SaaS Brief

Why Nonprofits Need to Rethink Their Operating Reserves Strategies

Nonprofit operating reserves

Operating reserves are a critical element in the financial sustainability of nonprofit organizations. Having bountiful reserves can help an organization weather unexpected changes in the fundraising landscape and provide an ultimate form of capital for internal funding. There’s a lot of pressure on nonprofit finance leaders to manage and govern reserves well.

Ben Aase, CLABenjamin Aase, is a Principal at CLA (CliftonLarsonAllen). He leads the firm's Public Sector Group's national consulting and charter school practices. He works directly with a range of foundation, nonprofit, and education clients to drive both organizational and field-wide changes and results at the intersection of strategy, finance, and operations.

Prior to CLA, he provided accounting and financial advisory services to over 40 Minnesota chartered and traditional school districts while working for School Business Solutions. Ben received his MBA in Finance, Strategy and Entrepreneurship from the Carlson School of Management at the University of Minnesota. Recently, he presented the session, Rethinking Reserves Strategies at the 2022 Nonprofit Finance Leaders Forum.

How are operating reserves built, accessed, maintained, managed, and reinvested in your organization? In his session, Ben encouraged nonprofits to reflect on what is working in your capitalization strategy and what aspects of your reserves policy needs improvement. He recommends adopting a framework to move toward a data-driven approach to reserves as an essential part of your organization’s financial sustainability.

In this article, we will outline some of the basic ideas from the session. Please watch the complete on-demand session replay to leverage Ben’s data-driven, practical tools for revising reserve targets and his insights about best practices and crafting reserves policy.

Watch a replay of the entire session and other virtual events at the Nonprofit Finance Leaders Virtual Forum.

The past decade in operating reserves management

Over the last decade, many nonprofits have had to reexamine their business model and framework for managing reserves. Recently, the COVID-19 pandemic required nonprofit organizations to lean on their reserves in new ways to navigate what seemed like impossible choices. Prior to that, the Great Recession also caused nonprofits to have to rebuild reserves while rethinking risk management, sustainability and capitalization strategies.

In recent years, many nonprofits have struggled with reserves management and financial stability. A 2018 analysis of nonprofit financial health conducted by Oliver Wyman, SeaChange Capital Partners, and GuideStar by Candid revealed that nearly half of nonprofit organizations have less than one month of operating reserves, and nearly one-third face potential liquidity issues due to minimal cash reserves to offset short-term liabilities. A State of the Industry survey by Nonprofit Finance Fund found nonprofit leaders identified financial sustainability and cash reserves as key financial challenges as outlined in the chart below.

State of the nonprofit industry

Operating reserves management is a strategic part of financial sustainability

Operating reserves represent an accumulated surplus of funds over time, some of which may be transferred to a long-term strategic investment pool, while remaining reserves are held in cash. Financial sustainability is the ability to carry out activities that will achieve your mission while also developing and maintaining capacity for mission relevance into the future.

Having the right amount of reserves helps nonprofits bridge cash flows, maintain financial solvency, and also weather ups and downs of economic cycles and the political landscape. Having reserves to spare can also help you fund unexpected opportunities that arise.

Financial reserves policy is an integrated part of your broader financial sustainability framework. Your reserves policy intersects with your investment policy, in terms of how you manage various pools of invested capital for return requirements, liquidity needs, and risk appetite. Reserves also informs your strategy for new revenue development. Reserve policy connects to risks regarding program margin goals. Finally, reserves are one type of capital at your disposal as you consider the sustainability of any of your programs.

Become more data-driven to optimize operating reserves management

Today, many nonprofits have improved enterprise risk management (ERM) by enhancing their governance. Additionally, nonprofits seek to use technology and leverage big data for more actionable insights. Consequently, organizations are moving away from simply keeping three or six months of expenses in reserves. Instead, nonprofits are turning toward a more data-driven, risk-based approach to reserves. By considering reserves strategy in the context of your operating environment, business strategies and risk profile, you can build a more dynamic reserve policy and practice. CLA uses the financial reserves maturity model below to help clients move their policy and practice through start-up, formative, growth and maturity stages.

Financial Reserves Maturity Model

Learn more best practices for data-driven operating reserves management

As you can see, modern operating reserves management requires a thoughtful, data-driven approach. Optimizing your organization’s reserves management directly improves financial sustainability, enabling you to weather economic shifts and fundraising dry spells without jeopardizing your mission. And when unexpected opportunities present themselves, having extra reserves can enable your nonprofit to act fast.

Ben Aase shared much more operating reserves management wisdom gleaned in his experience with nonprofit strategy, finance, and operations. You will want to learn how to use his data-driven, risk-based methodology for determining optimal reserves as well as his reserve model schematic which is a companion risk-management and planning tool. He also discussed how to revise reserve policy for today’s best practices. Watch the replay of the full presentation—and four other virtual sessions by nonprofit finance and technology experts—at the Nonprofit Finance Leaders Forum.

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