The question of how much funds a school needs to hold in reserve is a common one. “How much cash should we have on hand for emergencies? Should we set up a capital reserve for building repairs, or should we just pay down our mortgage? When should we start saving for our future expansion project?” The answer to these questions is always “It depends.”
There are typically three types of reserves a school may need:
Operating reserves are the typical rainy-day savings that organizations hold to pay bills and meet payroll when unexpected events happen. These emergency reserves should be distinguished from the normal cash flow management that covers seasonal fluctuations in the timing of grant and tuition payments over the year. Operating reserves are usually held in cash or liquid investments so they are available quickly. The oft-cited rule-of-thumb is that these reserves should equal at least three months of normal operating expenses (excluding amortization expense), but this benchmark may be different for schools with other contractual commitments or new project campaigns. In some circumstances, schools may want more readily available cash. Other schools may have managed to function for many years with minimal emergency funds because their revenues and expenses are very stable and predictable, or perhaps by relying on a line of credit for unexpected expenses.
Capital repair reserves are held for non-routine maintenance and repair of long-term assets. The roof may spring a leak or the school bus is finally beyond repair, and there is often not enough money in the annual budget to fund these large expenses. A capital replacement plan or depreciation report can help manage the timing of some of these costs, but others will be unexpected, and money will be needed in either case. A school that includes at least a portion of amortization expense (a non-cash expense) in a balanced budget can dedicate this cash flow to a capital repair or replacement reserve with relative ease.
Future opportunity or capital replacement reserves are monies held for bigger future projects such as adding classes or replacing the school building. These reserves are often tied to goals set out in the strategic plan and a large portion may come from donors, so they are best kept separate from the usual capital repair reserves due to the external restrictions on the use of these funds.
Having the appropriate reserves in place is important for several reasons beyond the simple management of cash flows:
- Cash reserves allow school administrators and the board to remain focussed on delivering the mission of the school, rather than dealing with recurring financial crises.
- Reserves can be used when strategic opportunities arise that otherwise would be missed.
- Schools with funds in reserve are more likely to get favourable borrowing terms from lenders when the time comes for a big capital project.
- Schools with sufficient reserves may be able to tolerate slightly more risk in their investment portfolios, and therefore generate a higher rate of return.
Should a school accumulate reserve funds when it has a mortgage to pay off? Again, the answer is usually “It depends.” Some form of operating reserve is always a good idea and is largely separate from the capital reserve/mortgage trade-off. Schools with new buildings may not need money for large capital repairs in the near term and can safely devote more funds to pay down their debt and reduce borrowing costs as quickly as possible. Schools with older buildings and a smaller mortgage balance may be wise to allocate more funds to reserves in preparation for major repairs or capital projects. Comparing the rate of return on invested reserves to the interest rate on the debt is also key to this decision.
If they haven’t already, school boards should develop a reserve fund policy setting out:
- which types of reserves the school will have,
- why each type of reserve is necessary,
- what the target reserve amounts are,
- where the money will come from,
- who has the authority to use reserve funds,
- how reserve funds will be invested, and
- how reserve funds are reported to the board and membership.
It is important for the society membership to understand why reserves are necessary and how the school is using them to meet its financial needs. Some charities believe that having too much cash on hand will reduce donor support, and schools may feel that raising tuition to increase reserves is not palatable for parents. However, transparency around the reserve fund policy, along with clear ties to capital and strategic plans, may actually improve buy-in from parents and donors as they see strong stewardship and are more assured of the financial resilience of the organization.
SCSBC Director of Finance
Irvin, Renee A. and Furneaux, Craig W. (2021, November 28). “Surviving the Black Swan Event: How Much Reserves Should Nonprofit Organizations Hold?” Sage Journals: Nonprofit and Voluntary Sector Quarterly. https://journals.sagepub.com/doi/10.1177/08997640211057405