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Running on empty: Why organizations need reserve plans

“Running on, running on empty; running on, running blind; running on, running into the sun, but I'm running behind…”

The chorus of Jackson Browne’s 1977 Top 20 hit can serve as a metaphor for the leadership and governance of many tax-exempt organizations.

As the demand for the services provided by tax-exempt organizations increases, so do the financial, operational and regulatory pressures. As the funders of many programs have either reduced or threatened to reduce reimbursement and awards for programs, many tax-exempt organizations lack the appropriate reserves to react to the risks, replace capital assets, and invest in their infrastructure. Without appropriate reserves, an organization can be thrown into cash flow distress and unable to focus on prudent, long‐term decision making. Instead, they may be making expensive, short‐term crisis‐based decisions, or worse, they may not have the funds to continue operating programs.

This past year, the implementation of the new accounting standard from the Financial Accounting Standards Board, ASU 2016-14, Presentation of Financial Statements of Not-for-Profit Entities, required disclosure about an organization’s liquidity and availability of resources. The disclosure increased the discussion and conversation with boards regarding the appropriate liquidity and operating reserves required for an organization.

It is easy to make the obvious statement, “tax-exempt organizations should create reserves in order to respond to unforeseen risks and investment in infrastructure.” Yet, the reality of developing, implementing, and funding those reserves is much more complex. This requires the guidance and commitment of the organization’s governance. Even entities fortunate to be in a position to fund reserves will need to develop policies and procedures to create accountability toward the purpose and use of those reserves.

In conjunction with an organization’s strategic planning process, governance and leadership should establish minimum and maximum reserve thresholds. Even if your organization does not currently have the resources to fund reserves, it is important to have a discussion and a plan in place should the resources become available in the future.

To drive discipline and accountability, tax-exempt organizations should develop a policy to create, manage, and use reserves. The policy should include the following:

  • Statement of purposes and philosophy – formalize the rationale for and objectives of establishing a reserve fund.
  • How the reserve levels will be calculated and when they will be measured
  • How the reserves will be initially funded and replenished
  • How the reserves will be invested
  • How the reserves will be managed and monitored
  • Who will be responsible for providing oversight of the reserves
  • What constitutes appropriate usage of reserves
  • What steps the governance and leadership should take prior to using reserves

Should the need to utilize funds arise, having a policy in place will make using the reserves a much smoother process.

Once it is agreed that a tax-exempt organization will develop reserves, the organization will then need to identify strategies to fund the reserves. Potential strategies could include:

  • Creating a budget line item for reserves
  • Use the non-cash depreciation expense with cash income.
  • Include as part of capital budgets
  • Include in capital campaigns and planned giving campaigns
  • Internal designation of Board contributions
  • Internal designation of staff vacancy savings
  • Windfalls from unexpected/one-time grants and gifts

Starting the conversation and identifying the need for reserves to address the operational and financial risks an organization faces will provide leadership fuel in their tank and a path to run on.

This material has been prepared for general, informational purposes only and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. Should you require any such advice, please contact us directly. The information contained herein does not create, and your review or use of the information does not constitute, an accountant-client relationship.