Operational reserves are funds an organization accumulates over the years by operating with a surplus. Consciously building a reserves fund allows the organization to:
- be prepared for the inevitable rainy days
- adjust to seasonal variances in revenue
- seize an unprecedented opportunity when it knocks on the door
Operational reserves demonstrate wise risk management and smart financial planning.
Each nonprofit must determine its own policy for operational reserves. There is no strict formula that applies to all nonprofits and appropriate for every organization. An educational organization looks at this issue from a very different standpoint than a relief organization.
The following questions can help the board with calculating the proper amount of operational reserves for the organization:
- What are our today’s needs vs. future needs?
- Do we have a moral obligation to serve today’s needs or should we consider the needs of our future beneficiaries?
- How secure are our funding sources?
- Do we function in a particularly vulnerable location or is our mission area susceptible to risks and set-backs?
- How important is additional income from investing our reserves?
The board may determine a three-month or a six-month reserve pool is enough. Or, it may calculate more precisely how many months it is possible for the organization to continue functioning without income and set the policy to reflect that goal.
The policy should specify that the board must give the green light before you dip into the reserve fund. Operational reserves are usually considered as board-designated funds.