An organization’s financial reserves are a discrete subset of its net liquid assets. They are a distinct pool of assets that an organization can access to mitigate the impact of unbudgeted, undesirable financial events and/or pursue opportunities of strategic importance that may arise in the future.
Mark Oster, national managing partner, Not-for-Profit and Higher Education Practices at Grant Thornton, LLP, presented ideas recently during the during the AICPA’s annual Not-for-Profit Industry Conference in a session called “Determining the Appropriate Level of Reserves for Your Organization,”
Factors that determine which assets can be counted toward “reserves” include liquidity, freedom from any corresponding liabilities and “unrestricted” with regard to donor intent. Specific examples of assets that would not be considered reserves would include plant, property and equipment; endowments and board-designated funds, and pension plan assets.
- Speed with which full funding of reserves occurs may vary based on financial stability – assets and ability to generate;
- Ability to “catch up” if circumstances require (generate additional margin if needed);
- Other funding requirements (e.g., annual operational investment); and,
- Organizational appetite and interest.
Beware the pitfalls of benchmarking. Two wrongs don’t make a right and more/less doesn’t mean better/worse. Similarities only go so far, such as risks, impact to organization, etc.
When implementing a reserves policy, it’s important to consider several things:
- Documenting your reserves policy: Every policy should have a clearly articulated purpose for reserves; a process for monitoring and reviewing annual reserve requirements; responsibilities for establishing and maintaining reserve levels and processes to respond to risk events, such as escalation, notification and approval.
- Communicate, culture and process: Publicize to internal and external constituencies: the plan can help development functions and board members more clearly articulate why their institutions are “not rich” and why these funds have been set aside
- Address the culture: it’s OK to spend this money, just because a risk occurred doesn’t mean offerings must be pruned or altered.
- Update the plan – and risk analysis – annually.
Methodology recommends organizations draw upon reserves to address deviations from budget. Drawing upon reserves should be expected, he said. Maintaining balance sheet health via reserves enables you to be prepared for the future while providing stability in your operations. Every organization should adopt a unique reserves plan to meet its specific needs and circumstances.