Finance Supplement: Reserve Rules
ASSOCIATIONS NOW, March 2008, Feature Supplements
By: Lisa Junker, CAE
|Summary: By following a few basic principles, you can help ensure your association will have the reserves it needs when it needs them.|
Once upon a time, there was a successful association. It served its members and its mission and saved a little for a rainy day. But when the rainy day came, it turned out the association hadn’t saved enough—and the association couldn’t serve its mission any more.
That brief fairy tale has been all too real for some associations. And running out of money isn’t the only reserves-related crisis that can befall you. Can you have too much in your reserve fund? How do you know if you have too little? And when is the right time—and what’s the right way—to spend some of that money?
Luckily, other association executives have been there before you and returned to tell the tale.
Know How Much You Really Need
Discussions about reserves often begin with, “How much should you have?” Some associations aim for six months of operating expenses, others for a year or more. But according to Dale Karen Silverman, CAE, former executive vice president for the Association of Woodworking and Furnishings Suppliers, “Everybody wants a nice, simple formula—six months, one year. They don’t really understand what you need to custom tailor a reserve for your own organization.”
Or, as Lawrence Merrill, CAE, executive director of the Michigan Townships Association, puts it: “One size doesn’t fit all.”
To begin the process of designing your association’s reserve policy, Silverman says, “Analyze every revenue stream and see which ones are vulnerable to a sudden horrible catastrophe.” For instance, in an association whose primary revenue source is annual dues payments, it’s less likely that there will be an unexpected plunge in revenue. But an organization primarily funded by grants could suddenly lose a large chunk of revenue if one of those grants isn’t renewed.
You should also examine the timing of your incoming revenue streams, says Merrill. “Some organizations, like mine, also have a high degree of multiyear fluctuations,” he says. “Within a four-year cycle, we know we have influxes of revenue from education programs at specific identifiable times, and we use those monies to offset expenditures in future years.”
Merrill also recommends looking at your cash-flow cycle throughout a typical year to ensure you’re planning for sufficient incoming funds to meet your obligations on a month-by-month basis.
Of course, “meeting your obligations” doesn’t have to mean “paying all the bills you’d normally pay.” Kristine Metter, CAE, vice president of administration and operations at the Visiting Nurse Associations of America, says, “A question to consider is what actually composes the ‘core’ operating expenses. Some programs, products, or services might be easy to drop or temporarily suspend and may not need to be counted in ‘core.’ My last employer did this and created a much lower reserve goal than 50 percent of our annual revenue budget.”
Know How Much You Have
Do you know what you have in reserve right now? Your association’s statement of financial position lists a number that, technically speaking, tells you: your total assets minus your total liabilities, also known as net assets. But don’t be fooled into confusing that number with money that’s immediately available in an emergency.
Silverman says, “It’s really important for people to understand how much of the cash in the bank is really a reserve and how much is really not a liability in any way and is truly available.” An example she suggests is an association that recently used a chunk of its reserve funds to purchase a building. While the building is certainly a valuable asset, it won’t necessarily be much help if the association suffers a catastrophic loss and needs ready cash to pay its bills. Silverman says, “I always think of cash reserves—money that’s easily available.”
You Can Have Too Much
For a struggling organization without much (or any) reserve funds, the idea of having too much in reserves might seem like a cruel joke. But an association with too much money in the bank may face questions from members. “That’s predominantly a political problem,” says Merrill. “It’s a better problem to have than too little, but it will be a problem nonetheless.” He does believe that the problem can be greater or lesser depending on where the money comes from; reserves swollen from a windfall donation, for instance, would be more acceptable to members than those coming from a dues increase.
Silverman has seen an association grapple with this issue. At one organization where she worked, donors were enthusiastically supporting the cause—to the point where, even after spending all of the interest generated by their reserve funds, “they were concerned that the reserves were getting pretty darn healthy,” she says.
The organization eventually split off some of their reserve—still leaving behind a fund for emergency use—and created a building fund as well as a facility-improvement fund, which allowed them to buy a building and establish new offices without dipping into operating monies.
The Adhesive and Sealant Council also has reaped the benefits of such strategic reserve funds. President Lawrence D. Sloan, CAE, says, “We added a new strategic initiative to our plan a few years ago that addresses what we as an association can do to grow the industry.” The association has funded research projects, such as examining new methods of nondestructive testing, as well as the development of a new website to educate engineers, architects, and others about the value of adhesives.
An association where Metter worked tapped its reserves to help fund a move from Boston to Washington, DC, that was determined to be in the organization’s best interest. And at the Michigan Townships Association, Merrill says, excess reserves helped his association celebrate its 50th anniversary and invest in new computer hardware and software, among other things.
Metter agrees that reserves can have a dual purpose: “It’s not just to protect against the potential bad things, but it’s also to take advantage of potential good things.” But she encourages associations whose reserves allow for such spending to make sure they think it through first: “If the organization is in the fortunate position of being able to spend reserves for the first time in a number of years, there could be a free-for-all in staff wanting to claim their part of the kitty for new projects or long-awaited opportunities to do something that has always been on their wish list. The board or the finance committee might want to have in place a formal way to evaluate requests for use of reserve money.”
That policy, she says, should align with the organization’s overall strategic goals. It should also weigh whether a proposed new program would require a one-time infusion of cash or longer-term support from reserves. Metter recommends that any new programs launched with reserve money should be required to hit certain performance benchmarks to receive additional “grants” of reserve money. “You don’t want reserves to become a line item in your annual budget,” she says.
Watch the Market
One critical element to a healthy reserve is a healthy relationship with your association’s investment advisors. But the association should be actively involved in monitoring the investments that are made. Prior to Sloan’s promotion to the role of president at the Adhesive and Sealant Council, his organization’s relationship with their investment managers ended badly. “They were very aggressive in the allocations, and we lost some money in the early part of the decade. I think we learned our lesson in paying really close attention to the allocation of the funds,” he says.
Sloan encourages other execs to make sure that a potential investment-management firm “has strengths that match your association’s needs.” In his organization’s case, a firm with a number of small-association clients was a better match than other firms more used to dealing with large organizations.
In addition to having the right partner in your investment advisors, you need to be aware of larger economic trends that might be facing your association’s sector or the larger national or international economy. With a rumored economic downturn facing associations here in the United States, “one may want to adjust the anticipated rates of return in the different pieces of the reserves,” says Sloan. In his association’s case, its core reserves or “rainy-day fund” is typically invested in equities and stocks, while its strategic fund, which is tapped more often, is kept in more conservative vehicles.
Still, as everyone interviewed for this article noted, different associations face different challenges. One sector might be strongly affected by a recession, while another might actually see growth during the same period. Take a good look around your industry before determining the steps you take to prepare for a downturn in the national economy.
Know Your Board
It’s important to communicate with your board about the role and value of reserves. As the saying goes, “nonprofit” is a tax status, not a business model. “If you don’t have a surplus each year, how are you going to fund the development of these special projects?” asks Sloan.
But different organizations have different tolerances for risk. No matter what, says Merrill, “Some of it is going to go to the bedrock values of the individuals who participate on the board.” Sloan has seen the same thing: “As we’ve gone through time, the makeup of the individuals on [the executive] committee has determined the comfort level of the association with regard to risk.”
Silverman recommends addressing risk with the board on a regular basis. “I think it should be brought up as part of the strategic planning meeting every time you have a strategic planning meeting,” she says. The discussion of risk tolerance should take place before any budget discussion, so that budget dollars can then be allocated based on the board’s consensus. A more risk-averse board might wish to put more money toward reserves and less toward expanding the scholarship program, for example.
“At the end of the day, it’s really up to the leadership to feel comfortable—because it really is the membership’s money,” says Sloan. With that in mind, perhaps the most important rule of all is to be sure that your reserve policies are the ones that will most benefit your membership, now and in the years to come.Lisa Junker, CAE, IOM, is deputy editor of Associations Now. Email: firstname.lastname@example.org
|Rate this item:||Comments:|
Dennis Madden , October 08, 2008
This story actually tells you almost nothing a reasonable person wouldn't already know. We all know the "Why?" about reserves. What we what to know is how much? Give a percentage under various circumstances for different types of associations as a guideline. Then you have something.
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