Nonprofit Leader Perceptions of Operating Reserves and Their Substitutes

• Date: 01 June 2016
• Author: Cleopatra Charles,Mirae Kim,Margaret F. Sloan
• DOI: http://doi.org/10.1002/nml.21207
• Published date: 01 June 2016

417

N M  L, vol. 26, no. 4, Summer 2016 © 2016 Wiley Periodicals, Inc.

Published online in Wiley Online Library (wileyonlinelibrary.com) DOI: 10.1002/nml.21207

Journal sponsored by the Jack, Joseph and Morton Mandel School of Applied Social Sciences, Case Western Reserve University.

Nonprofi t Leader Perceptions

of Operating Reserves

and  eir Substitutes

Margaret F. Sloan, 1 Cleopatra Charles, 2 Mirae Kim 3

1 James Madison University , 2 Rutgers University , 3 University of Missouri

This exploratory study has three objectives: (1) to understand the various ways academics,

consultants, and practitioners conceptualize operating reserves; (2) to explore differences

among academic findings, consultant recommendations, and nonprofit leader perceptions

of operating reserves; and (3) to identify how practitioners operationalize operating reserves

within their organizations. Using intensive interviews with nonprofit executives, we find

that the operating reserve ratio ( ORR ) commonly used in the nonprofit literature does not

accurately indicate whether an organization holds an operating reserve according to nonprofit

leaders. In addition, results indicate that experienced nonprofit leaders perceive a variety of

other fund types including endowment and investment savings as well as ability to borrow,

other assets, sister foundations, and donor networks as legitimate substitutes for a reserve.

Keywords: nonprofit , nonprofit leadership , financial management , nonprofit

management

OPERATING RESERVES CAN AID NONPROFIT ORGANIZATIONS in stabilizing periods of

fi scal stress by providing a cushion against unexpected events, an opportunity to seize a stra-

tegic opportunity, or even the ability to smooth cash fl ow problems in contracting and grant

relationships. 1 Within the recent fi scal climate, the need for such funds seems to be on the

rise among nonprofits. In 2012, more human service organizations drew from operating

reserves, froze or reduced salaries, or closed offi ces or programs than in prior years (Pettijohn

et al. 2013 ). Although nonprofi t organizations should ideally hold an appropriate amount of

highly liquid unrestricted assets in reserve to address fi scal shock or unanticipated opportu-

nity, many organizations face challenges in creating and maintaining such reserves for myriad

reasons (Sloan, Grizzle, and Kim 2015 ). Understanding the complex challenges presented by

operating reserves from both research and fi eld vantages is necessary to enable academics and

consultants to make sound recommendations and for nonprofi t leaders to make prudent

decisions regarding reserves.

Correspondence to: Margaret F. Sloan, James Madison University, School of Strategic Leadership Studies, 1077

S. Main Street MSC 1505, Harrisonburg, VA 22807. E-mail: sloanmf@jmu.edu.

 e authors express their appreciation to the nonprofi t leaders who participated in this study and the journal ’ s anonymous reviewers whose

critique improved the work. We dedicate this article to the memory of Woods Bowman whose foundational scholarship on nonprofi t

fi nance has inspired and challenged us.

Nonprofi t Management & Leadership DOI: 10.1002/nml

418 SLOAN, CHARLES, KIM

Nonprofit academics, consultants, and practitioners all discuss the concept of operating

reserves but can often mean very different things. Although these groups share some consis-

tencies regarding the optimal concept of operating reserves, how each operationalizes reserves

can differ dramatically. This qualitative exploration has three objectives: (1) to understand

the various ways academics, consultants, and practitioners conceptualize operating reserves;

(2) to explore differences between academic findings, consultant recommendations, and non-

profit leader perceptions of operating reserves; and (3) to identify how practitioners opera-

tionalize operating reserves within their organizations.

Quantitative studies with large numbers of observations have described nonprofit organiza-

tional operating reserves based on the Nonprofit Operating Reserves Initiative Workgroup

( 2008 ) definition of accumulated net assets.

2 These studies have found that a substantial

number of organizations hold less than the recommended optimal level of reserves. Although

important for considering the broad landscape of organizational accumulated assets, quanti-

tative studies do not fully represent the holding of operating reserves from the perspective of

nonprofit management and, like any studies assessing ratios of financial performance, should

be utilized and interpreted with caution (Prentice 2015 ). There are many different types of

savings funds, and it is difficult for researchers to discover how much is operating reserves,

particularly using only Internal Revenue Service (IRS) Form 990 data. Therefore, without

qualitative analysis, our knowledge of operating reserves is incomplete and potentially inac-

curate. Because our study explored the way nonprofit leaders perceive their own operating

reserve scenarios, it helps fill this need for understanding the complicated reality of reserves

from the perspective of organizations themselves.

Findings indicated that nonprofit leaders’ perceptions of operating reserves within their orga-

nizations do not often match operating reserve ratios calculated with 990 data. Further, the

study also found that although some nonprofit executives interviewed admitted that they

may not have a “true” operating reserve as defined by some academicians and consulting

groups, they believe they have substitutes in place that offer sufficient operational elasticity

in times of special need, thus acquiring, in their minds, the same purposes of a more strictly

defined operating reserve.

Literature Review

To understand the ways academics and practitioners conceptualize operating reserves we first

examined the literature that either described the state of accumulated net assets for various

pockets of the sector or prescribed what organizations should hold in reserve in an ideal-

ized fiscal picture. Descriptive studies often approached the issue of operating reserves using

large samples. Regarding accumulated net assets, Calabrese ( 2013 ) examined the factors asso-

ciated with operating reserves, finding that as fixed costs increase, organizations with positive

reserves increase their reserves and that a negative relationship exists with revenue diversity

and organizational size. Findings with a similar sample by Grizzle, Sloan, and Kim ( 2015 )

confirmed a negative relationship between organization size and operating reserves, although

these authors also found a mixed relationship with operating reserves among different types

of nonprofits. Within these two studies, 38.8 percent and 39.3 percent of the samples, respec-

tively, had either negative or no operating reserves. Other studies demonstrated concern over

the number of organizations deemed to have inadequate reserves. Notably, Blackwood and

Pollak ( 2009 ) empirically addressed the factors that determine which nonprofits maintain