Most Non Profits have little idea about the working capital to keep in the bank at all times. Nonprofit articles often recommend cash equal to 6 months of expenses. Those writers have obviously not actually worked in a smaller nonprofit. Aside from a legacy, there is little chance of putting aside half of the year’s program budget for a rainy day fund.
Many nonprofits take one of two approaches. One approach is to receive a windfall legacy or grant and keep the entire amount in a savings account to be safe. This sadly reduces the investment in mission. Imagine operating a food bank that can open a new location and get reimbursed for food. It will cost $1,000.000 to renovate the space. The Board decides not to proceed because it has $3 million available and fears drawing down its cash.
The other common approach is to put your head down, keep operating and hope that the day never comes when the unavoidable demand for cash clashes with the available bank balance.
Fortunately, there are formulas that help.
Greg Crabtree* advocates for 2 months of operations plus 10% profit of cash in bank. For example, a $12,000,000 revenue company might have $2,000,000 plus $1,200,000 ($3,200,000) in ready cash and securities.
On a daily basis that same company may only need $10,955 in constantly available cash and the rest in a money market (or line of credit).
Get out the calculator! The formula is (2 * monthly amount needed to pay bills) / (Interest rate on line of credit/ 12). Got that? Now take the square root of that number.
Example: Your budget is $12 million** and your business is so regular that you need exactly 1/12 of that every month to pay bills. Line of credit is 5%
(2 * 1,000,000) / (.05 / 12) = 480,000,000. The square root is $21,909. The maximum to keep in the bank account is that amount and the average daily balance should only be $10,955. Save on line of credit costs or get more interest from the money market by holding only what the formula requires.
You can feed the hungry while making sure that your agency doesn’t end up needing bread.
*CRABTREE, GREG. SIMPLE NUMBERS, STRAIGHT TALK, BIG PROFITS!: 4 Keys to Unlock Your Business Potential. LIGHTNING SOURCE, 2014.
**My companies always have regular numbers to make clear examples. Don’t be surprised if you need to make some adjustments when you apply the formulas 🙂
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