Non-Profit Cash Reserves the Right Way

By Michael R. Grubbs, Jr., Esq.

A 2015 survey of non-profits concluded that over 75% of all non-profits had less than 6 months of operating cash reserves, and almost a quarter had one month or less. According to a 2016 report, the story is about the same in the for-profit small businesses arena. Both surveys conclude that most non-profits and small businesses have insufficient cash reserves. How should churches, non-profits, and small businesses determine the correct amount of a cash reserve, and how should these organizations establish and maintain them?

Having a properly-funded cash reserve is good stewardship. Not only does a cash reserve allow financial margin to meet an unexpected need, but a healthy reserve also allows an organization to take advantage of a timely opportunity. A “non-profit” status is a tax status, and being a “non-profit” is no excuse for lack of a business plan to build long-term sustainability. In fact, not to do so is simply a bad business model, denying an important tool in the health of an organization.

How much is enough? Opinions vary on the appropriate level of a Christian entity’s cash reserve.  Yet one thing is clear—because revenue and expenses ebb and flow, nearly every church, nonprofit, and small business that does not have at least 2-3 months cash reserves will struggle to pay regular obligations in a timely manner. If there is an urgent need or opportunity, that entity will really be in trouble. Cash reserves are the cushion that ensures, for example:

• Funds are available to replace a worn-out HVAC, a roof, or other major equipment or needed repairs; and
• That the church, non-profit, or business has the necessary funds to open a new site or launch a new ministry.

As an organization embarks on the process of determining an appropriate cash reserve amount, consider the following:

• Unexpended designated gift balances.  There should be sufficient cash reserves to cover any unexpended balances of designated gifts.  Otherwise, the church is borrowing against these gifts—a highly dubious practice that, if restricted, could be illegal.
• Capital replacements.  Whether physical facilities or equipment, all assets have useful lives.  The more facilities and equipment a church has, the more assets must be replaced.  You may be able to “extend” the life for the replacement of some assets, but eventually, you will face the replacement costs.  There are only three options for capital replacement funding:   from operations, by incurring debt, or from a capital reserve
• Debt service reserves.  If a church, nonprofit, or small business has debt, maintaining reserves in conformity with mortgage reserve requirements is a must. If there are no reserve requirements, maintaining reserves to cover several months of mortgage payment is generally wise.

Following are some guidelines for building and maintaining a cash reserve the right way:

1. You need a written cash reserve policy. Each organization needs to debate and decide its own policy. Not having a policy altogether is unwise. It’s simply bad business to “wing it,” because, frankly, the long-term financial sustainability of the organization often gets buried under the tyranny of the urgent and the immediate. It’s human nature to see a pot of money and want to spend it; without a cash reserve policy, the funds may not be available when you need them most. In addition, because every organization is different, simply copying another organization’s policy is not wise. The needs of each organization are different, and the leadership discussion around the policy is a healthy process that clarifies uniqueness and expectations.

To establish a good written cash reserve policy, gather the board and:

• Establish the minimum level of cash reserves for the organization. A general rule of thumb is that your cash reserves should be no less than 2-3 months, and rarely more than 6 months, of operating expenses. If an organization has highly variable cash flow, or uncertainty surrounding expenses, it may want to choose a relatively longer operating window of cash reserves.
• Establish how the reserves will be stored. Will they be invested? If so, how? Who is responsible for maintaining the fund? We generally recommend the board set clear guidelines regarding the type and risk of investments. In most organization, we advise cash reserve be in low-risk and readily-accessible investments.
• Define how and when the cash reserves may be used. When can the organization dip into its cash reserves, and who must authorize it? The policy must clearly state who and under what circumstances the fund may be used.
• Define how the fund is replenished once used. Suppose the policy requires a 3 month reserve, and the organization properly uses 1 month of the reserve to meet an urgent need, or a timely opportunity. The policy should also define how the fund will be replenished. Who decides the amount of time to replenish the fund? Who decides the budget adjustment that will be required? How long should it take for the organization to replenish the reserve fully?
• Establish how often the policy will be updated, and the person responsible. The policy should designate a person responsible for placing on the board agenda a regular revisit to the cash reserve policy. For young organizations, or those that operate on low reserves, we recommend the board revisit this policy at least annually.

If we can assist your company in developing a cash reserve policy, let us know.

2. You need a budget that builds and maintains your cash reserve. Once you have a cash reserve policy, now it’s time to fund the reserve. We generally advise that you fund the reserve through the normal operating budget process. Set aside a goal for the reserve, and create a line item in the Chart of Accounts on a monthly basis. For example, if your current reserve is $30,000 (say, 3 months of operating expenses), and you want to grow it to $60,000 (6 months of operating expenses) over the 12 months, you need to distribute the difference ($30,000) over 12 months into the “cash reserve” line item of your budget. That means that, for 12 months, you will need to reduce your monthly operating expenses to offset a $2,500 monthly deposit into your reserve fund. This process will require you make intentional, strategic decisions at the outset about where to reduce expenses. The same process is required as part of a budget update after a cash reserve is diminished to below the threshold set by the cash reserve policy.

3. You need public transparency about your cash reserve. The Chronicle of Philanthropy listed “transparency and the donor” among its lists of “What Will Matter in 2017.” It’s a good bet that the issue of transparency is not going away, as the younger generations, used to the instant transparency of social media, begin to earn more and give more. As a company, you need to be honest about money, initiate the conversation often, and provide an overabundance of information to your donors and to the public. That includes the existence of, the amount of, and the reasons for your cash reserve. Be honest with your donors and the public about the need for the cash reserve amount you have chosen. As an introduction to the topic of transparency, the Montana Non-Profit Association has a list of legal, essential, and recommended practices here.

We hope these considerations are a helpful starting point in determining the appropriate level of cash reserves that you need. For more tips and essentials, check out ECFA’s latest eBook – 9 Essentials of Church Cash Reserves. Remember: Cash reserves are usually built in financially good times and rarely developed when times are tough. Churches, nonprofits, and Christian businesses in a growth mode should take advantage of a financially good time to build appropriate cash reserves. We at Simms Showers have extensive experience in helping organizations navigate the legal, essential, and recommended practices regarding transparency. If we can assist you in any way, please let us know. 

Disclaimer: This memorandum is provided for general information purposes only and is not a substitute for legal advice particular to your situation. No recipients of this memo should act or refrain from acting solely on the basis of this memorandum without seeking professional legal counsel. Simms Showers LLP expressly disclaims all liability relating to actions taken or not taken based solely on the content of this memorandum.  Please contact Mike Grubbs at MRG@simmsshowerslaw.com or Robert Showers for legal advice that will meet your specific needs.