budgeting and building cash reserves

Budgeting and Building Cash Reserves J. Scott Denlinger, CPA Director, CBIZ MHM, LLC Shareholder, Mayer Hoffman McCann P.C.

Overview

• Determining appropriate level of reserves

• Building and maintaining operating reserves

• Budgeting for increases in reserves

• How to create a cash flow budget

• DON’T HESITATE TO ASK QUESTIONS!

The Usual Questions

• How much should we have set aside in reserves?

• How far down should we spend it when times are bad?

• Subject of a lot of discussion

• The answer…

IT DEPENDS

Each Organization Is Unique

Operating Reserve Percentage

• Tells you how much of your organization’s operating budget is set aside in reserve

• Need to calculate the following: – Operating reserve

– Operating expenses

• Calculations among organizations may vary

Operating Reserve Percentage

How do you calculate operating reserves?

• Unrestricted Net Assets – Net Property & Equipment = Operating Reserve

• Deduct other assets? – Prepaid expenses – Inventory – Deposits – Others?

Operating Reserves

How do you calculate operating expenses? • Total Expenses – Noncash Expenses =

Operating Expenses – Depreciation – Amortization – Bad debt allowance? – Deferred benefit plans?

Example

Sample Calculation

What is an appropriate level?

• Minimum of 25%, or 3 months, of operating expenses

• Urban Institute examined the operating reserves of more than 2,500 nonprofits in the Greater Washington area

• 57% had operating reserves of less than three months of operating expenses; 28% of those had no reserves at all.

Factors to Consider

• Type of organization

• Types and diversity of revenue streams

• Peaks and valleys in expenses

• How susceptible the organization is to economic downturns

• Large outlays of cash projected in future?

Factors to Consider

Type of Organization (type of revenue stream) • How predictable is it?

– Grant driven (recurring or non-recurring?) – Membership dues – Special events

• Less predictable – higher reserve

Factors to Consider

Diversity of Revenue Streams

• How dependent are you upon one or a few donors?

• How reliable are those donors?

• Less diversity – higher reserve

Factors to Consider

Peaks and Valleys in Expenses

• Seasonal employees?

• Quarterly or annual publications?

• Annual conference or fundraiser?

• Less predictable – higher reserve

Factors to Consider

Susceptibility to economic downturns

• Dependent upon contributions

– Individual, Corporate, Foundation

• Dependent upon membership dues

– How strong is the industry (small business, oil, medical, etc.)

• More susceptible – higher reserve

Factors to Consider

Large Outlays of Cash Projected

• Upgrading computers or database

• Implementation of new program or service

• Moving to larger facility

• Trade show or conference

• Expanding membership base

Additional Considerations

• What types of reserves

– Emergency

– Expansion

– Equipment

• Determine time frame for building up reserves

Additional Considerations

• To borrow or not to borrow:

– Lines of credit

• How will the organization pay it back?

• Specific purpose (trade show, etc.) vs.

• Operating expenses

Additional Considerations

• To borrow or not to borrow:

– Term loans

• How will the organization pay it back?

• Consider building an intermediate reserve

What’s Appropriate for Your Organization?

Your Board should be involved in these discussions:

• Determine how your organization will define “operating reserves”

– Include Prepaid Expenses, Deposits, etc?

• Determine what level your organization wants to maintain

What’s Appropriate for Your Organization?

Your Board should be involved in these discussions:

• Establish a minimum level that must be kept intact and how it will be replenished if used

• Develop a policy as to how the reserves will be invested – Safety – no big risk

What’s Appropriate for Your Organization?

Your Board should be involved in these discussions:

• Establish how often the reserves will be evaluated (monthly? quarterly?)

– Financial statements

– Investment statements

Potential Obstacles

• Donors

• Staff

• Board

• Desire to fulfill mission

Importance of communication! Effective communication can help navigate obstacles.

Communication with Donors

• Doesn’t energize donors

• Reserves can be viewed as waste or abuse

• Communicate need for long-term reserves

• Stress protection of mission by mitigating risk

Communication with Staff

• May not understand finances

• May be viewed as robbing programs

• Communicate need for long-term reserves

• Engage certain staff in budget process

• Include conversation about risk management as a best practice

Communication with Board

• Same issues as both donors and staff

• Importance of monthly/quarterly review of financial statements

• Communicate need for long-term reserves

• Stress fiscal responsibility - risk management as a best practice

Can you ever be over-reserved?

Public Charities

• Perception by outsiders (donors, watchdog groups, media, etc.):

– Hoarding cash

– Not fulfilling mission

– Additional funding not needed

Can you ever be over-reserved?

Trade Association

• Perception by members:

– Hoarding cash

– Not doing enough to support industry

– Dues are too high

Can you ever be over-reserved?

• More than two years of expenses

• Understand the purpose of the reserves

• Be prepared to communicate

Building Reserves

• Making it part of the budgeting process

• How much per year?

• Similar to thought process for individuals

• Need for cash-flow budget

Building Reserves

• Prepared on GAAP basis – not cash basis

• Includes and excludes items which affect cash flow:

– Property & equipment purchases

– Depreciation

– Multi-year grants

• Need for cash-flow budget

Cash-Flow Budgeting

• Particularly important in economic downturns

• Shows seasonal fluctuations

• Allows evaluation and planning for capital needs

• Aids assessment of long-term borrowing needs

Creating a Cash-Flow Budget

• Operating budget as starting point – Typically Accrual-Basis

• Convert operating budget to cash-basis – Determine level of detail – Review budget line items – Determine line items to be converted – Examples

• Depreciation/amortization • Loan repayments • Fixed asset purchases

Example

Example

Example

Questions

Questions after the session?

J. Scott Denlinger, CPA Director and Practice Lead Outsourced Financial Services Nonprofit Services

Scott has more than 20 years experience in accounting, tax, consulting and auditing.

(301) 951-3636 Ext. 6739 sdenlinger@cbiz.com

Contact: Scott has dedicated much of his career to serving the nonprofit sector. He is the Engagement Shareholder on many of the firm’s larger audits of business and advocacy associations and charitable organizations. On the consulting side, Scott designs and implements outsourced CFO and accounting engagements and assists clients in the preparation of internal financial statements, presentation to their Boards and preparation for year-end audits. Known for his ability to translate difficult accounting concepts into layman’s terms and for his penchant for teaching, Scott is frequently asked to lead seminars and workshops on a broad range of financial management and reporting topics. In addition to his numerous speaking engagements on best practices and financial management, Scott’s involvement in the nonprofit community includes published articles and service on the Board of an organization that helps abused and neglected children.