On May 1, 2023, Janet Yellen, the US Treasury Secretary, announced that the US might run out of cash in a month. This should have nonprofit leaders and board members seriously asking themselves how much cash on hand the organization has in the event of an emergency.
Three years ago, the financial wreckage of the pandemic hit quickly so nonprofits without adequate reserves were able to rely on government and foundation grants and the generosity of wealthy donors to make it through the worst phase of the economic downturn.
Yet now with pandemic emergency funding depleted and donors pulling back seeing that the financial slump is lasting longer than expected, nonprofits are learning more than ever the importance of being prepared for emergencies.
The amount a nonprofit should have in emergency reserves is related to a nonprofit’s risk profile. Risk profile is just a fancy term to describe the organization’s ability and willingness to take chances that could lead to losses. To be clear, a risk profile is not “bad” or “good”. It’s merely a measure of how much an organization has to lose should things go wrong in delivering on the mission.
We often recommend nonprofits look at five areas to determine a nonprofit’s risk profile.
A very low-risk profile nonprofit might:
– Be able to replace staff easily,
– Have very uncomplicated program operations and technology,
– Does not require a physical location, and
– Has diverse funding sources.
A very high-risk profile nonprofit might:
– Have many employees with unique knowhow or experience that is hard to replace and/or
– Have many responsible critical to the organization’s survival concentrated with only a few employees,
– Be highly reliant on complicated technology, processes and or regulation to deliver on the mission,
-Need to maintain a physical presence to fulfill the mission and
– be reliant on very few sources of funding.
Determining the amount in emergency reserves is essentially deciding how much it would cost to resolve likely trouble in one of those areas, bringing the organization back to fully operational. This cash amount is typically depicted in the number of months of expenses required.
For example, a nonprofit with a very low-risk profile will require far fewer months of emergency reserve cash— three months as a bare minimum in a strong economy—than a high-risk profile nonprofit, which might want six months to a year in cash on hand.
While there is no exact science to determine the amount of emergency reserves a nonprofit requires to stay resilient, there are simple ways to come up with a pretty good ball-park figure.
The following worksheet is one approach. To complete, check the box of the risk factor that best describes your nonprofit. Then add up the number of checks per column.
A nonprofit with mostly “low risk” factor checks in the far-left column, could probably get away with 3-4 months of expenses in cash. A nonprofit with mostly “high risk” checks in the far-right column, probably should be carrying 6 months or more of expenses in cash.
When using this worksheet, one should recognize some caveats.
First, if your nonprofit has far less in reserves than is recommended by the exercise, no need to be anxious. A growing nonprofit needs to right-size its reserve as it scales or offers more programs and this is probably the case with your nonprofit.
Second, emergency reserves are meant to fund likely problems based on the profile of the organization. Problems like losing a key person, a major donor who stops giving or having to find a new facility. Funds to sustain the organization against more financially devastating or catastrophic events should come largely from insurance. Insurance often does not cover, or isn’t cost effective, for problems that the organization should be able to minimize or resolve on its own.
And third, building a robust emergency reserve is only as good as the focus you give all your nonprofit financial planning. The more you prioritize it, the better off the community you serve will be.
Talk to the financial experts at Fairlight Advisors to learn more about managing your nonprofit’s investments. Schedule a free consultation today!