Nonprofit Cash Reserves: What To Do with Too Much Cash?
Here are stories of three nonprofits with too much cash and how they handled it. At the end of the post we provide more information about reserves and quasi endowment.
The first organization earns fees from an educational program. They have been profitable for several years and as a result they have accumulated over $1 million in excess cash.
This organization has not taken any actions with respect to their excess funds. The money remains in their operating checking account.
Problems and opportunities:
- FDIC insurance only covers up to $250,000 per customer per bank. $1 million in cash exceeds FDIC insurance limits. Placing some funds with another bank would improve insurance coverage.
- Leaving this much cash in a non-interest bearing account means the organization is missing out on interest income. 2% on $1 million is $20,000 per year!
- The organization may wish to assess programs for more opportunities to serve constituents while maintaining a positive cash flow. For example, could they offer more discounted programs to income-disadvantaged persons? Is there a need for expanded programs – such as by topic or geographic region?
- The organization is missing an opportunity to set itself up for future financial stability by defining a purpose for the funds not currently needed to operate the organization. Read on for more on this topic.
The second organization was the beneficiary of an unexpected bequest about two years ago in excess of $1 million. The bequest was restricted for certain expenses and programs. As a result, they added two new programs and increased staff wages. At the same time, fund development fell by the wayside. There was little incentive to cultivate donors when they had so much cash at their disposal.
Problems and opportunities:
- In the year they received the gift, the profit and loss report showed a huge net income from the one-time windfall. But in subsequent years, the profit and loss report began to show losses as their regularly recurring revenue base was nowhere near their new level of spending. In fact, the organization was setting itself up to completely run out of funds in about three years.
- Possibly the gift could have been structured, at least in part, as a quasi endowment to help support the intended programs, rather treated as a spendable pot of cash which encouraged the organization to ramp up activities to an unsustainable level.
- The organization could have examined the programs supported by the bequest and shifted unrestricted funds and program service fees to other programs or to growing reserves. With strong planning, they could have gradually spent the large restricted gift without throwing the organization into an unsustainable level of spending.
The third organization is a museum with interactive programs for children that charges for admission. They deliberately budgeted for a profit each year for the purpose of increasing cash reserves. Through a combination of profitable programs and efforts to strengthen their base of donor support, over several years they accumulated nearly $1 million in cash.
Problems and opportunities:
- The organization has been able to implement their plan of setting aside funds for both an operating reserve and a capital reserve.
- Hard to find a problem here. The discipline involved in creating a plan and budget to reach a financial goal and working to make that plan a reality has put the organization on a strong, sustainable path.
The purpose of an operating reserve is to provide working capital in the event of a cash shortfall. Working capital is comprised of assets needed to run the day-to-day operations of the organization. Generally speaking, it’s the money needed to fund payroll, pay contractors and other vendors, and provide programs in advance of receiving payment. Organizations need to plan for how they will have enough cash available to meet monthly obligations, especially if cash flow is variable.
Reasons for a Cash Shortfall
A cash shortfall could occur for many reasons:
- An unexpected downturn in income, such as many nonprofits experienced during the last recession
- An expected need such as costuming and set design in advance of tickets going on sale for a theatre production
- The need to spend cash under a reimbursement type grant, especially where the invoice for reimbursement of expenses is not paid timely (a common complaint with government grants)
- An emergency need such as covering the insurance deductible for building repairs after a hurricane
The amount of operating reserves you need depends on your business and comfort levels. A typical goal would be enough to cover three to six months of expenses. Because the point of an operating reserve is to provide immediate access to additional cash, the investments chosen for an operating reserve should be highly liquid, such as a money market account or extremely short term CDs.
After adequate cash is set aside as an operating reserve, the next goal would be setting aside funds for a capital reserve. The museum in example #3 above has a campus with buildings, equipment and exhibits to maintain. Buildings and equipment wear out and need regular repair and replacement. Therefore it’s a good idea to save money for such needs. For example, the museum’s roof may have 15 years of expected life left. Setting aside funds to reroof in 15 years would be a smart move.
Funds set aside as a capital reserve that are needed in the longer term, such as ten years or more, may be invested in securities or other investments that are less liquid and/or that are subject to market risk. For example, a diversified portfolio of dividend paying stocks or a 5-year CD might be prudent choices. We recommend consulting with a professional investment advisor or community foundation in this regard.
After setting aside operating reserves and capital reserves, an organization with excess cash may want to establish a quasi endowment. A quasi endowment works just like a true endowment where a donor makes a gift that must be preserved and where only the investment earnings may be spent. A quasi endowment is sometimes referred to as “funds functioning as endowment.” The key difference is that a quasi endowment may be redirected to another purpose at the board’s discretion. A true endowment is subject to the donor’s restrictions so it does not have this same flexibility.
Endowments, whether true or quasi, typically are intended to be invested for a long time, often forever. As a result, endowment funds are usually invested with professional money managers in investments that are subject to market risk, such as stocks and bonds, to maximize the potential for long term gains.
Be Ready to Manage Excess Cash
Organizations can be ready for an unanticipated large gift by establishing a policy that unrestricted gifts over a certain dollar amount will go to reserves to the extent needed to reach board established goals and any excess will go to quasi endowment. That way there is no temptation to use up the funds in ways that may not be in the best long term interests of the organization.
Plan ahead for excess cash. Even if you don’t receive a windfall bequest or have a wildly profitable program, you can budget for a profit and work toward a positive cash flow. You might just surprise yourself at what your organization can achieve!