Reserve funds can be a key financial piece of the puzzle as a nonprofit seeks financial resiliency.
But what exactly are reserve funds?
Simply put, reserve funds are unrestricted funds set aside from normal operating funds for the nonprofit. It’s an organization’s savings account. Developing healthy reserves is a key financial milestone to building a sound, sustainable organization and 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 it should be intentionally planned for, just like you would build a savings account for your personal household.
There are generally two main types of reserve funds: operational and capital.
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 or used 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 who has physical assets such as vehicles, buildings, camp properties, etc. By owning or leasing physical property and assets, you often then incur capital expenses such as repairs and replacements of often large and expensive items. Think A/C units, roofs, carpet or flooring, paint, plumbing issues, parking lot resurfacing, etc. 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, but we advocate for separate funds for increased tracking, budgeting, and transparency.
Where should you keep reserve funds?
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 and inflation can dramatically impact the buying power of your savings. People often save for retirement not in a savings account, but a 401k because it allows them to hedge against inflation and often 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. $1M 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.
Best practices for nonprofit reserves:
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%.
- Keep 12 months of your operational budget in your checking account.
- Place 30-60 days of your operational reserves in a money market for emergency savings.
- Invest 9-12 months of your operational reserves in a conservative and diversified portfolio of stocks and bonds.
- Invest capital reserves that you don’t plan on spending in the next 12-18 months in a conservative and diversified portfolio of stocks and bonds.
- Use additional funds to start new ventures, create a growth portfolio, or seed an endowment to build long term sustainability.
We can help.
Infinite Giving can help you 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 you need to build your reserves, hedge against inflation, and grow your giving. We can help.