A Risk-Based Approach to Managing Reserves
In one sense, managing reserves is about stability — having enough to handle unexpected operating expenses, or providing an extra financial cushion to cover for down years. Reserves also help ensure sustainability, helping associations keep up with new technologies, demographic shifts, developments in the labor force, legislative and regulatory changes, shifting competitive landscapes, or cultural and lifestyle trends. For all these reasons, it is vital that association boards devise strategies for managing reserves. “Ultimately, an effective reserve strategy is about creating a more vibrant and sustainable organization, now, and into the future,” says Nat Bartholomew, principal-in-charge, associations and membership organizations at CliftonLarsonAllen, an accounting firm that serves some 8,000 nonprofit organizations. “That’s what reserve modeling is all about.”
Operating and Strategic Reserves
There is no one blueprint for how all associations should manage their reserves. As Bartholomew says, “If you’ve seen one association, you’ve seen one association.” But as a rule, an association should have reserves of between a half a year and a full year of operating expenses. Where an association is on that spectrum depends on a lot of factors specific to the organization.
Reserves are the monetary net assets of the association (assets minus liabilities equals net assets). Part of those net assets or reserves should be set aside for operating expenses, funds used to navigate the year-to-year peaks and valleys of the existing programs and expenses. For example, in one year meeting revenue might be up due to the location of the meeting. In another year it might be down. Operating reserves are necessary to fuel the association through those ups and downs.
The other major portion of the net assets is strategic reserves, or board-designated reserves. But what is the best way to decide the amount of strategic reserves needed?
Examining the Risks
Bartholomew recommends a risk-based approach to managing strategic reserves. It involves using data to examine the financial risks to the value proposition of the association, and then using that data to more effectively manage reserves.
That process starts with examining the value proposition that the association provides members. “What did members join the organization for?” asks Bartholomew, who sits on the board of the American Society of Association Executives. For some associations, one of the things members most value might be advocacy — working to challenge or change laws or regulations in the public policy arena. For some, perhaps medical or scientific groups, maybe it’s about publishing research that advances the field. For others, the value may be centered around education or certifications. Outlining that intrinsic value that sets the organization apart is the starting point for a risk-based approach.
Next, boards should define the risks to the essential values that the association provides. Are there risks that could be posed by potential new laws or regulations? Maybe there are demographic shifts in the offing that could impact a particular program? Perhaps there is operational risk to a specific program due to outdated technology. Of course, the risks are going to be different for each association because the value propositions are different for each association.
After the risks are defined, the next step in the process is to determine the likelihood and timing of each of those risks occurring. The board needs to consider when might each risk impact a program. One risk might pose an immediate concern, while another could have an impact down the road. This analysis will shed light on how urgently the board needs to address each of these risks, and — of course — shed light on how to manage reserves.
So, for example, if one of the primary values is education, what are the risks to the association’s ability to continue offering quality and relevant education to its members? In that area, maybe the board determines that there is a long-term risk of increased competition from another nonprofit or for-profit provider in the space down the road. In that case, the board may want to set aside a certain amount of reserves to broaden its capabilities or offerings if the need arises. Or maybe there is the possibility of a new regulation that will negatively impact the association and therefore requires immediate attention.
Assessing the Financial Impacts
Next, the board should estimate the potential financial impact of each risk. Board members should ask: If this risk were to impact us, what would be the financial need? Assets should be set aside appropriately, keeping in mind that some may be for short-, intermediate, and long-term needs. As part of this calculation, the board should also assess whether there are alternative funding opportunities that it could use instead of reserves, like for example, insurance.
The board should then communicate with management that reserves are set aside to potentially spend on targeted initiatives, each with specific time horizons. “I’ve seen associations purchase for-profit companies, develop online publications or magazines, launch certification or education programs, create audio visual studios to produce online education, and start insurance programs,” says Bartholomew. All were fueled by reserves. “It all depends on the association.” The world changes quickly, so strategies must do the same. That’s why boards need to revisit their strategic reserves each year to make sure they are still appropriate, or to determine if they need to be shifted in any way. Of course, it may be that a potential risk that the board had identified does not occur for some reason — changes in laws, demographic shifts, technology, or something else — in which case the reserves would no longer be required for that purpose and could be designated to other uses.
Using data to determine the risks, analyzing the time horizon for their occurrence, and assessing the financial impact of those risks will allow the board to most effectively manage reserves in a way that anticipates the needs of its members and sets the association on a path forward. This is but one approach to managing reserves. But whatever methodology a board uses, it’s essential that part of the strategy looks forward to future challenges and opportunities. “Board members need to make the organization better than the day they arrived. That’s always the goal,” states Bartholomew.
NOVEMBER/DECEMBER 2017 EDITION
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