7 Step Policy Guide for Nonprofit Operating Reserves

In part two of this series, “How To Develop Your Nonprofit Operating Reserves,” we examined common factors that organizations should take into account when considering how much to set aside for their operating reserves. This week, let’s walk through seven steps to developing a policy to manage the use and replenishment of reserve funds.

Once an appropriate target amount has been determined for operating reserves, the board needs to draft a policy that establishes the fund and sets forth guidelines for using it. According to a whitepaper published by Grant Thornton, “establishing and documenting a formal reserves policy is a best practice that should be adopted by all not-for-profits.”

7 Steps for Developing a Policy to Manage Operating Reserves:

1. Inception – Make the case for the need for an operating reserve fund to the board. NORI’s whitepaper or reserve introduction document may be helpful
2. Recognition of Need – Board concurs with the case and asks finance, or related committee to create draft
3. Development – Utilize tools from the Operating Reserve Toolkit (e.g. reserve ratio, outlines and sample language)
4. Draft Policy – Present draft policy to Board members
5. Board Feedback – Board may approve or request revisions
6. Final Draft – Policy is finalized and approved
7. Implementation – Put into practice the guidelines established in the Operating Reserve Policy

What strategies can we use to budget and raise funds for reserves?

There are several strategies your organization can use to budget and raise funds for your operating reserve. The most successful method usually budgets for operating surpluses annually. What the Nonprofit Finance Fund calls “chronic surpluses” is the best way to build reserve funds. Other potential strategies include:

• Include a “contribution to reserve” budget line item
• Fund non-cash depreciation expense with cash income
• Include in multi-year capital budgets
• Include as component of capital campaigns
• Include in planned giving campaigns
• Designate board contributions
• Designate staff vacancy savings
• Designate windfalls (one-time grants, gifts)
• Tariff (assign %) of unrestricted gifts to build the reserve

Nonprofit operating reserve fund basic policy components:

• Statement of Purpose and Philosophy – Put into writing the reason why your board established the operating reserve fund and state what the objectives for the fund are.
• Historical Information About the Fund – Inclusion of historical information about the fund will provide useful information for board or staff who were not present at the time that the fund was established. This will also prevent second guessing and an attempt to reinvent the wheel later on.
• Definitions – Provide definitions of key terms that are going to be used in the policy to ensure common understanding.
• Use and Replenishment of the Fund – Be clear about the use and replenishment of the fund before the need arises. This will help things go much more smoothly when the time comes. Prepare forms that ask for pertinent information and authorizations. Also make sure to determine how much can be drawn down before the fund has to be replenished, and who is allowed to do this. Thinking through the process and putting the details on paper in advance is going to help everyone follow appropriate protocol when the time comes to use the fund.
• Managing and Monitoring the Fund – Some boards allow a portion of the operating reserve funds to be invested but only in low-risk, near liquid vehicles, in order to preserve the ability to access funds quickly without penalty. Some groups actually have a separate investment policy that provides guidelines for liquidity and risk thresholds for various categories of funds. But if there is no separate investment policy, it’s a good idea to mention what the risk threshold is within the policy itself even if it’s only a paragraph or a couple of sentences.
• Role of the Finance Committee – Describe the responsibilities of the Finance Committee with regard to the operating reserve and other board-designated funds oversight.

To learn more about this topic, make sure to download the Operating Reserve Policy Toolkit for Nonprofit Organizations.

ABOUT THE AUTHOR

Bess Foley

Through her consulting practice, EHF Nonprofit Financial Management Consulting, Elizabeth (Bess) Hamilton Foley has provided consulting, training, and technical assistance as a finance specialist for a wide range of small and midsize not-for-profit organizations in Washington, DC since 2000, taking a holistic approach to building financial management capabilities for her clients. She also worked on multi-year capacity building projects in Cleveland, Baltimore, New Haven and Arizona as an associate with National Arts Strategies from 2001 through 2006. Ms. Foley then served as co-administrator of the DC Commission on the Arts and Humanities’ UPSTART Capacity Building Program for nine years, from its inception in early 2006 through 2014. She is a finance consultant/trainer for capacity building programs for Arlington Economic Development (Virginia) and the Community Foundation for the National Capital Region/Nonprofit Montgomery (projects in Maryland). Ms. Foley serves as a teaching fellow for the Executive Program in Arts and Culture Strategy, developed by National Arts Strategies working with the University of Pennsylvania.

Prior to consulting, Ms. Foley had extensive experience working in finance and administrative staff positions for several nonprofit organizations in the DC Metro area. She is an associate member of the Greater Washington Society of CPAs, a contributor to their award-winning website, www.NonprofitAccountingBasics.org. She serves as chair of the Nonprofit Operating Reserves Initiative Workgroup and was co-author of its Nonprofit Operating Reserves Policy Toolkit. She has also served on a variety of nonprofit boards and finance committees.