Based on insights we have gained from working with not-for-profit executives across the country, this report
addresses the importance of reserves, and shares our recommendations and industry best practices to enhance organizational practices. It is also designed to assist the industry as it transitions to a more sophisticated and standardized reserves planning methodology.
The report focuses on the concept of “risk reserves” — the amount of net assets a nonprofit organization should have on hand protect itself against risks that may adversely impact the bottom line.
While it is a common belief within the industry that nonprofit organizations should seek to achieve standard reserve-level targets (e.g., three months, six months or one year of operating expenses in reserves), these generic thresholds underserve organizations and their constituents. Each organization has a unique business model, risk exposure and financial circumstances; therefore, the level of assets set aside to mitigate against risks should vary from organization to organization.We recommend a methodology that nonprofits can use to determine the appropriate level of risk reserves specific to their organization. Our four-step solution will enable you to better determine your nonprofit’s target reserves level.
- Develop a baseline long-term financial forecast. Begin the reserves planning process by developing a five-year financial forecast for all aspects of the organization. This forecast will enable management to develop insights into key drivers and identify trends not evident in annual budgets.
- Perform a detailed analysis of potential risks. Identify potential downside performance within the organization’s short- and long-term financial plan.
- Quantify your average annual risk exposure. Evaluate downside performance across all identified one-time or recurring budget line items, and apply probability-weighted, net present-value-adjusted averages of risk exposure.
- Establish your target reserves level and funding approach. In addition to establishing a reserves target, develop a funding plan to designate appropriate balance sheet assets to fund the organization’s reserves.
No two organizations’ business operations and risk profiles are alike. Just as all organizations establish their own unique business plans and associated operating budgets, we recommend that every nonprofit adopt a unique reserves plan to meet its specific needs and circumstances.