Writing a Nonprofit Reserve Policy

Why reserves deserve a written policy

Most nonprofits know they should have some money set aside. Far fewer have written down how much, for what, and who decides when to use it. Without a policy, reserves tend to be whatever happens to be left at year end, and the first serious cash crunch becomes a scramble.

The need is real. The Ontario Nonprofit Network’s 2022 Sector Survey found that 21 per cent of nonprofits had no reserves. When a grant payment arrives months late, a funder changes priorities or the furnace fails in January, an organization without a reserve can be forced into hard choices: cutting programs, delaying payments or borrowing at short notice.

A reserve policy changes that. It turns saving into a deliberate decision made by the board, with a clear purpose, a target and rules for using the money. It also gives staff, funders and auditors confidence that the organization is managed with care.

“A reserve is not idle money. It is the reason a bad month does not turn into a crisis.”

What counts as a reserve

A reserve is money your organization can use freely, set aside on purpose, to protect its work. That definition rules out a lot of money that looks like savings on a bank statement.

• Restricted grants and donations are not reserves. They belong to the purpose the funder or donor specified.
• Money tied up in buildings, vehicles or equipment is not a reserve. You cannot pay staff with a van.
• Deferred revenue, such as a grant received in advance for next year’s program, is not a reserve. It is already spoken for.
• Money owed to suppliers or government is not a reserve, even if it is sitting in your account today.

The Charity Commission for England and Wales offers a helpful model in its guidance on charity reserves, written for charities there but practical anywhere. It describes reserves as the part of a charity’s unrestricted funds that is freely available to spend on any of its purposes, and it excludes fixed assets used to carry out the charity’s activities and funds designated for essential future spending.

Types of reserves

Many organizations hold more than one kind of reserve, each with its own purpose. Naming them separately makes the policy clearer and stops one pot quietly doing another’s job.

Small organizations usually start with an operating reserve and a cash flow buffer. The others can come later, once the basics are in place.

If you name more than one reserve, give each its own target and its own rules. A capital reserve that gets raided every winter to cover a late grant is no longer a capital reserve.

Restricted, designated and unrestricted money

Reserve conversations get muddled when people use the same words for different things. Three categories are worth separating:

• Externally restricted money comes with conditions set by a funder or donor. Only they can change those conditions.
• Internally restricted or designated money has been set aside by your board for a purpose. The board can change its own designation, following the policy.
• Unrestricted money can be used for any purpose within your mandate. Your reserves come from here.

Board-designated reserves are a choice your board makes, not a legal restriction, which is exactly why the policy matters. It records the decision, the reasons and the rules, so the next board and the next executive director understand them.

Talk to your accountant about how your reserves should appear in your financial statements, for example as internally restricted net assets, so the presentation matches your policy and your auditor or reviewer is not surprised.

How much is enough?

There is no single right answer. The Charity Commission’s guidance puts it plainly: there is no single level, or even a range of, reserves that is right for all charities. The right level depends on your income, your commitments and your risks.

For a Canadian reference point, the Ontario Nonprofit Network has written that most nonprofits have reserves somewhere in the three to six months range, and it encourages organizations with bigger plans, such as a capital project, to justify larger reserves in a documented policy.

Factors that push your target higher:

• Income from one or two large funders, or income that arrives in a few large payments
• Grants paid in arrears, after you have already spent the money
• High fixed costs, such as a lease or permanent staff
• Programs that would be hard to pause without harming the people you serve
• Known risks in your risk register that would cost money to manage

Factors that can justify a lower target include steady monthly donations, diverse income, low fixed costs and reliable access to short-term funding. A strong monthly giving program or a well-diversified mix of revenue, covered in our revenue diversification guide, reduces the risk your reserve has to cover.

How to calculate your reserve target

A simple, defensible approach combines a months-of-expenses base with specific risks you can name.

1. Find your monthly operating cost. Take your annual operating budget, leave out one-off and non-cash items, and divide by 12.
2. Choose a base number of months. Decide how long you would need to keep going while you replace lost income or adjust plans.
3. Add named risks. Estimate the cost of specific risks, such as a lease you could not exit quickly or a program you could not pause.
4. Add planned commitments. Include known future costs the reserve is meant to cover, such as replacing equipment.
5. Set a timeline. Decide how many years it will realistically take to reach the target.

The example is not a recommendation. It shows how to turn your own numbers into a target the board can explain to anyone who asks.

Measuring what you have now

Once you have a target, you need a consistent way to measure progress. A common measure is months of operating reserves:

Months of reserves = available unrestricted net assets divided by average monthly operating expenses

Available unrestricted net assets means unrestricted money you could actually use: leave out amounts invested in buildings and equipment and anything already designated for another purpose. Agree the exact definition with your treasurer and accountant, write it into the policy and use it the same way every time, so the board is comparing like with like from one report to the next.

Registered charities and the disbursement quota

If your organization is a registered charity, reserves need to be planned alongside the Canada Revenue Agency’s annual spending requirement, the disbursement quota. CRA describes it as the minimum amount a registered charity is required to spend each year on its own charitable activities or on qualifying disbursements.

The quota is based on the value of property not used for charitable activities or administration. According to CRA’s calculation guidance, the rate is 3.5% of the average value of that property up to $1 million, and 5% on the amount above $1 million. It applies when that property is worth more than $100,000 for a charitable organization, or $25,000 for a foundation. CRA’s examples of included property include cash in bank accounts, GICs, stocks, bonds and mutual funds.

In practice, money you hold as a reserve may count toward the property used to calculate your quota. Separately, CRA says that as of January 1, 2023 it no longer reviews or grants requests to accumulate property, so new reserve plans cannot rely on that permission.

None of this means charities should avoid reserves. It means the reserve policy and the spending plan need to be built together. Our guide to charity compliance in Canada covers the wider annual obligations.

Nonprofits that are not charities

Many organizations are nonprofits but not registered charities, and the questions are different. If you are not sure which you are, our guide to nonprofit vs charity in Canada explains the difference.

For nonprofits that are not charities, the Ontario Nonprofit Network has written that CRA has repeatedly said nonprofits are entitled to budget for a reasonable reserve. It points to archived CRA guidance that treats reasonableness as a question of fact, depending on things like future anticipated expenditures and the pattern of the organization’s income.

The practical lesson is the same as for charities: document why you hold the amount you hold. A written policy that connects the reserve to your purposes and your real costs is far easier to explain than a surplus that simply grew. Get qualified advice on how the rules apply to your organization.

What your reserve policy should include

A useful policy does not need to be long. It should be specific enough to guide decisions and simple enough that a new board member can understand it in one reading.

The Charity Commission’s guidance says a reserves policy should justify and clearly explain keeping, or not keeping, reserves, and plan for maintaining essential services for the people the charity serves. Those two tests are a good check for any Canadian policy too.

Deciding who can use the reserve

The most important clause in the policy is often the one about authority. Who can say yes to using the reserve, and how fast?

One workable approach gives the executive director limited authority for genuine emergencies, with a dollar limit and a requirement to tell the board chair and treasurer right away, and requires a board decision for anything larger or not urgent. The board then receives a short report: what happened, how much was used and the plan to rebuild.

Write down what counts as an appropriate use. Covering payroll during a delayed grant payment probably qualifies. Covering a planned deficit year after year does not. That is a budgeting problem, not an emergency.

Clear roles make this easier. Our guide to board and staff roles covers how to divide responsibilities so decisions like this do not stall.

A scenario: the late grant payment

A made-up example shows how the pieces work together. A community organization with a monthly budget of about $50,000 learns in June that a grant payment expected in July will not arrive until October.

Without a policy, the executive director spends a week phoning board members, nobody is sure who can approve what, and supplier payments start to slip. With a policy, the executive director uses the emergency authority to draw on the cash flow buffer, tells the chair and treasurer the same day and brings a short report to the next board meeting.

When the grant arrives in October, the money goes straight back into the buffer, as the replenishment clause requires. The board sees the reserve back at target in the next finance report, and the program never paused. That is the whole point of writing the policy before you need it.

Rebuilding the reserve after you use it

Using the reserve is not a failure. That is what it is for. The failure is using it and never rebuilding it.

Your policy should set out how the reserve will be replenished: for example, by budgeting a set amount each year until it returns to target, or by directing a share of any year-end surplus or unrestricted bequests to the reserve. Set a realistic timeline, and have the board review progress at each finance report.

If the reserve was used because of a lasting change, such as losing a major funder, rebuilding it is not enough on its own. The board also needs to adjust the budget or the plan, so the same gap does not open again next year.

Building a reserve from zero

If your current reserve is close to nothing, the goal can feel out of reach. Start smaller than you think.

• Set a first milestone, such as one month of operating costs, before the full target.
• Budget for a small surplus each year, and say in the budget that it is for the reserve.
• Recover your real costs in grant budgets, including a fair share of administration, so programs are not quietly subsidized by your unrestricted money.
• Direct a share of unrestricted windfalls, such as a bequest or an unexpected gift, to the reserve.
• Keep reserve money in a separate account so it is not spent by accident.

Our guide to building a grant budget covers how to include fair administrative and overhead costs, one of the most reliable ways to free up unrestricted money over time.

Where to keep reserve money

Reserve money needs to be safe and available when you need it. An operating reserve locked into a long-term investment it cannot easily leave defeats its own purpose.

• Keep operating reserves and cash flow buffers in accessible, low-risk accounts.
• Match the timing of any investment to when the money might be needed. A capital reserve for a purchase years away can be planned differently from emergency money.
• Follow your board-approved investment policy, and check your governing documents and incorporating legislation for any limits on how the organization can invest.
• Keep records that show which money belongs to which reserve.

If you hold significant sums, get advice from a qualified financial professional who works with nonprofits, and remember that registered charities need to consider the disbursement quota when planning investments.

Talking to funders and donors about reserves

Some boards worry that funders will see reserves and decide the organization does not need support. A clear policy changes that conversation. The Charity Commission’s guidance notes that a good reserves policy can give confidence to funders by demonstrating good stewardship and active financial management.

Be open about what you hold and why. Explain the target, the reasons for it and what the reserve protects, for example in your annual report. When reserves are high, the same guidance warns charities not to misrepresent the urgency of their need for funds, which is good practice everywhere.

If a funder asks why you hold a reserve, the honest answer is usually the strongest: it is how you make sure the programs they fund keep running when something goes wrong.

When reserves are too high or too low

Both extremes need attention.

The Charity Commission’s guidance suggests that charities with low reserves should plan to build them or explain how they will manage the risk, and that charities with high reserves should make sure they do not misrepresent their need for funds. Either way, the answer is a decision, recorded in the policy, rather than drift.

A sample reserve policy outline

Use this outline as a starting point and adapt it with your board, treasurer and accountant. The wording and the bracketed amounts are placeholders.

• Purpose. [Organization] holds reserves to protect its programs and people from unexpected loss or delay of income and to meet planned future costs.
• Definition. Reserves are unrestricted net assets, excluding amounts invested in capital assets and amounts designated for other purposes.
• Target. The operating reserve target is [X] months of average operating expenses, plus [named risks], to be reached by [year].
• Use. The executive director may use up to [amount] in an emergency, informing the chair and treasurer within [number] days. Any other use requires a board resolution.
• Replenishment. After any use, the board will approve a plan to restore the reserve within [timeframe].
• Reporting. The treasurer reports reserve levels against target at each board meeting.
• Review. The board reviews this policy at least once a year.

Common mistakes

• Counting restricted money as part of the reserve.
• Measuring from the bank balance instead of the financial statements.
• No rules for using the reserve, so it gets spent on routine shortfalls.
• No plan to rebuild after it is used.
• Copying another organization’s target without checking your own risks.
• Forgetting the disbursement quota if you are a registered charity.
• Writing the policy and never reviewing it.

Most of these come from treating the reserve as a number rather than a decision. A policy that names the purpose, the rules and the review cycle prevents nearly all of them.

Reviewing and reporting

A reserve policy only works if the board sees the numbers regularly. Report actual reserves against target at each finance update, and look at the trend, not just the latest figure.

Review the policy itself at least once a year, as part of budgeting or strategic planning. The Charity Commission recommends that trustees review their policy at least annually and monitor the reserves actually held throughout the year. Revisit the target whenever something important changes: a new major funder, a lease, a new program or a change in risk.

Reserves sit inside your wider financial management and risk planning. Our guides to nonprofit financial management and nonprofit risk management show how the pieces fit together.

Getting started this month

You do not need a perfect policy to begin. A good first version, approved by the board and reviewed next year, beats a perfect draft that never reaches a meeting.

• Pull your last financial statements and calculate your current months of reserves.
• List the three or four risks that would hurt most if they happened next quarter.
• Draft a target and a timeline, using the steps above.
• Write the authority and replenishment rules.
• Bring the draft to your finance committee or board for discussion.

If your strategic plan is due for a refresh, build the reserve target into it. Our strategic planning guide explains how to connect financial goals to the bigger picture.

Frequently asked questions

What is a reserve policy for a nonprofit?

A board-approved document that sets out how much unrestricted money the organization aims to hold in reserve, why, what it can be used for, who can authorize using it and how it will be rebuilt.

How much should a nonprofit have in reserves?

There is no single right level. Base the target on your income patterns, fixed costs and risks. The Ontario Nonprofit Network has written that most nonprofits hold reserves somewhere in the three to six months range.

Can a registered charity in Canada hold reserves?

Charities do hold reserves, but they need to plan them alongside the disbursement quota. Cash and investments not used in charitable activities or administration can count in CRA’s quota calculation, so review your plans with an accountant.

Can a nonprofit that is not a charity keep a surplus?

The Ontario Nonprofit Network has written that CRA allows nonprofits to budget for a reasonable reserve, with reasonableness depending on the organization’s circumstances. Document your reasons in a policy and get qualified advice.

Is restricted funding part of our reserves?

No. Money restricted by a funder or donor belongs to the purpose they specified, so it cannot be counted as a general reserve.

Who should approve using reserves?

The board sets the rules in the policy. One workable model gives the executive director limited emergency authority up to a set amount, with larger or non-urgent uses requiring a board decision.

How often should we review the reserve policy?

At least once a year, and whenever something significant changes, such as a major funder, a lease or a new program. Report reserve levels against target at each board finance update.

Where should a nonprofit keep its reserves?

Operating reserves belong in accessible, low-risk accounts kept separate from day-to-day money. Longer-term reserves can be invested according to a board-approved investment policy and your governing documents.