What is an operating reserve? And how much is too little — or too much? Let’s take a look.
What it is
An operating reserve is a portion of an organization’s net assets that’s unrestricted and relatively liquid. But it shouldn’t be defined so narrowly that it only includes cash or cash equivalents. (That would make it a working capital reserve created to ease routine cash flow swings.)
An operating reserve generally spans a period of years and usually comes from operations that create a surplus. Receiving unrestricted contributions, generating investment income and budgeting for a surplus are all ways to create unrestricted net assets. And that, in turn, can be considered your operating reserve. In most cases, nonprofit boards are responsible for setting operating reserve policies, including the desired fund amount and circumstances under which it can be drawn down.
How much you need
Generally, if your nonprofit depends heavily on only a few funders or government grants, it should keep a larger reserve. And if personnel costs make up a significant part of your expense budget, your organization could use the cushion that a healthy operating reserve provides. On the other hand, nonprofits with diverse funding, or whose expense budgets are less personnel-intensive, probably need smaller reserves.
For many nonprofits, three to six months of operating expenses is an appropriate reserve. But rather than thinking of this as a benchmark, consider it a safe-harbor range established to cover any emergency. This would enable you to continue operating for a relatively brief transition in operations or funding. Or, in the worst-case scenario, it would allow for an orderly winding down of affairs.
An operating reserve of more than six months of expenses offers greater flexibility. For example, it might provide your organization with funds to pursue a new program initiative, or to leverage debt funding for needed facilities.
Consider all factors
As your nonprofit establishes its operating reserve, consider all factors that impact your organization’s finances.