• Cash flow shortages which arise when expenses fall due before the income to pay for them is received.
  
  Factors which contribute to cash flow shortages in a balanced budget include seasonal or irregular cash flows (e.g., a summer camp or a theater company which receives most of its cash in a few months of the year, but have to pay bills year round), delays in collecting fees for service, and delays in grant payments or contract reimbursements.
  
  This type of cash flow shortage can usually be uncovered by realistic and careful cash flow budgeting. Questions frequently asked during this process include:
  
  • How much do you usually need to borrow to meet payroll and other ongoing expenses during the course of the year?
    
  • How often do you have to delay payments to vendors? How much are those bills?
    
  • How late is your government reimbursement each month? What is the average outstanding amount at any given time?
    
    
• Cash flow shortages which are caused by the unpredictability of delivering services which are part of the organizationís basic mission.
  
  For example, the Red Cross, which is in the disaster ìbusinessî needs an enormous reserve to accommodate years when earthquakes, floods, and fires all hit at the same time. Money saved for unexpected problems is sometimes called a ìcontingency fund,î and can be calculated either as a percentage of annual expenses or as a percentage of a key fundraising event if you have one. The more past experience you have to rely on when making contingency calculations, the more accurate they are likely to be.
  
  
• Cash flow shortages which are caused by unexpected emergencies, such as the withdrawal of a key funder or the loss of a key asset.
  
  Examples of unexpected emergencies include a fire destroys your site, your heating system needs to be replaced, etc. There is no easy or sure way to predict these kind of cash needs. Factors which contribute to these kinds of emergencies include the stability of funding sources (in general, fees for service or from sale of products and membership dues are considered more predictable and stable than grants and contributions) and the predictability of expenditures (if you have old equipment or other fixed assets there is a higher probability that something will go wrong ìunexpectedlyî).
  
  The more thought you give to anticipating these kinds of emergencies, the easier it will be to cope with them. The types of questions asked to anticipate these situations vary from organization to organization. Some examples include:
  
  • If the fall fundraiser is rained out, how much do you need to tide you over until you can try it again in the spring?
    
  • If a fire destroys your theater and you want to move the play to another venue how much will it take to keep the staff and actors on payroll during the transition? How much will additional rent and publicity costs amount to?
    
  • How many months would it take your organization to get back on its feet in case of disaster? What are your monthly core operating expenses?
    
    
• Cash is needed to start a new program or take advantage of an unexpected opportunity which will significantly contribute to your mission.
  
  You might want to determine what it would cost to implement a pilot project, allowing you to test the concept and show some preliminary results to potential funders.
  
  In addition to a reserve for operating expenses, some organizations may build a reserve for an endowment fund or save money towards a large capital purchase (such as a building or computer equipment.)

Each of these areas should be considered by your board and senior staff to determine how much of a cash reserve is desirable for your organization. There is no one answer to how much of a reserve is ìrightî for nonprofits because the answers to the questions noted above will vary from agency to agency. You might consider each of the points raised above and determine how much of a reserve is needed for your organization. The following example illustrates how to establish an operating reserve goal:

Example 1 - The Helpful Organization

The Helpful Organization has had to borrow $5,000 from the board president for the past two years in order to meet cash flow shortages over the summer. In addition, its current government funder has been predicting cuts of 5-16 percent sometime in the next two years. Its current grant is $35,000.

The Helpful Organization also hopes to start a family literacy program on the weekends which will complement its after-school tutoring program for high school students. One semester of the program is likely to increase its expenses by $7,000. Given these factors, the Helpful Organization might set the following reserve goal:

Cash flow	$ 5,000
Guard against reduced funding - 16% x $35,000	$ 5,600
Investing in new program	$ 7,000
Operating reserve goal	$17,600

Another organization might include in its calculation some percentage of its annual operating expenses. Recommendations on ìhow much is enoughî vary from source to source, ranging from no reserve (from some funders) to up to two yearsí worth of expenses (the maximum acceptable to the National Charities Information Bureau.). You want to balance prudent management, taking into account the factors noted above, with putting your assets to work to serve the community. If you perform the calculations above and your reserves significantly exceed your anticipated needs, it is probably time to discuss how to invest more of those funds into programs serving the community.

Building a reserve requires an operating surplus, or ìprofitî from unrestricted sources during the year to provide extra, or reserve cash. Even nonprofit organizations are legally entitled to show an operating surplus. They may not use that surplus to benefit any member or officer of the corporation, but must use the surplus for their designated mission to the community. Cash reserves do not need to be held in separate accounts. To indicate that the board has set aside money as a cash reserve for operations, the unrestricted net assets on the balance sheet might be divided as follows:

Assets	$35,429
Liabilities	$12,226
Unrestricted Net Assets	$23,203

Board designated reserve	$15,000
Undesignated portion	$ 8,203

An operating reserve, whether it is designated as shown above or simply an accumulated fund balance, is likely to have some impact on your fundraising. Some funders may question your need for their contribution if you have had surpluses from previous years. You will need to explain your policies regarding your cash reserve(s), what factors you considered and why the reserve is there. This will often alleviate a funderís concern that you are accumulating cash at the expense of the people you serve.

In summary, you will need to develop a policy which articulates how much is enough to guard against emergency, invest in new programs, replace or improve capital assets, smooth out cash flows, and put the rest of your cash to work for the community.