Using Operating Reserves During a Crisis: When and How Much?
Posted in News Story
By A. Michael Gellman, CPA, CGMA
April 16, 2020
A. Michael Gellman is an independent Fiscal and Financial Strategist (CFSO) for nonprofit organizations and a founding principal partner for Fiscal Strategies 4 Nonprofits, LLC. He is also a part of the Center for Public & Nonprofit Leadership faculty.
This article and other resources can be found at: www.se4nonprofits.com. You can contact Mr. Gellman at email@example.com.
Many nonprofit organizations have worked very hard over numerous years to build up operating reserves to a level that allows them to be considered financially healthy organizations with enhanced sustainability prospects for weathering an unexpected economic downturn. However, now that we are in the midst of a full-blown economic crisis, organizations that have built-up substantial operating reserves are faced with a real quandary of answering two simple questions: When? And how much?
The answer is not so simple because there is no answer that fits all nonprofit organizations for all unanticipated economic events. That is why it is very hard to find specific guidance or best practices for how to use operating reserves, especially during times of unpredictable hyper-change.
Generally speaking, there is uniform agreement that nonprofit organizations that have less than 3 months of operating reserves are considered to be in a weakened financial position. Stronger nonprofit organizations typically have formal operating reserve policies with operating reserve goals of somewhere between 6 months on the low end to 12 months on the high end. It is not unusual to find some nonprofit organizations that have built up operating reserves of more than 12 months with some having 2 to 3 years or more.
The only uniform fact for most of these nonprofit organizations is that it probably took many years of hard work and even some good luck to build up these operating reserves. The reality is that if you are not careful, operating reserves that took 20 to 30 years to build up can be burned through in 20 to 30 weeks.
One more reality: no operating reserves goal is designed to protect an organization against a long-term or even a mid-term financial economic change. Operating reserves are there for two main short-term strategic purposes:
- To help bridge an unexpected economic short-period downturn like a delay in getting a new grant approved, temporary rescheduling of a major event due to weather, temporary demand for disaster relief services and support, or other similar short-term temporary changes.
- To support future growth strategies like the temporary investment in the launch of a new program, funding the costs to merge with or acquire another nonprofit organization, funding an expansion of a new web portal or website, or other similar one-time uses of operating reserve funds.
So how do we answer the questions of when and how much?
I do not know – especially now considering the unpredictable hyper change circumstances cascading from COVID-19. What I do know with great certainty is that the current situation with COVID-19 is not by any stretch of the imagination a short-term event. This means that organizations are having to (and must learn to) pivot quickly to new norms of lower sources of funding that are also coupled with changing (increasing and decreasing) demand for services for at least the foreseeable future.
The best method for using operating reserves is to define strategies quickly that will set specific rounds for metering-out limits. (Here the term metering-out emphasizes that a systematic and thoughtful approach to using operating reserves to subsidize current operations has been developed and put in place.)
The First Round for Metering-Out Operating Reserves:
For the super short term, set a percentage of operating reserves that will be available to bridge deficits while the organization pivots, downsizes and recalibrates to be in line with lower expected funding levels. Hopefully this time period is for 4 weeks or less. But often this turns out to be 6 to 8 weeks, as some nonprofit organizations are not as nimble as others to make appropriate changes.
- How Much: First metering-out level of subsidy – 10% to 20% (max) of operating reserve balance (pre-crisis)
- When: Immediately
The Second Round for Metering-Out Operating Reserves: When you have a clearer sense of the duration of the economic crisis or if you are still in pre-recovery economic conditions, you can then determine if you made good choices in the first round metering-out of funds. This assessment usually occurs 60 to 90 days later. You now can set a percentage for the second round of operating reserves that will be made available.
- How Much: Second metering-out level of subsidy – 5% to 10% (max) of operating reserve balance (remaining balance)
- When: 60 to 90 days later
Planning Tip – This is my conservative method based on experiences of the 9/11 and 2008-2009 banking crises. Until I see true long-term recovery being realized, for the second metering-out round and others that may follow, I reduce the percentage of operating reserves that can be used.
There will most likely not be a situation where you will use none of your operating reserves and you must—at all costs—avoid burning through all of your operating reserves too quickly.
For sustainability and continuity purposes, some operating reserves must be set aside to seed future operations and be there as a base for rebuilding operating reserves back towards original operating reserve goals post-recovery. With this long-term sustainability goal in mind, establish (at least for now) a base level of operating reserves that will not be touched. For example, if you determine that preserving a base of 60% of operating reserves for the future is a good, conservative goal, then that will leave 40% that will be in play for metering-out in rounds one and two over the next three months with some left over for a possible round three.
Additional articles in this series, Leading in Times of Hyper Change, can be found on our website, Facebook and Twitter.