- Why an NFP needs a cash reserve
- The importance of getting the level right
- Why your NFP must explain the amount decided
Having an adequate amount of cash on hand to cover an emergency is important for not-for-profit organisations (NFPs) as much as for commercial businesses.
Australia's charity sector is about the same size as the retail sector and the nation's second biggest employer. New Zealand has more charities per capita than any other country.
The tricky bit is working out the right level of cash reserves. Too much and people question why the organisation is seeking more funds. Too little and potential donors wonder if the business is viable.
"Too much and people question why the organisation is seeking more funds. Too little and potential donors wonder if the business is viable."
Not-for-profit Cash Reserves, a Business Insight paper published by Chartered Accountants Australia & New Zealand, sets out how to determine the amount. NFPs need to generate a surplus to be sustainable, to invest in staff, assets and services, and to produce cash reserves for unexpected circumstances. Cash includes money in the bank and on deposit and other liquid assets.
Having too high a cash reserve can give the public the impression that more funding is not needed and that the NFP is not fulfilling its essential function. There can also be tax implications in having too high a cash reserve without a specific purpose.
The paper stresses that to demonstrate the organisation's effectiveness, its financial statements should set out how it intends to use the reserve, which may include asset acquisition or replacement.
Having too low a cash reserve can indicate inviability, which can make donors and investors nervous about whether the organisation can fulfil its objectives. Low cash reserves can also render the organisation vulnerable to sudden changes in government policy, and world and economic conditions. They may mean the charity cannot respond to unexpected opportunities or survive unforeseen funding downturns.
In determining the right level of cash reserves, the Insight paper stresses the importance of examining your NFP's particular circumstances and purpose. The factors to consider include its size, its needs and objectives, the types and sources of funding, impending changes in the sector, and the broader economic climate.
Once you determine the level of cash reserves, the financial statements should adequately explain that decision. A large reserve may be the result of years of saving towards a particular long-term project. Conversely, an annual deficit may mean the NFP is run tightly to provide the services for which it was set up.
The financial statements should be thorough and not selective in the good or bad information provided.
Learn more about financial reporting requirements that may apply when you work with charitiesFind out more