Association for Public Policy Analysis & Management

Financial management theory states that operating reserves should allow nonprofit organizations to smooth out annual imbalances between revenues and expenses, helping to maintain program output in the presence of fiscal shocks or also to allow managers to take advantage of unexpected opportunities. Despite the importance of operating reserves, nonprofits frequently report living on shoestring budgets whereby resource inflows and outflows are tightly matched, and small interruptions can have dire potential consequences. Deficiencies reported by Blackwood and Pollak (2009) and Calabrese (2013) should not be interpreted as a new phenomenon triggered by the economic turmoil that began in 2008; Smith and Lipsky (1993, p. 154) document that nonprofits are essentially prohibited from building up or maintaining reserves and that public agencies that contract with nonprofits in particular look negatively on such reserves.

            Unlike in government research which has an abundance of analyses devoted to understanding the causes and effects of “rainy day funds”, the academic literature has not focused significantly on the topic for nonprofits – despite sectorwide management concerns about the lack of reserves. Calabrese (2013) analyzed why different nonprofits report and manage different operating reserve amounts. This paper analyzes the implications of holding or not holding reserves for nonprofits, with a research question of whether or not operating reserves even matter for nonprofit organizations. Two important policy implications are 1) how operating reserves affect the ability of nonprofits to provide and grow public services as demanded, and 2) whether reserves influence the ability of nonprofits to invest in themselves to grow or improve service delivery (that is, do theories about nonprofit fiscal health matter). In addition, agency theory would also suggest that managers could use excessive reserves for increased perquisites, job security, and other priorities that differ from mission services. Interestingly, despite financial management theory pointing to the obvious benefits of operating reserves, significant numbers continue to operate with no reserves at all. The question about whether reserves even matter remains fundamentally an unanswered empirical issue.

References

Blackwood, Amy and Thomas H. Pollak (2009). “Washington-Area Nonprofit Operating Reserves.” Urban Institute: available at: http://www.urban.org/publications/411913.html.

Calabrese, Thad (2013). “Running on Empty: The Operating Reserves of U.S. Nonprofit Organizations.” Nonprofit Management & Leadership 23(3): 281-302.

Smith, Steven R. and M. Lipsky (1993). Nonprofits for Hire: The Welfare State in the Age of Contracting. Cambridge, MA: Harvard University Press.