August 1, 2011 | Read Time: 3 minutes
As the economy continues its slow recovery, nonprofits and donors are more frequently trying to understand the role of financial reserves—a tool that may have been an option in the past but is now a must-have for organizations that hope to maintain stability in turbulent times.
In particular, people want to know how reserves compare with endowments, because both are ways for nonprofits to help secure the organization’s future.
Reserves are a lot more flexible than endowments—and often more appealing. The money and the interest from a reserve are governed by a nonprofit’s board and can be used for many purposes.
Endowments tend to last a longer time than reserves but are much more restricted. Typically, nonprofits can spend only the interest generated by investing the money in an endowment, and donors can place many restrictions on how the money may be used.
Organizations often spend a good deal of fund-raising energy building up endowments and then find they can tap only a small portion of the pool of money raised. Making matters worse, donors who have recently given to endowments often don’t want to make a second gift for current needs—so nonprofits find themselves in a squeeze to pay for current operations even when they have just completed a successful campaign.
The first question a nonprofit should ask before creating a reserve is what the purpose of the money is. Is it just there in case of a catastrophe or to pay for building maintenance or to provide the kind of capital that can be used to change or transform the organization?
The second question is about the board: Has it defined the purpose, policies, and management that will govern the reserves? The board can always revisit these policies, but it needs to set out the basic rules for spending the money.
The next question is more practical: Does the nonprofit have a chance to achieve a surplus on any of its programs or other operations such that it can create savings and fund reserves?
Once the reserve is in place, it can often be tempting to use that money to meet shortfalls. And that may be a smart course to follow in the short term. However, nonprofits need to develop a plan to replace the lost revenue and get the organization back on a steady and healthy financial course so it’s not constantly falling short of budget.
Just as important, organizations need to explain to donors and others why a surplus is not put toward paying for immediate needs or more services. It’s important to explain that reserves are a safety net in case of crisis and a way to guarantee nonprofits can seize on great but unexpected opportunities.
Reserves are not just a financial tool, however. They are a concrete way to promise the people who count on a nonprofit that no matter how much of a roller coaster an organization faces in a bad economy, it will continue to provide vital services.
