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Nonprofits Imperiled By Low Reserves
In Tight Times, Lack of Cushion Can Mean Failure

By Megan Greenwell
Washington Post Staff Writer
Wednesday, June 24, 2009

More than half of Washington area charities had dangerously low operating reserves even before the recession began, leaving them especially vulnerable to service reductions in a time of sharply declining revenue, according to a new report.

Fifty-seven percent of charitable organizations had less than three months of reserves -- the industry standard -- in the bank in 2006, according to a study scheduled to be released today by the Urban Institute, a Washington-based think tank that specializes in economic and social policy. Operating reserves are considered crucial if nonprofit groups are to weather a recession, but 28 percent of area groups had none.

"It's an amazingly high percentage that have less than the recommended three months of reserves," said Thomas H. Pollak, an author of the report, the first of its kind in the Washington region. "In some cases, they got too accustomed to the economy zooming along and didn't appreciate the risk they were facing."

Operating reserves are especially critical for nonprofit groups because of the way they receive funds. Many rely on occasional large gifts and grants rather than a consistent stream of revenue throughout the year. If a government grant is delayed or a foundation cuts its giving, charities without reserves could be forced to reduce services, lay off staff or close.

At D.C. Central Kitchen, a nationally recognized hunger-prevention group, a lack of operating reserves caused a cash flow crisis in 2006. Chief Executive Michael F. Curtin Jr. approached one of the group's most generous donors that summer for a $100,000 loan. The contributor agreed and later that year donated the first of two $1 million gifts to create an operating reserve.

"He said, 'My one requirement is that you use this money so that you're never in this situation again,' " Curtin recalled. "We lost the sick feeling of thinking we might not be able to pay the bills."

The reasons that groups lack operating reserves vary, but one major factor is the feeling among nonprofit leaders that they should spend as much as possible on program expenses, according to Richard L. Moyers, director of the nonprofit sector fund at the Washington-based Eugene and Agnes E. Meyer Foundation. Consequently, direct-service organizations, such as soup kitchens and homeless shelters, which often struggle to find money to provide services, are among the least likely to have sufficient operating reserves.

"Many executive directors view money they would put away for a rainy day as detracting from services they could provide now," said Moyers, whose group funded the operating reserve study. "It's not that they're poorly managed; it's that they have this incredibly positive desire to use as much as possible to help people."

Many government and foundation grants can be spent only on program costs, and some private donors prefer that their money be spent on something tangible rather than put in the bank. At D.C. Central Kitchen, no other donors have contributed to the operating reserve fund since the initial gift, Curtin said.

The researchers examined 2006 tax filings for 2,648 Washington area nonprofit groups, including environmental groups, arts and culture organizations and direct-service providers. The results were sorted by the size and type of organization.

According to the study, larger groups were less likely to have sufficient operating reserves than smaller ones, a finding that surprised researchers. Seventy percent of charities with expenses over $5 million had low operating reserves, compared with 50 percent of groups with less than $100,000 in expenses.

The Meyer foundation is among a handful of private foundations that lend money to nonprofit organizations that are running low on cash, and Moyers said the group has seen a significant increase in applications for those loans, which can total as much as $75,000. Although the program has saved several groups from crisis, building operating reserves is a more sustainable solution, he said.

"If they had some money in the bank, they could just loan themselves the money and not have to worry," Moyers said. "It's so debilitating for a group to be scrambling around panicking about how they're going to make payroll."

That scramble can quickly put a nonprofit group in danger of going under, said Pollak, one of the report's authors. According to his research, 16 percent of existing nonprofit groups in 2000 either disappeared or became so small that they were no longer required to file tax returns by 2006. Those groups had a median operating reserve of about 21 days, compared with two months among organizations that survived.

Pollak and others said that they expect to see even fewer nonprofit organizations with sufficient operating reserves by the end of this year, and that some groups are likely to fail or merge in the next several months.

"What if the bank goes under, or the government agency you counted on decides it doesn't have the funds?" Pollak said. "It's the managerially and ethically wise thing to do to have reserves to cushion the blow."

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