The Importance of a Financial Reserve Policy for Nonprofits

Imagine you’re planning your animal shelter’s annual fundraising event. Although you fundraise throughout the year, this event generates nearly a third of your annual revenue, allowing you to expand your programming and match more animals with loving homes.

However, a major, unexpected hurricane wipes through your area days before the event, leaving you no choice but to cancel. After refunding attendees and sponsors, you start to wonder: “How will we be able to cover our expenses?”

To prepare for emergencies like this, nonprofits must build financial reserves and develop associated policies. Considering that 34% of nonprofits don’t have a reserve fund separate from operating cash, this guide is the perfect opportunity to explore the basics and learn how to develop your own financial reserve policy.

What is a financial reserve policy?

A financial reserve policy is a plan for how your organization will build, manage, and use reserve funds. Similar to setting aside a contingency fund in your budget to cover short-term financial emergencies, a financial reserve enables you to keep your organization’s finances stable long-term.

You can set aside reserve funds for emergencies, unexpected expenses, revenue drops, or financial instability. Alternatively, you may build these funds to fuel future growth and sustainability.

Your policy should outline the fund’s amount, purpose, access stipulations, management procedures, and monitoring guidelines. We’ll dive deeper into how to create a comprehensive policy in a later section.

Why is it important for nonprofits to have a financial reserve policy?

By developing a financial reserve policy, your nonprofit will be able to:

• Ensure financial stability and sustainability. As YPTC’s nonprofit financial management guide explains, “Sometimes, you can’t prevent financial challenges or uncertainties from occurring. However, you can prepare for these issues ahead of time and ensure your organization remains stable.” A financial reserve allows your organization to power through financial challenges and keep running normally.
• Support program continuity. With access to a reserve fund, you can continue delivering key programming and serving beneficiaries, even during financial disruptions. Program continuity is especially important for organizations offering life-sustaining programming, such as food banks, homeless shelters, healthcare facilities, and disaster relief nonprofits.
• Build trust with stakeholders. As donor retention continues to trend downward, it’s more crucial than ever to prove that your nonprofit is worthy of support. Informing stakeholders that you have a financial reserve instills trust in your nonprofit and shows you’re committed to using funds responsibly.
• Enable long-term planning and growth. Even if your organization isn’t currently experiencing financial struggles, a financial reserve offers the flexibility to invest in strategic planning that allows your nonprofit to expand. For example, you may use reserve funds to design new programming, adopt new tools, or hire more team members.

With a strong financial reserve policy, you can ensure your ability to continue pursuing your mission, regardless of obstacles.

How can my organization create a financial reserve policy?

Follow these steps to create a comprehensive financial reserve policy:

1. Define the fund’s purpose. The purpose of your financial reserve fund should reflect your overarching strategic goals. As mentioned before, nonprofits most commonly establish reserve funds to prepare for emergencies, but you may also build a reserve to support long-term sustainability and growth. Alternatively, you may create separate reserve funds for different purposes, such as emergency, operating, capital, and/or program reserves.
2. Determine the fund’s size. Develop a realistic goal for how much money your reserve fund should include. A standard recommendation is for nonprofits to reserve at least three to six months of operating expenses. However, each organization will have a different ideal amount depending on its size, mission, typical cash flow, and risk tolerance. For example, a nonprofit offering life-sustaining services may build a larger reserve fund to continue delivering programming during an extended emergency.
3. Create guidelines for accessing reserve funds. Usually, you’ll set aside reserve funds for true emergencies only. Establish the conditions needed to access your reserve fund to prevent misuse. For instance, if your net assets fall below a certain amount, you may enable your team to access the reserve. You should also determine who can approve using reserve funds, such as your executive director, finance committee, or board.
4. Set a timeline for building the fund. A reserve fund timeline keeps your team on track and ensures you build your fund as efficiently as possible. This will likely be a several-year period in which you allocate a specific portion of your budget to the fund each year. If you have surplus funds, you may also contribute them to your fund. Additionally, you can lead dedicated fundraising campaigns to build the reserve.
5. Establish an investment strategy. Investing your reserve funds allows them to grow over time, increasing your ability to prepare for financial challenges. Consider opening a nonprofit brokerage account, which will allow you to invest in stocks, mutual funds, or bonds.
6. Create monitoring and reporting procedures. You’ll want to monitor your reserve fund to ensure it grows over time. You may set regular benchmarks to track the growth of your fund and develop reports that allow you to share updates with the rest of your team.

Once you’ve developed your financial reserve policy, share it with your board to collect feedback. Then, finalize and implement your policy to start preparing for future growth.

Establishing a financial reserve policy empowers your nonprofit to fulfill its mission despite internal or external conditions that may threaten its financial situation. If you need help sorting out policy nuances, building your fund, or managing it, work with a fractional CFO who has experience with nonprofit financial management.