Understanding Operating Reserves: Essential Guidelines for Associations

Operating Reserves

At AMR Management Services, a common question from both current and prospective clients is: “How much should an association maintain in operating reserves?” The answer is nuanced: it depends. Key factors to consider include:

• Revenue Stability: Are your revenues consistent or unpredictable?
  
  
• Expense Predictability: Are your expenses fixed or variable?
  
  
• Revenue Sources: Does your budget rely on a single event or multiple income streams?

These questions are crucial when assessing your operating reserve needs. However, we can offer some helpful guidelines.

What are operating reserves?

Operating reserves are the association’s excess financial resources, without donor restrictions, that are built up over time.  If an association ends the fiscal year with a budget surplus (without donor restrictions), those funds are considered operating reserves for subsequent fiscal years.  Operating reserves are often displayed as “unrestricted net assets” or “net assets without donor restriction” on the association’s statement of financial position.

While some associations choose to transfer excess funds into separate savings or investment accounts, this is not mandatory. Operating reserves can remain in the general checking account or be transferred into separate savings or investment accounts, or a combination of accounts. These choices should be made collaboratively with the management, governing body, and/or investment advisor.

Why are operating reserves important?

Operating reserves serve as a financial cushion, allowing 501(c)3 and 501(c)6 organizations to:

• Address revenue shortfalls or unexpected expenses without making immediate budget cuts.
  
  
• Provide initial funding for new programs until they achieve financial sustainability.
  
  
• Support special one-time projects that typically require fundraising.

General Guidelines for Operating Reserves

As a best practice, AMR Management Services generally recommends that associations maintain a minimum of 6 to 12 months of operating expenses in reserves. This is a baseline; certain circumstances may warrant higher reserves. For instance, associations planning to expand or associations relying heavily on a few large donors or grants may find it prudent to have reserves exceeding 12 months. Conversely, associations with stable and predictable finances might find 6-12 months sufficient.

Guidelines Based on Reserve Levels

Less than 3 Months

• Avoid budget deficits; analyze budgets and cash flows closely each month.
  
  
• Prioritize financial decisions in response to revenue deficits or unexpected expenses.
  
  
• Refrain from launching new programs unless they are immediately financially viable.
  
  
• Avoid using operating reserves for special or one-time projects.

3 to 6 Months

• Avoid budget deficits; analyze budgets and cash flows closely each month.
  
  
• Short-term programmatic decisions may take precedence over financial ones in response to revenue deficits or unexpected expenses.  Adjust future budgets to prevent recurring deficits.
  
  
• Refrain from launching new programs unless they are immediately financially viable.
  
  
• Avoid using operating reserves for special or one-time projects.

6 to 12 Months

• Minor, non-recurring deficits are manageable; review projections one to two times per year.
  
  
• Programmatic decisions may override financial ones in response to revenue deficits or unexpected expenses.  Adjust future budgets over time to avoid long-term recurring deficits.
  
  
• Be cautious about launching new programs that might reduce reserves below 6 months before they are financially viable.
  
  
• Operating reserves may be allocated to fund special or one-time projects but ensure they do not drop reserves below 6 months.

More than 12 Months

• Budget deficits will not jeopardize long-term financial health; address recurring deficits gradually.
  
  
• Programmatic decisions should override financial ones in response to revenue deficits or unexpected expenses.  Adjust future budgets over time to avoid long-term recurring deficits.
  
  
• The association has the financial flexibility to launch new programs that will become self-sustaining over time.
  
  
• Operating reserves may be allocated to fund special or one-time projects.

Looking for the financial expertise to help your association grow and thrive? AMR Management Services offers a team of accounting and financial management experts well versed in nonprofit financial strategies, including operating reserve policies. Contact AMR for more information.