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.
“There are risks and consequences associated with failing to examine funding needs closely, when an organization is planning its reserves levels.”
Through it all, leaders, board members and finance executives at not-for-profit organizations have continued to ask, “What is the right level of reserves for our organization?”
There is no settled single law for the right level of reserves at not-for-profit organizations. Notional heuristics, like “six months of operating expenses,” are simple to communicate and understand. However, they fail to consider an organization’s true underlying needs for liquidity.
“There are risks and consequences associated with failing to examine funding needs closely when an organization is planning its reserves levels,” said Grant Thornton Not-for-Profit & Higher Education Principal Joseph Mulligan.
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?
These questions can help position an organization to deliver on its mission and strategic, organizational and financial objectives.
Not-for-profit organizations that dutifully consider their specific needs for reserves are better able to convey a clear and compelling rationale to stakeholders, codify their intentions in a formal reserves policy and make decisions to effectively position their organizations from a mission and financial standpoint. One size definitely doesn’t fit all, and a thoughtful, customized analysis for determining a reserves target is much more appropriate than adopting commonly cited rules of thumb.
Contacts:
Dennis J. Morrone
National Managing Principal, Not-for-Profit & Higher Education Industries
Grant Thornton Advisors LLC
Partner, Audit Services, Grant Thornton LLP
Dennis Morrone is the National Managing Partner of Grant Thornton's Not-for-Profit & Higher Education Practices.
Iselin, New Jersey
Industries
- Not-for-profit & higher education
Service Experience
- Advisory
- Operations and performance
- Audit & Assurance
- Finance Transformation
- Employee Benefit Plan Audits
- Transaction advisory
Joseph Mulligan
Principal, Growth Advisory Services,
Grant Thornton Advisors LLC
Joe is a Principal with Grant Thornton's Advisory Services practice. In this capacity, Joe partners with leaders, including boards, committees, and management that aspire to enhance the attainment of organizational, mission and financial objectives.
Iselin, New Jersey
Industries
- Not-for-profit & higher education
Service Experience
- Advisory
- Commercial and growth
- Growth and transformation
- Operations and performance
- Finance modernization
- Technology transformation
- Restructuring and turnaround
- Transaction advisory
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