Lead your nonprofit to greater financial security with a contingency fund
Nonprofit Boards of Directors have fiduciary responsibility for their respective nonprofit organizations, but what does it look like to fulfill this commitment at the highest possible level? It means more than compiling a budget or signing off on taxes; it means integrating sound financial thinking into every aspect of board governance to ensure the financial health of your organization long-term. One critical aspect of this responsibility is the mitigation of risks. In this post I’ll share how you can mitigate financial threats to your nonprofit by establishing, growing, and managing an adequate contingency fund (aka cash reserve).
Why are cash reserves important?
If your nonprofit made it through two years of a pandemic without a contingency fund, you may be thinking “We already made it through the worst. Do we really need this?” My answer is a resounding “yes.”
Certainly, a contingency fund can help you handle unexpected financial obligations outside the range of your usual operating budget, such as paying for masks for your entire volunteer staff. However, a contingency fund is about much more than the next global crisis. It is also there to help you pay for essential items/services without interruption in the event of an existential threat or emergency, such as a sudden loss of revenue.
Consider the following scenario:
Fifty percent of your organization’s revenue is based upon the donation of one major partner. This partner has been loyal and consistent over the years, but due to economic pressures, is suddenly unable to make the donation this year. All at once, your organization is facing an income shortfall that you will be hard pressed to immediately replace.
With a strong cash reserve, your organization can continue to function while other sources of income are secured.
How much do we need?
As a rule of thumb, healthy organizations should have enough money in reserve to cover typical (budgeted) expenses for three to six months. At the high end, reserves should not exceed the amount of two years' budget. At the low end, reserves should be enough to cover at least one month’s full expenses.
Your board should ensure that there is an amount in reserve large enough to protect the organization from a bad fundraising year or an unexpected crisis (and if anything is the hallmark of the 2020s so far, it is an unexpected crisis).
How do we get started?
Creating a contingency fund should begin with your Board of Directors adopting a cash reserve policy. A policy appropriate for your nonprofit might include:
how much money you will set aside to protect the organization from unforeseen financial issues,
the types of circumstances that will result in assets from the reserve fund being used,
the process by which the board will make the determination whether to dip into reserves,
the process and timeframe for repayment into the reserve account, and
whether there should be any directives or restrictions on how the reserve money may be used.
Once the policy and procedures are in place, your organization will need to find or raise the money to place in reserve. There are many ways to build a reserve fund, even in difficult financial times. An organization can use unexpected (and un-budgeted) gifts to create a reserve fund. Any overage in the operating budget at the end of the fiscal year can be directed to the reserve fund. Some nonprofits earmark a certain percentage of each donation the organization receives for the reserve fund, while others look to their board members to create a reserve fund through outright gifts.
Whatever the method, be sure to have a system in place to gather and segment these funds so that they are secure and ready when you need them.
Is it only for a rainy day?
A contingency fund is primarily about accountability to your funders and protecting your ability to serve your community and constituents. However, it can also be used to take advantage of a sudden opportunity that may not have been included in your budget. As you define your reserve fund policy, you may also want to consider this possibility.
Board members, I encourage you to be amongst the most forward-thinking of your peers by starting a contingency fund, growing your existing fund to a more sufficient level, or fine-tuning your policies around it. Now is the time for your nonprofit to prepare for the next financial challenge – or opportunity – that may come your way.
More Than Giving Co. consultants can help you develop a contingency fund policy — or make other moves to increase your nonprofit’s financial sustainability and capacity. Reach out to us to discuss your particular needs.