5 Considerations for Establishing a Reserve Policy
Tuesday, December 8, 2020
Reserves, commonly referred to as net assets, are important to build and maintain, but the amount that should be maintained depends primarily on the appropriate assessment of an organization's overall financial risk. A common rule of thumb among non-profit organizations is to build and maintain net assets that equal 50 percent of annual operating expenses. While this is a good starting point, there are a number of key considerations that volunteer boards should evaluate when assessing financial risk and ultimately setting a reserve policy for the organization, including:
- Trends in industry or profession: Is the industry or profession currently experiencing a volatile period or significant change? Is there significant consolidation or growth? Is there an increased risk related to dues renewal or event attendance? What is happening in the ecosystem of the organization is an important risk factor that may suggest either a higher reserve needed to protect against difficult years or a lower reserve amount to increase spending in support of growth.
- Revenue diversification: What percentage of revenue comes from different sources within the organization? Is the organization highly dependent on dues or a primary event for survival? What has been the revenue growth in these areas over the past few years? Understanding the revenue mix will help to gauge financial risk. If the organization is highly dependent on a single source of revenue, for example, then a higher reserve level may be warranted to protect against any shortfall in a given year.
- Cash flow experience: Does the organization experience wide swings in cash flow, or does it have periods in which little or no cash is coming into the organization? Does the organization have periods where there is not enough cash to fund operations? Cash flow volatility is an important consideration in setting reserve policy from operations, particularly if the organization holds highly liquid assets such as a money market account and other marketable securities.
- Competition: Does increased competition put more pressure on the organization’s revenue streams? Are members increasing their expectations of value, which will require more strategic investments in new programs to meet? Many organizations are experiencing increased competition from both non profit and for-profit players. Considering the competitive landscape can help an organization gauge the potential impact on the organization’s financial situation.
- Anticipated change: Is the organization experiencing significant change, such as major technology upgrades, changes in governance or a shift in overall mission? Does this change add risk to the financial viability of the organization? As change can cost more than expected, anticipating major change is also prudent when evaluating future reserve needs.
With these considerations in mind, boards should either increase or decrease their desired reserve level to protect the organization against potential adversity and prepare for anticipated future strategic investments. Once determined, it is critical that boards establish a documented reserve policy that will serve as a financial management guide for both volunteers and staff. However, this policy should be flexible and reviewed annually to determine if any change is needed.
Return to Home