Maintaining adequate reserves is essential to establishing financial stability. These reserves provide a cushion to deal with operating deficits that may arise due to unexpected events, economic uncertainties, lean funding periods or opportunities for strategic investment. This presentation offers Grant Thornton’s latest thinking on how to establish appropriate reserves levels and our methodology for developing a sophisticated and robust risk-based approach to establishing a reserves policy within your organization.

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Reserves planning
Determining the appropriate level of reserves
for your organization
Original Broadcast Date: October 2013
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2. Presenters
Mark Oster
Matt Unterman
National Managing Partner
Not-for-Profit and Higher
Education Practices
Senior Manager
Not-for-Profit and Higher
Education Practices
Joe Mulligan
Manager
Not-for-Profit and Higher
Education Practices
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2

3. Reserves planning
Learning objectives
• Explain the importance of reserves planning in
today’s not-for-profit environment
• Describe how to use key financial modeling and
risk analysis techniques to determine an
appropriate reserves level for your
organization
• Identify how to best implement a
reserves policy
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3

4. Reserves planning
Agenda
• Introduction
• Approach to determining “appropriate”
• Implementation considerations
• Questions/Comments
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4

5. Reserves planning
Agenda
• Introduction
• Approach to determining “appropriate”
• Implementation considerations
• Questions/Comments
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6. Introduction
What are reserves?
• Rainy day fund to bridge cash flow needs
• Insurance to maintain financial solvency and mitigate risk
• Cash on hand to fund new activities – unbudgeted required
initiatives or unexpected opportunities
• Hedge against inability for timely adjustments to operations
in response to negative events
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7. Introduction
What are reserves? Our definition…
• An organization’s financial reserves are a discrete subset of
its net liquid assets. They are a distinct pool of assets that
an organization can access to do the following:
– Mitigate the impact of unbudgeted, undesirable financial events
– Pursue opportunities of strategic importance that may arise in
the future
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8. Introduction
What types of assets qualify as “reserves”?
• Factors that determine which assets can be counted toward
“reserves” include the following:
– Liquidity
– Freedom from any corresponding liabilities
– “Unrestricted” with regard to donor intent
• Specific examples of assets that would not be considered
reserves would include the following:
– Plant, property, and equipment
– Endowments and board-designated funds
– Pension plan assets
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9. Introduction
Challenges and issues
• Addressing criticism for “hoarding funds”
• Keeping expectations in check on how and when funds
may be spent
• Maintaining continuity in fiscal practices during periods of
transition or turnover
• Cultivating a culture of long-term
sustainability; avoiding knee-jerk responses
• Substantiating that the reserves amount is appropriate and
providing rationale
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10. Introduction
How organizations determine their reserves levels
• Conventional wisdom and limited tools
– Number of months operating expenses
– Liquid net assets as a percentage of budget
– Specific dollar level
• Your organization is unique and your reserves level should
be, too!
– Each organization has a unique business model, risk exposure
and financial circumstances
– The level of assets that are set aside to mitigate risks should
vary from organization to organization
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11. Introduction
How organizations determine their reserves levels
• Generic rules of thumb are somewhat simplistic and could
result in the following:
– Underserving organizations and constituents
– Higher borrowing costs associated with underfunded reserves
– Forced abandonment of strategic investments
due to lack of expendable resources
– Hard-to-defend position; poor optics
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12. Reserves planning
Agenda
• Introduction
• Approach to determining “appropriate”
• Implementation considerations
• Questions/Comments
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13. Approach to determining “appropriate”
Step-by-step process
1. Develop a baseline long-term financial forecast
2. Perform a detailed analysis of potential risks
3. Quantify your average annual risk exposure
4. Establish your target reserves level and funding
approach
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14. Approach to determining “appropriate”
Step-by-step process – benchmarking?
Note: Our recommended approach does not include
benchmarking to peers. Why not?
• Beware of the pitfalls of benchmarking:
− Two wrongs don’t make a right and more/less
doesn’t mean better/worse
− Similarities only go so far (risks, impact to
organization, etc.)
• May be performed for change management purposes
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15. Approach to determining “appropriate”
1. Develop a baseline long-term financial forecast
• Several purposes to financial modeling
– Establish a “baseline” – anticipated future performance and
financial position
• Understand financial dynamics of the organization and
engage in dialog regarding drivers
• See trends that are not evident in annual budgets
– Link risk model to financial model
– Identify needed reserves derived from risk analysis
– Validate ability to fund determined reserves level
– Use as ongoing tool to “adjust” reserves level as circumstances
require
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16. Approach to determining “appropriate”
1. Develop a baseline long-term financial forecast
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17. Approach to determining “appropriate”
1. Develop a baseline long-term financial forecast
• Explore the following questions:
– Given your current operations and programs, what level of
margin/reserves do you anticipate generating?
– Can this be altered by modifying your underlying business plan
(revenues and expenses)?
– What impacts to your financials may occur due to external
events and internal decisions?
• Generate a solid understanding of your future financial
picture
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18. Approach to determining “appropriate”
2. Perform a detailed analysis of potential risks
Purpose:
To build consensus among management and the board on the
risks that may affect the organization, the financial impact
those risks could have, and their likelihood of occurrence
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19. Approach to determining “appropriate”
2. Detailed risk analysis – types of risks to consider
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20. Approach to determining “appropriate”
2. Detailed risk analysis – recommended steps
• For each line of business and the organization as a whole,
work with “owners” to identify risks that have monetary
impact
– Analyze all key budget line items (i.e., revenues and expenses)
where variance from plan could have a material impact on the
organization’s financial performance
• Define scenarios for each risk with associated likelihood of
occurrence to establish a “range” of outcomes
– Include recurring, multiyear, and one-time risks
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21. Approach to determining “appropriate”
2. Perform a detailed analysis of potential risks
• Shortfalls in financial performance (i.e., underperformance
or undesirable deviations) can occur due to:
– Factors beyond control within the organization’s operating
environment
– Forward-looking predictions regarding the organization’s ability to
execute
– External influences
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22. Approach to determining “appropriate”
3. Quantify your average annual risk exposure
• For each risk that you have identified, determine potential
monetary impacts over a time horizon
– Use financial model as input
– Calculate all downstream results of identified risk
• Calculate Net Present Value (NPV) based on likelihoodadjusted impact by year
• Use NPV to calculate average annual risk exposure
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23. Approach to determining “appropriate”
3. Quantify your average annual risk exposure
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24. Approach to determining “appropriate”
3. Quantify risks – linking financial model
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25. Approach to determining “appropriate”
3. Quantify risks – revenue example
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26. Approach to determining “appropriate”
3. Quantify risks – expense example
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27. Approach to determining “appropriate”
3. Quantify risks – NPV/risk summary
Then, calculate average annual risk exposure by dividing NPV
by number of years in financial model.
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28. Approach to determining “appropriate”
3. Quantify risks – challenges
• Building consensus can be challenging
− Risks
− Impacts
− Probability
• If the underlying assumptions are sound, good
approximations can be made in the aggregate
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29. Approach to determining “appropriate”
4. Establish your target reserves level and funding approach
• Once we estimate the organization’s anticipated average
annual risk exposure, we must then determine how much
risk funding to maintain on hand
• Such a decision should consider the following:
• Likelihood of a higher-than-average risk year
• Timeline required to identify the manifestation of a “one-time” risk
versus the establishment of a new normal
• Organization’s ability to identify drivers and make decisions to
respond to change in a timely manner
• Anticipated time horizon to implement operational changes and
“open and close the spigot”
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30. Approach to determining “appropriate”
4. Establish your target reserves level and funding approach
• In addition to understanding average annual risk exposure,
the organization may also wish to consider the means by
which it can move the reserves target “goalposts”
– Explore strategic alternatives for reducing risk
– More aggressive budgets typically require more dollars in
reserves
– Obtain insurance coverage to offset the exposure resulting from
potential risk events
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31. Approach to determining “appropriate”
4. Establish your target reserves level and funding approach
• Speed with which full funding of reserves occurs may vary
based on the following:
– Financial stability – assets and ability to generate
– Ability to “catch up” if circumstances require (generate additional
margin if needed)
– Other funding requirements (e.g., annual
operational investment)
– Organizational appetite and interest
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32. Approach to determining “appropriate”
4. Establish your target reserves level and funding approach
• Reserves can be funded via income statement or balance
sheet
– Designate existing unrestricted net assets
– Set aside annual amount from operations/assets
– Explore strategic alternatives to generate margin (“hard
choices”): reduce costs, increase fees, etc.
– Hybrid
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33. Reserves planning
Agenda
• Introduction
• Approach to determining “appropriate”
• Implementation considerations
• Questions/Comments
© Grant Thornton LLP. All rights reserved.
33

34. Implementation considerations
Documenting your reserves policy
Every reserves policy should have the following elements:
• Clearly articulated purpose for the reserves
• Process for monitoring and reviewing the annual reserves
requirements
• Responsibilities for establishing and funding reserves level
• Processes to respond to risk events (escalation, notification,
approval, etc.)
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35. Implementation considerations
Communication, culture, and process
• Publicize to internal and external constituencies
– The plan can help development functions and board members
more clearly articulate why their institutions are “not rich” and
why these funds have been set aside
• Address the culture
– It’s OK to spend this money; just because a risk occurred doesn’t
mean you need to prune/alter offerings
• Update the plan (and risk analysis) annually!
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36. Implementation considerations
When to draw upon reserves
• Our methodology recommends organizations draw upon
reserves to address deviations from budget
• Drawing upon reserves should be expected
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37. Implementation considerations
Reserves are a subset of your overall liquidity
• In addition to “risk reserves,” management must also
ensure that it’s maintaining adequate cash on hand/liquidity
to fund day-to-day operations
• Organizations should also consider what additional
discretionary funds should be set aside to pursue key
strategic priorities or capital improvement projects
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38. Conclusion
Determining appropriate reserves level for your organization
• Maintaining balance sheet health via reserves enables you
to be prepared for the future, while providing stability in
your operations
• No two organizations’ business operations and risks are
alike
• Every organization should adopt a unique reserves plan to
meet its specific needs and circumstances
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39. Comments?
Questions?
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40. Grant Thornton
Not-for-profit and higher education resources
Publications for not-for-profit and higher
education organizations:
www.grantthornton.com/nfp
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40

41. Presenters
Mark Oster
Matt Unterman
National Managing Partner
Not-for-Profit and Higher
Education Practices
212.542.9770
mark.oster@us.gt.com
Senior Manager
Not-for-Profit and Higher
Education Practices
212.542.9834
matt.unterman@us.gt.com
Joe Mulligan
Manager
Not-for-Profit and Higher
Education Practices
212.542.9513
joseph.mulligan@us.gt.com
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41

42. Disclaimer
This Grant Thornton LLP presentation is not a comprehensive analysis of the
subject matters covered and may include proposed guidance that is subject to
change before it is issued in final form. All relevant facts and circumstances,
including the pertinent authoritative literature, need to be considered to arrive at
conclusions that comply with matters addressed in this presentation. The views
and interpretations expressed in the presentation are those of the presenters and
the presentation is not intended to provide accounting or other advice or guidance
with respect to the matters covered.
For additional information on matters covered in this presentation, contact your
Grant Thornton LLP adviser.
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