Operating Reserves: How Much is Enough?

A few weeks ago, the president of an all-volunteer youth sports league asked me how much operating reserve his organization should have on hand. I started to tell him that most organizations should aim for six months cash on hand, but three months is more common. After all, this is what I’ve heard from non-profits and industry experts (like this one) for years.

Why Standard Ratios Don’t Make Good Operating Reserve Policies

But that wasn’t a good answer for several reasons.

First of all, this organization’s revenues and expenditures all flow through the organization in about five months. So, depending on when you measured the operations, the reserve could either be 100% of the organization’s budget or nothing at all. Using 25% (3 months) or 50% (6 months) of the annual budget also seems fairly arbitrary.

Second of all, this organization’s expenses are primarily variable, and move in direct proportion to revenues. The more kids who enroll in the sport, the more uniforms, insurance and field rentals they need to purchase. Revenue comes in before expenses are incurred and fees are designed to cover the direct costs with a margin. With this model, it would be hard to justify a large reserve.

Finally, the organization already maintains a reserve for capital investments, such as improvements to the fields it rents. These reserves tend to be sizable, and could be tapped in the highly unlikely event that the organization had a significant shortfall.

At the same time, suggesting that the organization carry no operating reserve at all seemed foolish.

A better answer would be “it depends.” While the standard ratios work well for many organizations, others are better off thinking outside the standard ratio box.

Finding an Operating Reserve Number that Makes Sense

In the end, I suggested that the board consider scenarios that would have significant, negative impacts on the organization’s performance. For example, they might consider what might happen if a child was molested by a volunteer in the organization. Or, they might ask what would happen to the organization if we were to go through a major natural disaster. They might also look at what would happen if none of their sponsors renewed. For each of these cases, they should consider what they would need to have on hand to pay for expenses like public relations or legal counsel, cover emergency repairs, or make up for an unforeseen drop in revenue.

Then, based on the outcomes of those conversations, they can select a level of operating reserve that will allow them to survive that type of negative impact. It might end up being 25% of their operating budget, but at least the process they went through to evaluate the need would reflect the actual needs of the organization rather than some ballpark figure. (Pun intended.)

Make Sure to Document Your Policy – and the Process

Your policy regarding operating reserves should be documented. In organizations with a professional staff, having the policy in writing helps to ensure accountability. However, it’s even more critical to document the policy – and the process for getting there – when you are working within an all-volunteer organization.

As an all-volunteer organization, institutional knowledge often leaves as board members turn over. Kids age out of the program, and the leaders who helped create the policies leave. Soon, the organization new board either drops the reserve requirement or forgets how it was developed and makes a random adjustment to the number. Then, when the organization needs the reserve, it isn’t there. Or, they have a reserve that is greater than the amount required to keep the organization afloat through tough times. Documenting the process and policy reduces this risk.

What’s Your Number?

What operating reserve does your organization use? How do you calculate what makes sense? If you have a best practice, please share your thoughts by leaving a comment in response to this blog post!

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