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Should My Organization Consider Establishing an Operating Reserve?

The recent Accounting Standards Update (No. 2016-14) issued by the Financial Accounting Standards Board on the Presentation of Financial Statements of Not-For-Profit Entities has increased awareness of liquidity in not-for-profit financial statements. New disclosures required by this standard assist financial statement readers in determining how liquid your organization is, or simply how much cash the organization has to support continued operations. Understanding how much cash an organization has on hand is critical. Even more importantly, cash without donor restrictions. Cash without donor restrictions is used to pay the general operating expenditures (rent, utilities, payroll, etc.) of the organization without having to worry about what its restricted use is. This new standard makes the management of cash even more critical as grantors, contributors, members, etc. will now be getting a clearer picture of how stable and solvent your organization is and if it appears you’ll be around for the long term.

One important tool for an organization’s cash management is the establishment of an operating reserve. An operating reserve is essentially a separate fund established with the accumulation of surpluses without restriction that is available for use at the discretion of the board. It is typically made up of liquid assets (i.e. cash, money market, short-term investments) which increases the ability of an organization to absorb or respond to unexpected but necessary expenses. Many not-for-profits experience uneven revenue streams, unanticipated expense increases, or temporary losses in operating revenues leading to shortfalls throughout the year, which makes an operating reserve essential to giving the organization some financial breathing room. An operating reserve cannot only serve as an emergency fund, but could also be used for seizing new opportunities, starting different programs, or purchasing new equipment or property.

Should your organization consider establishing an operating reserve? Absolutely. With the implementation of the recent accounting standards allowing financial statement readers to scrutinize your financial solvency more than ever, consider the value of establishing and maintaining an operating reserve to strengthen your organization’s financial position. There are several toolkits and guides that are available online that will aid in setting up an operating reserve policy and get the ball rolling for your organization.

If you would like to discuss this further, please contact your local Blue & Co. advisor.

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