Full Cost: What All Nonprofits Need
Total Expenses, Working Capital, and Reserves
Total expenses are the day-to-day expenses of running your organization. They include:
- Regular or recurring expenses (i.e. salaries, phone bill, program supplies)
- One-time or extraordinary expenses (i.e. legal fees to defend a lawsuit, or the cost of launching a capital campaign)
- Depreciation, which is a non-cash expense that estimates the decreasing value of your fixed assets (e.g. building, vehicles, computers) over time until they are expected to need replacement
- Upfront and ongoing cost of impact measurement
- “Direct” program expenses
- “Indirect” or “overhead” expenses
- Unfunded Expenses
Unfunded expenses are those expenses that are not currently incurred, but, if covered, would allow your organization to work at its current level in a way that is reasonable and fair. One common example in the nonprofit sector is overworking and underpaying staff.
Example: An Executive Director works 60 hours per week. The organization should hire a part time assistant, so the Executive Director can reduce her hours to 40 hours per week (without taking a pay cut). The salary of the assistant would be the unfunded expenses.
Other examples of unfunded expenses include making do with outdated software, slow internet, or sub-par supplies.
Unfunded expenses are NOT associated with expanding or doing more; they support what is already being done by your organization.
The income statement reflects total expenses, except for unfunded expenses. Unfunded expenses are not captured in financial reports.
Total Expenses do NOT include:
- Any purchase that is capitalized, such as a building or equipment; such purchases are captured in Fixed Asset Additions.
- Repaying debt principal; this lives in Debt Principal Repayment.
Working capital is the dollars to cover the predictable timing of cash ebbs and flows in the normal course of business. Organizations with sufficient working capital are able to pay bills on time, even during months when there are no cash receipts.
Working capital is needed by all organizations. It should be easily accessible to management, without restrictions or strict designation. Working capital dollars are usually held in the organization’s main checking account.
The amount of working capital needed is highly variable from organization to organization, as it depends on the unique timing of cash in-flows and out-flows within each nonprofit. Some organizations have minimal gaps between cash in-flows and out-flows. Less than one month of working capital may be sufficient for them. Others have very large gaps between cash in-flows and out-flows. They may need to have 11 months of working capital at their cash high point in the year to make it through their cash low point in the year.
Securing a line of credit from a bank or credit union is one way to manage cash flow. The line of credit can be used to increase working capital during cash low points and repaid during cash high points. Banks will rarely extend new lines of credit when cash is at a low point. Organizations should establish a line of credit “when they don’t need it” so it is available when they do.
Working capital is NOT meant to cover lost revenue, pay for annual deficits, or continue unsustainable activity.
Reserves are savings that mitigate risk for the organization – whether that be the risk inherent in your funding streams, the risk of trying something new, or the risk that something may go wrong with your building or equipment.
Reserves are needed by all organizations, but the size and purpose vary – there is no one-size-fits-all.
Common examples of reserves:
- Operating reserve: To protect the organization from short-term risk (e.g. lost funding, unexpected expense, leadership transition) or pursue opportunity
- Facilities reserve: To maintain fixed assets and pay for repairs and/or replacement (e.g. building, equipment, etc.)
- Research and development reserve: To allow for experimentation, risk-taking, trial and error; to investigate a new program or approach
- Investment reserve: To generate revenue through investment vehicles like stocks
You can name and define reserves for your organization in a way that best supports your mission and vision. An operating reserve is often a good first priority when it comes to reserves. It is possible to have a single reserve that can serve multiple purposes. For example, you could have an operating reserve that can also be used for research and development of new programs. However, you should carefully define the criteria of the reserve and the amounts needed for different purposes. One aggregated reserve can give a false impression that resources are adequate to meet your needs.
Reserves should be accessible to management depending on the immediacy of need. Some may be board-designated and require board approval to spend. They may be held as cash in a bank account or as investments that can be liquidated in a reasonable timeframe. Most reserves are intended to be replenished once they have been used.
Calculate your organization’s full cost needs with the Full Cost Workbook.