episode 154 – transcript

Dave Cain: Welcome to unsuitable on Rea Radio, the award winning financial services and business advisory podcast that challenges your old school business practices and the traditional business suit culture. Our guests are industry professionals and experts who will challenge you to think beyond the suit and tie while offering you meaningful modern solutions to help enhance your organization’s growth. I’m your host, Dave Cain.

Dave: We’ve all heard how important it is to put some money away for rainy day. Well, this practice is just not important for individuals, it’s especially important for organizations as well. In the not for profit world, this type of rainy day fund is called an operating reserve and it can help sustain the organization when times get tough. Today’s guest talks a lot about the importance of this type of fund and regularly works with not for profit organizations to help them establish their safety net. Ben Antonelli, a principal on Rea’s Assurance Team, located in Dublin, Ohio, works closely with the nonprofit industry on a variety of projects. He is oftentimes pulled in to consult on topics related to operating reserves, financial reporting, and internal controls. Welcome back to unsuitable, Ben.

Ben Antonelli: Thank you, Dave.

Dave: So, I understand volleyball season, the co-ed volleyball season is up and running.

Ben:   That’s correct. Yeah, Rea got a team together this year.

Dave: Okay, how are we doing?

Ben:   Not too bad. I think we’re in second place.

Dave: Second place?

Ben:   Yeah.

Dave: Now I understand that you are the star of the show, of the team, the volleyball team.

Ben:   No, I’m more on the drinking team.

Dave: On the drinking team?

Ben:   Yeah, I’m kind of walking wounded right now.

Dave: So what are you about 6’4″, 6’5″?

Ben:   6’4″.

Dave: Boy, you can bring it.

Ben:   Yeah, I played club volleyball in college and I grew up right on Lake Erie. So we played sand ball all summer long.

Dave: So, quite the athlete and I appreciate you representing Rea. Bring home the trophy.

Ben:   Yeah, we’ll do that.

Dave: But make sure if we’re playing against a client, make sure they win, a client’s team.

Ben:   Always.

Dave: So we want to talk about this operating reserve process that you brought to the table from the not for profit community. But I think, in the intro, we talked about the freedom of a rainy day fund. But let’s jump right into it, and tell me what an operating reserve fund is. The name itself is kind of self explanatory, but in a not for profit, it has different meanings. So, what is an operating reserve fund and why do we need one?

Ben:   Sure. Yeah.

Ben:   And I’m glad we’re talking about the topic. We present financial results, the results of the audit to all of our assurance, nonprofit clients. And I feel like this is one topic that really gets the most engagement out of our nonprofit boards really, because there’s so much to it. I mean, you can easily calculate it from, on a global level, from one client to another. But this is one I’ve had experience with that it really generates a lot of engagement and a lot of the discussion because you’re doing a lot of a lot of things when you’re talking about your reserves. It’s a budgeting function, it’s a risk assessment function, and it’s a lot of strategic planning.

Ben:   So I’m glad we’re talking about it from that standpoint. And then, there’s actually a new financial reporting, specific to nonprofits, standard that’s coming out that you’re going to have to disclose a component. That’s pretty close to what an operating reserve is.

Dave: So, new regulations on board that we have to be on top of.

Ben:   Right. So we discussed this with our current clients, and it’s actually going to be a requirement they have to disclose. So, in terms of what it is, you think of from a pure accounting standpoint, the reserve of any entity, for profit, nonprofit, your first accounting class, you see what the balance sheet is, assets, liabilities, and equity, right? Assets minus liabilities is equity.

Dave: Accounting 101.

Ben:   Right.

Ben:   And so, on the nonprofit-

Dave: I missed that day.

Ben:   Right, right.

Ben:   So, on the nonprofit space, it’s called net assets. So, that’s the general reserve. So, there’s a lot that goes into all types of assets, current, long term, restricted.

Ben:   To get to an operating reserve out of that entity wide reserve, you start with that and then you deduct longterm assets, assets restricted for use by donors and contracts and things like that. And then, you get down to what is actually a hard number at any given point, you’re operating reserve, funds available for use.

Dave: Okay. We’ll dig into that a little bit. There are experts and then there are experts. And I know, from your experience, you touch probably close to 75, 100 not for profit organizations in a given year, whether it’s talks, consulting. I mean, you’re out there. You are an expert.

Ben:   Sure, yeah. I serve about that many number of clients in some capacity. And then, actually sit on three boards myself. So, I’m speaking from both sides when we talk about this number.

Dave: You know, you walk the talk, talk the walk, or whatever they say. You do it all.

Ben:   Yep. Absolutely.

Dave: So, this operating reserve concept again, we referred to it in the intro as rainy day fund, it’s just not as simple as opening up a bank account and throwing a couple grand in there to get it started. There are rules and regs that must be followed.

Ben:   Yes, definitely best practices on how you calculate that number. And that’s really, when we talk about board engagement and really strategic thinking is, what the calculation is for one, and it’s specific to entity. And then, what number are we going to target, and there’s a reason for that. So we kind of see three reasons to have one, right? So, I guess three reasons to have any reserve.

Ben:   One is capital, right? We have clients that are heavily invested into their buildings and equipment, and there’s a capital reserve, right? So you need a reserve for unexpected regular maintenance and repairs on those heavy investments. So that’s one, reason to have a reserve.

Ben:   The other two reasons are operating related and one is, an unexpected decrease in funding, right? I just think of our client base and we have a lot of mid-market nonprofits that have a diverse number of funding sources. Their portfolio of revenue is diverse, right? And that’s great, it de-risks that. But what’s the risk of, since you have that many, some are likely to drop off here or there. So, it’s one reason to have the operating reserve is for unexpected losses in funding.

Dave: Sure. Let me back up just a shade. Again, that’s not an industry that I work in a lot, but I’m aware of, just from listening to you guys and your team talk around the state of Ohio and the seminars you do in the training. So, I get a pretty good feel for some things you jump into. But does a written policy need to be in place for an operating reserve? And if so, what should that policy look like? Can you give us some thoughts on that area?

Ben:   It definitely doesn’t have to be. There is no rule for that. You think of nonprofits and 990’s, there’s the seven policies listed in the 990 to ask if you have a written one or not. This is not one of those, but something this important definitely should be. I recently wrote an article on this very topic and the AICPA comes out with kind of a standard template that I usually forward that to clients looking to establish one. A lot of terms that should be in there, if I just read some of these, I brought it with me.

Dave: Sure. Laundry list it. Let’s go.

Ben:   Right.

Ben:   The purpose of the reserve, calculation of the target, the intended use of the reserves, who has the authority to use the reserves, how the account will be monitored, and then a plan for replenishing in the event that you have to use them.

Dave: Yeah. I want to go back to again, you’re you’re talking right on point to a blog that you wrote back in, actually, of August, about a month, two months ago. And it’s titled Does Your Nonprofit’s Operating Reserve Balance Stack Up? And it talks about how to calculate how long it should last. It’s located on our website at Rea&Associates.com. I think we just go through your bio and our listeners can look that up. And it’s really right on point, well written, well done.

Ben:   Thanks you.

Dave: So, I think that will be very helpful to the listeners.

Dave: You talked a little bit about the 990, which is the tax form for a not for profit organization. In the for profit world, we always are concerned about compliance with the internal revenue service in the state of Ohio. But in the non for profit environment, does the IRS scrutinize a nonprofit’s operating reserve? And if they do, what kinds of things are they looking for? You alluded to that a little bit on the 990. There anything that’s jumping out that you’ve heard?

Ben:   Nope, I can’t really think of anything specific regulatory wise on this policy or related to that. I think the only thing they’re worried about related to, I guess, that’s really unrelated business income.

Dave: Income. Stuffing it away.

Ben:   Right. Because nonprofits are allowed to generate a profit. It just has to be related to their exempt purpose. And so, if it’s not in your building reserve off of that, then yeah. Then they’ll be taxing that.

Dave: You know, I have to chuckle a little bit when you say nonprofits are allowed to make money. There for awhile, there’s the thought process that, you spend every dollar of what you make in your programs. And I think that’s maybe a thing of the past that hey, you’ve got to put money aside for future projects. And so, are you seeing that in real life? I mean, is it happening out there? Is it still in just discussion phase?

Ben:   Nope, absolutely. I see that trend a lot in various- every answer is it depends, right?

Dave: It depends.

Ben:   It varies by type of entity. And a lot of times, membership organizations, they’re not necessarily running a surplus and building up a reserve, unless the members are really involved in determining what the membership fees are so that they can build. That would be a strategic thing to build a reserve through raising the membership fee, things like that. But yeah, across the board, I see a lot of our clients like building this and coming to us wanting to build a policy around that, and looking for advice.

Dave: I want to go back to something you mentioned in your blog article that caught my attention. And it says, in our experience at the high end, an operating reserve probably won’t exceed three years, and at the low end, you’re operating reserve should be able to cover at least one pay period.

Ben:   Right, at the minimum, right?

Dave: Boy. There’s a range of events right there.

Ben:   Right? Yeah. Like I said, it definitely is across the board in our client base and then in our communities.

Dave: So, when I set up an operating reserve in my organization, am I restricting that money in any way, shape, or form? Or can I use that to pay the light bill, hire a PR employee?

Ben:   Right, right.

Ben:   Well, yeah, the accounting term is designating. A restriction is-

Dave: Thanks for that correction.

Ben:   I got you.

Dave: In your face, I suppose that was. That’s what that’s called.

Ben:   Yeah, nope. Absolutely. Yeah. And we have clients-

Dave: Don’t worry, you’re an expert, we know.

Ben:   Right. Our clients are designating operating pieces that can’t be touched for at least periods of have, or under certain circumstances.

Dave: Okay. So again, we talked about calculating. I used the example of early on, it goes deeper than just throwing the excess for the year into a savings account. How should I calculate this funding? You have some suggestions? Can you walk me through that again?

Ben:   Sure.

Dave: And did I use the right terminology? I want to make sure.

Ben:   100%. So, yeah, whenever we go over this number, we think of, I went through a calculation and we got to have a hard number. Let’s say we’re looking at a balance sheet and then we got to 15 million, right? Is that big enough? And the question is, well, it depends. Like how big is the organization? Let’s go back 12 months, see what the operating expenses were for the organization. Months is usually the unit of time that we’re talking about. So let’s say, well, on average we’re spending three million a month, we have 15 in reserve. Oh, we have five months of expenses in reserve.

Ben:   So, we get questions all the time on that. And it really depends on what your future goals are, but three to six months is good-

Dave: Three to six is where you want to be?

Ben:   Barometer.

Dave: And again, you use the term- we talked about designated funds. An operating reserve is not a designated fund. I want to make sure that that’s clear, or is a designated fund?

Ben:   Right.

Dave: Or can be?

Ben:   Yeah, that’s perfect. It can be.

Dave: It can be.

Ben:   You can designate it for future use if some X, Y, Z happens. You can designate that.

Dave: What are some of the common items that are often forgotten or overlooked when an organization calculates the operating reserve?

Ben: The main thing that comes into play, and I talked about looking 12 months back and seeing what your operating expenses are, and before I mentioned two types of reserves, operating and capital. Well, in capital, on a financial statement, you’ll see depreciation expense in operating expense as well. When you go to calculate that, what is our monthly burn rate or expense rate, you should reduce depreciation out of there.

Dave:  So there’s an art for the calculation, again, not to be forthcoming and strategic looking forward for the organization.

Dave:  We talked about what is an operating reserve and why an organization needs one. We touched base on how to calculate the operating reserve. Let’s talk about some operating reserve trends, or maybe some case studies or some stories that you have, if you have one or two to share. But, are you seeing more organization having these operating reserve funds than ever before as kind of the economy has changed a little bit?

Ben:     Right. I think that definitely correlates with the bull run. I mean, most of our nonprofits are putting their reserves or dollars, if they’re not designating a specific operating reserve, investing those for longterm use. Definitely, seeing them used in that way.

Dave:  And you see everybody following the formula, or maybe they don’t know the formula is out there? That’s when they call you.

Ben:     Yeah. And that’s one thing, in terms of recommendations, I would recommend more organizations have that in the agendas in some of these meetings. Knowing what the calculation is and why we have that number targeted, anytime you’re looking to expand a program, or cut a program, or do any strategic decision, you need to factor in that number.

Dave:  Are you seeing charitable giving on the increase? You seeing that in the organizations you work with, donations on the increase?

Ben:     Right. With the tax reform, we were concerned the number of discretionary donations, are people really managing that if they’re not getting the deduction? And the question comes down to, why do people give? Is it because of the deduction? And that was a complete unknown. And working with the clients throughout this 2018, really have not seen and have not heard that as a concern, so.

Dave:  That’s good news. Again, coming from an expert, as you see that across the state. There was a concern about that funding dropping off, but it appears to be holding strong for now.

Ben:     Yeah. Yeah. From what I’ve seen.

Dave:  So, we never thought the tax cut and tax reform would impact not for profits, but they will, and they have.

Dave:  Are you seeing an increase in audits not for profit organizations, their 990? Anything happening there our listeners need to be aware of?

Ben:     I have not, no.

Dave: Not an increase? Good.

Ben:   No flags there.

Dave: Okay.

Dave: And that tax return has become a rather detailed return, full of a lot of information.

Ben:   Yep. A lot of information.

Dave: And so, it is no longer fill out your numbers on an EZ form and send them in. There’s a lot of information in there.

Ben:   Right.

Dave: What are organizations doing wrong, as far as operating reserve trends? Anything jumping out for you that you see that you can share?

Ben:   I might have alluded to that before, but really, having those strategic discussions on what the balances are, and what they mean, and what the risks are. I guess, taken from a risk assessment perspective, because we have to look at, when we go and do an audit, we’re looking at the risk assessment procedures at each organization and from a financial standpoint. I don’t know if that’s happening all the time where people are doing the what if. What if we lose this funding, what if this happens, and building that into the budgets and reserves that they have.

Dave: Okay. Let’s give you a test here.

Ben:   Sure.

Dave: Okay. You had mentioned you volunteer your very precious time on three not for profit boards.

Ben:   Yep.

Dave: These boards that you serve on, do you guys have an operating reserve fund?

Ben:   No, that’s a great question. I’m on three boards, and it is across the board, in terms of the size that it is. We have one that is very significant. Right? And we actually-

Dave: Okay, one out of three.

Ben:   I do a risk assessment analysis for this board every year. Yeah, and we’re on the high end. We talked about that range of what the recommended- so we’re on the high end there. And then, one position, I actually took Dave Cain’s position, as treasurer of another board.

Dave: Did we have a reserve fund there? I don’t think we did.

Ben:   We’re almost so small that it’s pretty black and white of what our funds are.

Dave: See? We needed the expert on there.

Ben:   Right. Right, right, right.

Dave: Yeah, kind of run something by you a little bit for our listeners, Rea & Associates invest a tremendous amount of hours and time from our team members in the not for profit. We donate our time, whether it’s a project or board functions. If a listener out there is on a board and is looking for a board member, you’re pretty full, but can they call you and you can make a recommendation from within Rea & Associates to maybe help them out with a board member?

Ben:   For sure. Yeah, I can. I would be more than happy to do that. I know the Ohio Society of CPAs assist in that. I haven’t seen it recently, but they have- or at least check the website recently- but they do have a spot on their website looking for- and organizations can post that they need a CPA. So, that’s a good resource.

Dave: Good, good. I think that is a good and great resource, and I think you’ll captain that ship if we get a call. I know we have a lot of people who are really willing to donate their time, and that’s a piece of our culture and our core values that we give back to the community. And you certainly have given back to your community, not only in your time, but in your professionalism, and becoming famous, and you’ve dedicated probably 95% of your professional career to working in this industry. So, well done.

Dave: Any rainy day stories, good, bad, or indifferent you want to share before we get on out of here?

Ben:   No, I think we’ve summed it up. I think it’s a really healthy discussion that boards can have, and we’re more than willing to be a part of that discussion. It seems like the most questions that we get from board members are how do we stack up, right? And how does our reserve stack up, and we can help benchmark and help lead that way.

Dave: And again, serving on boards. I think once you get into a board meeting, you’re talking about how are the financial statements, how are the employees doing, this and that, how’s the funding, how is that program, and you don’t have a lot of time left at the end of the day or the end of the meeting to talk about strategic planning. And this is really a pretty neat, pretty good piece of strategic planning. But it does have some strings, and some bells, and whistles, and some new regulations coming down. And you’re ready and your team is ready to meet that challenge. So, I encourage our listeners to give you a call.

Dave: Our guest today has been Ben Antonelli with Rea & Associates, a specialist and famous for his consulting in the nonprofit world. Thanks again for joining us today, Ben. Great thoughts.

Ben:   Thanks for having me.

Dave: I think we all know how important it is to financially prepare for the tough times, but it never hurts to be reminded.

Dave: Did you enjoy today’s episode? Let us know. Like it, comment on it, or share it, and don’t forget to check out videos of our podcast on YouTube. Until next time, I’m Dave Cain encouraging you to loosen up your tie and think outside the box.

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