Thinking About PASS – Operating Reserves

Note 1: I started this post two years ago and am finally publishing even if its not as detailed as the topic deserves. I wrote this to build awareness of reserves in general because they are one of the key indicators of fiscal health for an org. My best guess is that PASS is “somewhat underfunded”, but it’s just a guess (read the whole thing for more). After thinking on it a lot, I’m asking that PASS amend their published Reserved Policy as follows:

  1. Put in a formula that tells members (and Board members) how to determine how much should be in reserves and how much should typically be added to reserves on a yearly basis.
  2. Commit to increasing transparency by doing a single topic blog post at the end of each fiscal year on the state of reserves all changes to reserved during that period, and whether current reserves are at or above the level defined in in the reserves policy per item #1 above.
  3. Commit to increasing transparency by doing a single topic blog post on any passed or failed motion to alter reserves or reserve policy once the minutes of that meeting are approved by the Board
  4. Remove or seriously edit item 7 from the existing policy that states details of the reserves are confidential outside the Board. Certainly we do not expect account numbers to be shared, but beyond that I see no reason for confidentiality or having to ask anyone to see the state of the reserves.

Note 2: At that time I started this post (see slide below) the reserves were set at $1.14 mil. Per the March 2018 quarterly statement reserves are at $1.16 mil. I don’t have details on if there were deposits/withdrawals made from Nov 2015 to Jun 2018.

During the 2015 PASS Summit Adam Jorgensen presented the following slide as part of the Day 2 keynote:

Funds2015_3

What are reserves?

In financial accounting, reserve is any part of shareholders’ equity, except for basic share capital. In nonprofit accounting, an “operating reserve” is the unrestricted cash on hand available to sustain an organization, and nonprofit boards usually specify a target of maintaining several months of operating cash or a percentage of their annual income, called an Operating Reserve Ratio. (Source: Wikipedia)

In plain terms it’s cash that is set aside for the rainy day that will probably happen at some point. If something bad happens PASS has to have enough funds available to pay the office rent, salaries, benefits, etc, until normal operations resume or other funding is obtained. Without enough funds key personnel may be laid off, important operations paused, or in the worst case the organization could cease to exist. In practical terms PASS needs enough cash on hand to weather an incident that delays or cancels a Summit. Such incidents aren’t just theory, there have been three major problems since PASS was founded:

  • The 2001 Summit was rescheduled due to the terrorist attack on September 11th
  • The 2004 Summit in Florida was impacted by a hurricane
  • The economic downturn in 2009 (at one point we were $800k down on hotel room commitments)

PASS carries insurance to guard against a massive incident, but it can take a long time for the claim to be settled – as much as 18 months. Insurance alone doesn’t guarantee that the org can survive. PASS has also supplemented their cash position with a line of credit, most recently one for $250k according to the June 2014 audit results. Credit lines aren’t without downsides. The one PASS has was at prime plus 5.25%, so it’s not cheap, and there is also the risk that a credit line can be reduced or revoked if the lender believes that the organization is no longer as credit worthy.

Reserves are a good thing, to a point. Every business struggles with how much to set aside versus how much to invest back into operations. Cash (or equivalent, such as a CD) doesn’t earn much right now, maybe one percent, compared to using that money to grow attendance/revenue.

Does PASS have sufficient reserves? I did some research and there is no single answer on “sufficient”. Guidelines such as 10% or 3 months are out there, but most of the my reading says that it needs to be tailored to the financial model of the org. That makes sense to me, especially given that the Summit generates about 90% of the annual revenue. Here is some of that reading if you’re interested:

The link from Charity Navigator is interesting. Their evaluation policy is as follows:

We analyze a charity’s working capital ratio by determining how long it could sustain its current programs without generating new revenue. To obtain this ratio, we divide the charity’s working capital by its total expenses, including payments to affiliates, for the most recent fiscal year. For example, Charity Z holds $5.4 million in working capital. Its total expenses for the most recent fiscal year are $3.6 million, including a $100,000 payment to an affiliate for its national dues. Thus, it has a working capital ratio of 1.5 years.

I don’t know if we have sufficient reserves or not. We have enough to weather a minor storm and that is good, but I want to be sure that PASS can survive and thrive even through the worst event.

Here’s some information I received from PASS after sending an inquiry (this is old, but is what I have):

  • 82% of the reserves are invested in CD’s
  • PASS uses two investment companies, Merrill Edge and Morgan Stanley
  • PASS worked with the auditor to determine that that 22.8% to 32.7% of the total assets should be invested. In Nov 2015 that stood at 27.6%.
  • The policy for reserves assumes 20% annual grows revenue growth, cash reserves would be about 12% of that, and new investments would be laddered over 4-6 years
  • Hard to define worst scenario the reserve would support – other steps can be taken to reduce costs for example
  • Adding or removing funds from reserves would require a board vote and be recorded in the minutes

I was thrilled to see a formal reserves policy (added April 2017) that requires a Board vote to move money in/out of reserves, but it doesn’t specify or suggest what level should be maintained during “normal” operations. I think incoming Board members need that kind of level-set to help them assess and vote well on motions related to reserves.

Having looked at what I could find via PASS and on the web, I still don’t have a good answer to “do we have enough”. The 2017 budget has $2 million for corporate administration (HQ), but there are plenty of other expenses. I’d guess we have enough cash/credit for 3-6 months, giving us enough time to make hard choices about reducing costs if needed. The big variable is the float on Summit registrations. If the Summit is just delayed there will be some refunds, but many will just go to the rescheduled date. Thinking about it more, the percentage thing may be fine, but I’d be happier if we also had a rule that said we had to carry enough for x months expenses.

I’d like to see more discussion on that. I’d also like to see the Board post a state of the reserve post once a year showing the current state, any changes, plus any line of credit or other items used to supplement the core reserve. If we could see that in a year over year document it would be really clear what we have.