The Importance of Cash Reserves

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eveloping and maintaining the financial health of your organization is a critical component of carrying out your mission. Ways to do this include actively managing your cash flow and making sure you have adequate cash to cover unplanned expenses, slow revenue collection or an unforeseen circumstance.

In general, a good rule of thumb is to keep at least three to six months of a reserve balance. For example, if your monthly expenses are $5,000 for ongoing expenses like payroll and employee contributions, a $15,000 reserve balance would be appropriate for your organization. While a larger reserve balance, let’s say $30,000, might sound appealing, it may be unnecessary due to the operational strain created from an aggressive monthly cash allotment.

Determining an appropriate cash reserve depends on several factors, including sources of income, the frequency of those sources of income, the stability of the income, and more.  As a nonprofit organization, make sure you analyze your cash flow for seasonal factors, stability and predictability of the cash flow items. The more stable and frequent your income, the less reserve balance amount you may need. If your income tends to be less frequent and more seasonal, you’ll want to set aside a higher cash reserve balance.

Factors to consider when assessing your reserve needs, include:

  • Revenue stability
  • Revenue predictability
  • Seasonality
  • Rapid growth
  • Unpredictability of revenue and expenses

Furthermore, as you begin to build a cash reserve, make sure that the effort to accumulate the balance does not become a burden to your monthly financial management. In other words, avoid being too aggressive in building up the reserve balance. Your organization will also be better served if you open up a savings account in order to separate the reserve balance from your business checking account. Consider a low-risk, interest-bearing account to hold the cash reserve balance.

Once you have developed the path to establishing a cash reserve, make sure that the organization creates a policy that includes the amount that should remain in the reserve as well as the incremental amounts to set aside in building the cash balance. As part of the policy, include the circumstance(s) where the reserve balance will be accessed and the timeliness of replenishing the balance.

By adopting a cash reserve balance and building on that balance over time, you’ll be well on the path to building a sustainable organization and effectively executing your mission.

Author: James Masias

Want to learn more about how to get your organization’s cash reserves up to snuff? Contact James Masias at James@missionedge.org.

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