Reserves and the Recession
By: Stephen C. Carey, CAE
How are your reserves doing?
In recent months, it has become painfully apparent that many associations have strayed from a fundamentally conservative reserves policy, intended to protect member equity, to one of using reserves to grow member equity. Many associations have lost 30 to 60 percent of their reserve lines in the recent downturn as a result of optimistic reserve management policies.
The guidelines below are based on a variety of sources and intended to safeguard your association's equity through the recession and beyond. Based on your association's environment, you may choose to change the percentages outlined below, but to avoid severe risk turbulence in the future, I would not suggest venturing too far astray.
Definition of reserves. Reserves are unrestricted net assets, excluding property, and should be calculated on a consolidated basis, including all organizational sub-units. Reserves can be divided into various funds given the needs of the association, such as a general reserve fund, a building reserve fund, and other funds the association needs to earmark for later use.
Use of reserves. Reserves should be tapped in the following situations:
- To infuse funds for maintaining operations during times of financial or other stress, given a solid plan of action;
- To be used as venture capital or seed money for new programs and services necessary for organization growth and for appropriate multiyear programs and services, to be repaid to the reserve fund if possible when the venture is operational and sustainable;
- To fund necessary, multiyear research, such as needs assessments, market research, or other research with multiyear benefit that cannot be funded from one fiscal year;
- To fund infrastructure requirements that cross several years in service or use and therefore should not be charged to the yearly operating budget, such as IT systems with multiyear impact.
Maintenance of reserves. Reserves should be targeted at a minimum of six months (50 percent) of annual unrestricted operating expense and should be 100 percent funded within a reasonable timeframe. However, be aware that the organization and its environment will change over time. The reserve level should be reviewed annually, balancing the needs of the organization against the desire to achieve the 50 percent target.
Reserve levels should not be permitted to drop below 25 percent of unrestricted annual operating expense. If the budget process or financial projections show that this threshold will be crossed, the finance committee and the board should be informed and management should take corrective action as directed.
Sixty-five percent of the reserve fund should be maintained in cash instruments such as money-market funds, short-term U.S. Treasury Bills, or certificates of deposit, timed to mature somewhat evenly year round. The remaining 35 percent may be invested by a balanced formula in stock, bond, and/or real estate mutual funds, depending on the advice of the organization's independent investment advisor. Investment in any individual stocks or bonds would establish a much greater risk margin and should be off limits.
Annual reserve contributions and withdrawals. The organization should build in an annual contribution to reserves as part of the expense budget. In normal times, nonprofits should budget to contribute between two and five percent of total revenue to reserves, while in financially difficult times, they should budget for a five to 10 percent infusion of reserve funds into the operating budget if needed. (This assumes that downturn years will be substantially fewer than better years.)
Reserve assumptions. No volunteer leader or staff member should have authority to make investment decisions. The executive committee, treasurer, finance committee, and/or board will approve the investment strategy suggested by the organization's independent investment advisor, and the investment advisor should present the board with a summary of the year's activities and future projections at least once per year, and more often as necessary.
- Additional assumptions to keep in mind:
- Appropriate insurance coverage should be maintained to offset revenue losses for events that are at risk (such as event cancellation insurance).
- Revenue sources should remain fairly diverse and relatively balanced in their overall impacts.
- Overall unrestricted operating income should be expected to grow approximately one to three percent per year in normal years and decline by less than 15 percent in challenging years.
Use these guidelines to have a conversation with your board to ensure you have thought through key elements that are important to include in any well crafted association reserve policy.
Stephen C. Carey, Ph.D., CAE, is lead strategist for Association Management & Marketing Resources, Bethesda, Maryland, a full-service association management consulting firm that conducts programs and assessments in the areas of management and staff structural operations, strategic planning, governance, research, marketing, and communications. He can be reached at www.ammr.com.
|Organization:||Association Management + Marketing Resources|
|Description:||This reserve and reserve investment policy has been developed for associations wishing to update their own policies in light of the recent economic downturn.|
|Contact:||Stephen Carey, Ph.D., CAE, email@example.com|
Find similar sample documents under "Finance Tools and Resources: Investment and Reserve Policies" in ASAE & The Center's Models & Samples Collection.