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by Thomas J. Raffa
DEFINED
Operating reserves or unrestricted fund balances are similar to retained earnings or owners' equity in business enterprises. They are funds, usually accumulated over several years, which are available for use by the organization at the discretion of the board of directors (i.e., net unrestricted money).
PURPOSE
Nonprofit organizations must maintain the balance between operating income and expenses in order to survive. Achieving this balance year after year is a considerable challenge due to fickle funders, economic uncertainties, etc.
* Whether for-profit or nonprofit, most organizations can expect to incur some operating deficit at some time. Operating reserves can provide the cushion necessary for an organization to survive the lean periods and the unexpected events which can drain funds.
Operating reserves perform the following functions:
* Enable an organization to survive operating shortfalls caused by economic conditions or management error. Without such reserves or use of other assets, survival of an organization during a steep or protracted budget deficit may be threatened.
* Enhance the flexibility of an organization when used as venture capital to develop new programs, replace outdated programs or expand the organization's interests and services.
* Expand credit opportunities and permit favorable financing of an organization's growth and expansion. This includes permitting a change in direction or focus of programs and activities.
HOW MUCH IS ENOUGH?
The amount of operating reserves needed by an organization depends upon its individual characteristics and circumstances, as follows:
The reliability of sources of income. If income is derived primarily from a predictable, broad based membership or body of contributors, the level of operating reserves may generally be lower than if income is derived primarily from a few large grants or contributions.
Seasonality of cash flow. If cash flow is irregular, characterized by periods of dormancy (usually due to a large annual meeting/convention or a one-time anniversary date for all members), operating reserves should be generally higher than if cash receipts are consistent throughout the year.
Other ways to spread out until reserves build up:
Stagger dues anniversary of members
Offer prepaid discounts for convention
Short-term use of government or foundation money until intended program begins (i.e., as an advance)
Improve billing on cost reimbursement contracts
Timing of cash flow. If there is a substantial delay in collection of receivables, reserves should be higher than if revenue receipt is prompt.
Availability of external financing. If external sources of credit are available, or if fixed or investment assets (endowments) are available for use as collateral, the level of operating reserves may generally be lower than if no external financing is available to cover emergency situations.
Stability of expenses. If expenses are primarily fixed and predictable, reserves can generally be lower than if expenses vary and are unpredictable. If an organization owns fixed assets that are likely to require renewal or replacement, then operating reserves should be higher. However, operating reserves should accumulate as fixed assets age, so that replacement and repairs can be funded.
Nature of Liabilities. Reserves should be higher for those organizations with significant liabilities which include long-term debt, payables, and deferred income. Noncurrent liabilities and debt reduce operating flexibility and access to external financing and increase risk of penalties and interest for untimely repayment.
Nature of Other Assets. Reserves may be reduced with an increase in unrestricted investments or endowments.
Nature of Opportunities. If opportunities requiring large expenditures occur periodically and unpredictably, reserves should generally be higher than if opportunities occur on a more regular or predictable basis. For example, an organization planning to buy a building within the next five years, whenever a good deal becomes available, would maintain a high level of reserves.
EDUCATE
An organization has the responsibility to educate its constituency on the need and purpose for reserves.
Are members or contributors likely to withhold dues or contributions because of operating reserves?
The constituencies should be informed of need for and the purpose(s) of reserves.
SURVEY
In a recent survey, the relationship between current unrestricted funds (operating reserves) and unrestricted expenditures for 25 national associations (both trade and individual membership) was examined. The following is a summary of their findings:
More than half surveyed maintained unrestricted reserves between one and 49 percent of current unrestricted expenditures. The median percentage of unrestricted expense is 31.1% for membership associations/societies.
This percentage of current unrestricted reserves to current unrestricted expenses usually increases as the level of current unrestricted expenses increases.
Sixteen percent of the associations had no unrestricted operating reserves; that is, they had a negative unrestricted fund balance.