Poster Paper: Do Nonprofit Organizations Need a Rainy-Day Fund? Nonprofit Operating Reserves and Financial Vulnerability

Thursday, November 6, 2014
Ballroom B (Convention Center)

*Names in bold indicate Presenter

Min Su, Georgia State University
How long could an organization continue to fulfill its mission if there were an unexpected revenue loss or surge in demand for services? This is an important question to all nonprofit leaders and managers. This question becomes even more critical during economic recessions. Operating reserves, also called rainy-day funds, are the proportion of unrestricted net assets that are available for use in emergencies to sustain financial operations in the unanticipated events of significant unbudgeted increases in operating expenses and/or losses in operating revenues. Operating reserves are used as a financial management tool to keep an organization afloat in the event of unforeseen circumstances when revenue cannot meet the expenses. It has been demonstrated that maintaining a certain level of operating reserves is a sound financial management practice in the private and public sectors. In the nonprofit sector however, leaders and managers are often under pressure from charitable rating agencies, donors, and the popular press to spend rather than save. Therefore, it is not surprising to see that nearly 30 percent of charities had no operating reserves and 60 percent of charities had operating reserves of fewer than three months of expenses.

Much of the existing nonprofit financial management literature focuses on how nonprofit organizations bring in revenue from various financial sources, such as fundraising, donation, capital campaign, and so forth. Less attention has been paid to how nonprofit organizations allocate their existing financial resources, and how to balance spending and saving. My study examines nonprofits’ saving behavior and the impact of nonprofits’ operating reserves on nonprofit organizations’ financial conditions—whether nonprofit organizations’ operating reserves mitigate nonprofit organizations’ financial vulnerability.

I use the SOI financial data between 2001 and 2011, which covers two periods of economic recessions. The dependent variable is nonprofit financial vulnerability. A nonprofit organization is defined as financially vulnerable if it reduces its expenditures on programs by more than 20% for three consecutive years. The primary independent variable is operating reserve ratio. It is calculated by using operating reserves divided by the annual expense budget. Key control variables include those factors that have been examined by previous researchers that they may have significant impacts on the financial condition of nonprofit organizations. Those are: revenue diversification, program expense ratio, short-term leverage ratio, sector, donative organization, and log of assets. A fixed effects regression will be employed to address the omitted variable bias problem and also to control for other unobserved factors. The explanatory variables will be lagged one year to mitigate potential endogeneity concerns.

This study contributes to the nonprofit financial management literature by examining the impact of maintaining operating reserves on nonprofits’ financial conditions that has not attracted much research attention. I expect the results from this study will provide recommendations to nonprofit management, especially to board members and managers seeking sound financial management practice and the sustainability of their organizations.