The right reserves level for your not-for-profit

Over the past five years, not-for-profit organizations have found their reserves to be critical — or perhaps insufficient.

The macroeconomy has been tumultuous, the financial markets — including investment values and interest rates — have been moving noticeably, a global pandemic and public health measures have impacted how resources are deployed and how programs are delivered, while federal intervention has provided liquidity and incentives to encourage certain actions.

A methodology for reserves planning 

To effectively address the complexity of reserves planning and determining an appropriate reserves level at a not-for-profit organization, leaders need to use a comprehensive methodology.

When working with our clients on reserves planning initiatives, we recommend a tailored assessment of various factors, including: 

• Determine the current reserves level
  Not-for-profit organizations are inconsistent in how they calculate their point-in-time reserves funding, largely because they use different definitions for “reserves.” For example, one nonprofit might consider a subset of its investment portfolio to be its “reserves,” while another could be applying a more holistic assessment of net balance sheet liquidity. It’s typically best to apply a holistic view when considering which assets could serve as reserves.

• Consider multiyear plans
  Not-for-profits differ dramatically in how they envision and forecast their next few years of operations. A mature organization with solid market share in a heavily regulated aspect of the not-for-profit sector could have a noticeably different three-to-five-year outlook compared to an organization that has experienced sizable year-over-year growth in pursuit of national or global ambitions. An organization should closely consider its growth agenda, long-range outlook, strategic aspirations and associated funding needs when evaluating the appropriate reserves level.

• Manage risk
  While it’s true that not-for-profits usually have 501(c) status in common, sometimes that’s where the similarities end. The diversity of not-for-profits is part of what makes the sector so unique — and with that diversity comes myriad missions, operating and business models, revenue streams, regulatory considerations and organizational cultures, among many other differences. These can impact how leaders should conduct reserves planning activities. The level of reserves for a particular organization should be related to the nature of financial risk, magnitude of exposure, organizational agility and level of effort required to overcome burgeoning fiscal and operational challenges.

To approach reserves planning in a thoughtful and comprehensive manner, we recommend that boards, finance executives, leaders and other stakeholders consider the following questions:

• What is an appropriate level of reserves for our organization?  
• Given the risks facing our organization and the associated potential financial impact, how can those determinations inform what financial impact they might have on our ability to achieve budgets and financial plans?
• Beyond “risk reserves,” what are our organization’s needs for liquidity, given future plans and other financial obligations (such as strategic endeavors, growth, capital expenditures and anticipated deficits)?
• Given our present statement of financial position, which assets could legitimately be categorized as reserves? How does this level of resourcing align with our overall reserves target?  
• How can management coherently communicate its fiscal intentions to the board, management team and other key constituents? 
• How should we consider measuring and evaluating our reserves position moving forward?