor now than ever before.
It is essential to include an operating reserve into the non profit organization’s financial planning. The most common mistake organizations tend to make is insufficient funds or a negative cash flow, forcing them into serious operations risks. Having a well-calculated, positive reserve delivers operational stability and can attract potential donors.
Nonprofits function in a very different way from typical businesses. The ultimate goal of the nonprofit is to create a robust and steady foundation upon which the organization can flourish and continue to contribute to world change. The organizations accumulate asset balances with non-restricted donor funds and utilize them for various organization’s impactful programs to achieve this. Restricted grants can be used only for the purpose stated but the donor.
Read more about restricted grants here: What Is A Restricted Grant And How To Handle It? – A Nonprofit Guide
Handling negative recurring deficits when the expense exceeds the contributions is a daunting task and raises a red flag to existing and potential contributors. Likewise, nonprofits occasionally have insufficient funds to manage operational costs and use net assets with restrictions. Using restricted assets is a considerable risk, and the organization ultimately has to repay the sum utilized from its restricted donor funds.
Operating reserves are part of the net assets nonprofit organizations keep to use in times of emergency. These are non-restricted donor funds that can be used for any organizational purpose. These operating reserves help organizations perform financial operations during unexpected events like a natural disaster or a global pandemic. As there will be an increase in operating expenses and a dip in revenues during these situations, the operating reserve is the savior.
There is no pre-defined amount that should be set aside as an operating reserve. Each nonprofit organization is different, with different operational cultures and goals. Therefore, various factors such as organization location, number of employees, and the organization’s mission affect operating reserves’ appropriate amount. As suggested by Nonprofits Operating Reserves Initiative Workgroup, a minimum of 25% of the annual operating budget should be set aside as reserves. This can go up to 50% as needed.
The operating reserves differ from year to year for every organization as their goals and event planning change. It is the responsibility of management and board members to evaluate every factor affecting the organization’s operating expenses and strategy. Essential factors to consider include the expense and revenue stability, future plan and events, and the overall vision of the organization.
After determining the optimal amount to set aside as a reserve, the organization should evaluate ways to build the fund. For more prominent and well-established organizations, this may seem to an easy task. But for smaller organizations, building a reserve is a Himalayan task considering they have to start from scratch. Developing and implementing a plan now could be an ideal start. If you work through the current crisis efficiently, you and your organization will be better positioned to handle the next. Another way to build a reserve is to add each year’s excess from the operational budget. So over a period of time, your reserve is all set.
The reserve balance should be analyzed annually in order to ensure the nonprofit organization’s financial security. With so much uncertainty looming around and unaware of the future outcomes of this pandemic, nonprofits should add operational reserve maintenance to their priority list.
To conclude, an operating reserve can be the difference between just surviving and laying a solid foundation for your nonprofit organization. Set an operating reserve as soon as possible and drive your organization to safety in times of crisis.