Presentation discussing the importance of reserves, how they should be used, ways to predict risk, and strategies for enhancing - Tate Tryon CPAs - Nonprofit CPA Firm

1. Targeting Reserves
Bull’s Eye versus Shot in the Dark
Presented by:
Susan E. Colladay, CPA, Partner
Charles F. Tate, Managing Partner
Tuesday, July 17, 2012

2. How Much Should We Have in Reserves?
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3. Agenda
 What are Reserves
 Enterprise Risk Management
 Identify Events - Risks and Opportunities
 Event Quantification and Assessment
 Targeting Reserves
 Take Away Points
 Additional Resources
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4. What and Why
 What are reserves?
 Why are reserves important?
 How does your organization define reserves?
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5. Illustration of Current Liquid Reserves
Total Budgeted Expense $ 16,397,494
Total Net Assets 28,512,121
Fixed Assets (135,482)
Expendable Fund Balance $ 28,376,639
Ratio of Expendable Fund Balance to
173%
Total Expenses
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6. What are Reserves?
Reserves = Expendable, Liquid Net Assets
Net Assets
(Assets - Liabilities)
Temporarily Permanently
Unrestricted
Restricted Restricted
Not Available Program Time
Reserves
(fixed assets) Restricted Restricted
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7. ERM Expands on Internal Control Adding Three
Components to Risk Assessment
Control
Environment
ERM Objective
Control Activities
Setting
ERM Event
Identification Monitoring
ERM Risk Information &
Response Communication
Risk Assessment
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8. Enterprise Risk Management (ERM)
 Developing a reserves target is similar to ERM.
 ERM is a process, effected by an entity’s board of directors,
management, and other personnel, applied in strategy setting across
the enterprise, designed to identify potential events that may affect
the entity, and manage risk to be within its risk appetite, in order to
provide reasonable assurance regarding the achievement of entity
objectives.
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9. ERM - A Top Down Approach From Strategy to
Reserves
Strategic Plan • What are the mission
critical initiatives?
Operational Plan • How do we get there?
Financial Plan • How much will it cost?
Reserve • How will the financial plan impact
Policy reserves?
Investment • What is the time horizon and risk tolerance?
Policy
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10. Identify Events – Sample Risks
Natural
Economic Political Social Technology
Environment
•Capital •Emissions and •Governmental •Demographics •Interruptions
availability waste changes •Consumer •Electronic
•Credit default •Energy •Legislation behavior commerce
•Concentration •Natural •Public policy •Corporate •External data
•Liquidity disaster •Regulation citizenship •Emerging
•Financial •Sustainable •Privacy technology
markets development •Terrorism
•Unemployment
•Competition
•Mergers and
acquisitions
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11. Identify Events – Sample Opportunities
New Programs Use of Facilities Personnel Unique Aspects
•New programs in •Excess capacity •Technically skilled •Products or services
strategic plan •Ideal location •Well trained •Reliability or
•Research and •Database and •Highly motivated reputation
development costs systems •Strong management •Innovation
•Advertising and •Acquisition team •Expertise in service
public relations advantage delivery
•Related overhead •Customer service
•Financial stability
•Member or donor
loyalty
•Fair pricing
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12. Summary of Quantified Risks
PRESENT
VALUE OF
OCCURRENCE
RISK IDENTIFIED (Rounded)
1. Revenue Volatility $(974,000)
2. Investment Portfolio Volatility (1,912,000)
3. States change Licensing Requirements (137,000)
4. Licensing Changes to a Uniform process (300,000)
5. Licensing Volumes and Revenues (146,000)
6. Legislation (4,267,000)
7. Legislation (4,329,000)
8. One-Stop Shopping (327,000)
9. Merger of sponsors/industry partners (2,366,000)
10. IT Reengineering - general (428,000)
11. Software upgrade – product delivery (315,000)
12. States Perform Their Own Processing (54,000)
13. Administrative Fee (4,654,000)
14. States Use Other Vendors (296,000)
15. Competitor Expansion (1,012,000)
16. Litigation (210,000)
17. Massive Disaster (94,000)
TOTAL ESTIMATED REQUIRED RESERVE $(21,821,000)
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13. Identify Events – Determine Risk Response
Avoidance Sharing
•Disposing of a program •Buy insurance
•Deciding not to engage in •Joint venture/outsource
new initiatives/activities •Hedging risks
Risk Response
Reduction Acceptance
•Diversifying/rebalance •Self insure
•Limits/processes •Accept risk that conforms
to risk tolerance
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14. Identify Events – Mapping Risks
ERM Risk Appetite Matrix
(Exhibit 3.5 from COSO’s ERM Guidance)
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15. Quantify Events - Risks Assessment
High
 Amount of
reserves will
$$ $$$$
depend on events
identified in the
SWOT analysis.
$ $$
 Events may be
interdependent –
not isolated.
Low High
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16. Identify Events - Risks and Opportunities
 Unique analysis for each organization
1. Identify every potential event, no matter how small
2. Narrow the list down to significant events and use broad
event categories
3. Determine risk response (avoid, reduce, share, accept)
4. Assess event likelihood / magnitude – map the event in
the ERM Risk Appetite Matrix
5. Include board of directors, management, and others in
event identification and risk assessment to gain
consensus
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17. Risk Quantification Worksheet Summary
Present Value of
Exhibit Occurrence
No. Risk Reference (Rounded) /1 . 2008 2009 2010 2011 2012 2017
1 Revenue Volatility EXHIBIT 8 $ (974,000) $ 1,604,886 $ 471,710 $ (678,515) $ (1,447,095) $ (1,594,279) $ -
2 Investment Portfolio Volatility EXHIBIT 3 $ (1,912,000) (1,049,000) (893,000) (151,000) - - -
3 States change Licensing Requirements EXHIBIT 6 $ (137,000) - - (20,550) (20,550) (61,650) (102,750)
4 Uniform Licensing process EXHIBIT 6 $ (300,000) - - - (200,000) (40,000) (200,000)
5 Licensing Volumes and Revenues EXHIBIT 6 $ (146,000) - (44,500) (44,500) (44,500) (44,500) -
6 Legislation EXHIBIT 6 $ (4,267,000) - - (825,000) (825,000) (825,000) (4,125,000)
7 Legislation EXHIBIT 6 $ (4,329,000) - - (837,000) (837,000) (837,000) (4,185,000)
8 One-Stop Shopping EXHIBIT 6 $ (327,000) - - (200,000) (200,000) - -
9 Merger of sponsors/industry partners EXHIBIT 6 $ (2,366,000) - (350,000) (350,000) (350,000) (350,000) (2,187,500)
10 IT Reengineering - general EXHIBIT 6 $ (428,000) - - - (540,000) - -
11 Software upgrade – product delivery EXHIBIT 6 $ (315,000) - - (375,000) - - -
12 States Perform Their Own Processing EXHIBIT 6 $ (54,000) - (8,750) (8,750) (8,750) (8,750) (43,750)
13 Administrative Fee EXHIBIT 6 $ (4,654,000) - - (900,000) (900,000) (900,000) (4,500,000)
14 States Use Other Vendors EXHIBIT 6 $ (296,000) - (48,750) (48,750) (48,750) (48,750) (243,750)
15 Competitor Expansion EXHIBIT 6 $ (1,012,000) - (167,000) (167,000) (167,000) (167,000) (833,000)
16 Litigation EXHIBIT 6 $ (210,000) - - (250,000) - - -
17 Massive Disaster EXHIBIT 6 $ (94,000) - - (111,600) - - -
Total Estimated Liquid Reserves
$ (21,821,000) $ 555,886 $ (1,040,290) $ (4,967,665) $ (5,588,645) $ (4,876,929) $ (16,420,750)
Needed (Rounded)
/1. Discounted at the 6.00% rate.
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18. Targeting Reserves (cont.)
 How much is too much?
 IRS has not successfully challenged accumulation
of reserves in exempt organizations
 Amount will depend on each entity’s Event
Identification and Risk Appetite
 Document Target Reserve Ratio in a written
Reserves Policy
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19. Characteristics of Comparable
Organizations
Summary of Liquid Reserves (Exhibit 4)
(Source: 86 Organizations From Tate & Tryon Database)
Net
Budget Net % of Fixed % of
(millions) Assets Budget Assets Reserve Budget
Average $27 $20 73% $3 $16 61%
Median $25 $17 62% $2 $13 48%
25th Percentile $21 $8 34% $1 $6 26%
75th Percentile $31 $24 99% $4 $22 84%
High $49 $65 248% $23 $55 232%
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20. Liquid Reserves of Comparable
Organizations – A Refined Benchmark
Summary of Liquid Reserves (Exhibit 5)
20 Organizations with Non-Dues Revenue exceeding 90%
(Source: Tate & Tryon Database)
Net
Net % of Fixed % of
Budget Assets Budget Assets Reserve Budget
Average $25 $20 83% $3 $17 70%
Median $22 $17 69% $2 $15 49%
25th Percentile $20 $11 42% $1 $9 32%
75th Percentile $29 $23 106% $5 $16 84%
High $44 $61 237% $9 $54 210%
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21. Conclusion
1. The actual liquid reserve of 173% is at the high end
for most organizations of similar size.
2. The calculated reserve of 133% may be viewed as a
minimum reserve based on the identified risks.
3. National Association is unique because?
4. We are not aware of any situation where the IRS
successfully challenged the reserve of a section
501(c)(6).
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22. Quantification and Assessment – Same
Concept with Different Approach
Example reserves analysis for a 501(c)(3) credit to Operating Reserve Policy Toolkit for Nonprofit
Organizations by NORI.
Major Economic Major Start a new Funder 3
natural or recession capital program months late
manmade (5% GDP expense (earned
disaster decline) income=$0)
Additional reserves needed 585,000 0 0 90,000 0
Likelihood of occurring in next 3 years 50% 30% 10% 10% 50%
Impact on earned income (12 month period) -25% -5% 0% 15% 0%
Impact on donations -15% -10% 0% 0% 0%
Impact on investments -10% -20% 0% 0% 0%
Impact on demand for your goods and services 50% -10% 0% 20% 0%
Short-term impact on cash flow and costs 0% 0% 5% 5% 10%
Projected earned income 300,000 380,000 400,000 460,000 400,000
Projected charitable donations & grants 425,000 450,000 500,000 500,000 500,000
Projected investment and other income 90,000 80,000 100,000 100,000 100,000
Projected revenue 815,000 910,000 1,000,000 1,060,000 1,000,000
Projected expenses 1,500,000 900,000 1,050,000 1,250,000 1,100,000
Net (loss) income if event occurs (685,000) 10,000 (50,000) (190,000) (100,000)
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23. Take Away Points
 Benchmarking is a starting point - not one size
fits all
 Use ERM to develop a Target Reserve
 Identify Events
 Quantify and Assess Events
 Gain Consensus and Board agreement
 Develop Target Reserve Ratio
 Accumulating reserves is allowed
 Implement a Written Reserve Policy
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24. Questions or Comments?
Susan E. Colladay, CPA
Partner, Audit and Assurance Services
Direct: 202-419-5112
E-mail: scolladay@tatetryon.com
Charles F. Tate, CPA
Managing Partner
Direct: 202-419-5101
E-mail: ctate@tatetryon.com
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25. Additional Resources
 Operating Reserves – NonprofitAccountingBasics.org
Website sponsored by Greater Washington Society of CPAs Educational
Foundation
 Maintaining Nonprofit Operating Reserves
A whitepaper by The Nonprofit Operating Reserves Initiative (NORI)
 Operating Reserve Policy Toolkit for Nonprofit Organizations
An outcome of the whitepaper by The Nonprofit Operating Reserves
Initiative (NORI)
 The Chronicle of Philanthropy series: Against the Grain (blog) by Rick
Moyers, Vice President, Eugene & Agnes E. Meyer Foundation
 Four Things Boards Should Understand About Operating Reserves, April 26,
2011
 What Operating Reserves Are and Why They Matter, April 29, 2011
 How Nonprofits Build Operating Reserves, May 3, 2011
 There’s No Penalty for Having Reserves, May 6, 2011
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26. Speaker Biography
Susan E. Colladay, CPA, is a partner within the Firm's Audit
and Assurance Services practice. In this capacity, she
provides audit and consulting services to a wide variety of
nonprofit organizations and their related employee benefit
plans. Susan graduated cum laude from Hood College with a
Bachelor of Arts degree in mathematics and a minor in
physics. After graduation, Susan worked for more than 4
years in the accounting department of American Society of
Travel Agents (ASTA), a multi-entity trade association.
While working for ASTA, Susan graduated with a Bachelor of Science degree in
accounting from University of Maryland. Susan joined Tate & Tryon in 1997 and
has significant expertise with a multitude of financial issues confronted by her
nonprofit clients. Susan has made numerous presentations to audit committees
and boards of directors. Ms. Colladay has also lead in-house continuing
professional education for Tate & Tryon employees.
Susan has written several articles, most recently for the Tate & Tryon newsletter on
topics such as Enterprise Risk Management and Red Flags Rules.
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27. Speaker Biography
Charles F. Tate, CPA, is the Managing Partner of Tate & Tryon and
has over 35 years of experience working with nonprofit organizations.
Prior to forming the Firm, he worked in the Washington, DC office of
Ernst & Young, LLP where he began working with nonprofit
organizations. Mr. Tate works directly with the management and
boards of hundreds of organizations in helping them assess and
improve key aspects of the organization’s financial governance,
strategy, and operations, such as:
• Establishing critical links among the key elements of the strategic,
operational, financial, reserve, and investment plans;
• Development of guidelines for financial oversight by top management and
the board of directors based on best practices
• Establishing and benchmarking key performance indicators
• Enhancing internal control design and structure using the COSO
framework
He is a regular presenter to the Greater Washington Society of CPAs and the
American Society of Association Executives (ASAE) on these and other related
topics on emerging financial practices and financial governance.
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