Where should nonprofits store money?

Published in the August 21, 2009 edition of Columbus Business First

There has been a great deal of attention paid to banking problems and losses over the past year.  Many nonprofits are concerned about where they should be placing their money. 

The answers will vary depending on when that money will be needed and for what purpose.  In general, the so-called investment market should be limited to funds that are not needed for more than two to three years and for which there is a tolerance for temporary loss of principal in exchange for a likelihood of higher income over a period of five years or more.  Uses for these monies is a very short list:  endowments, reserves for major facility repairs, and reserves you will not need to draw upon in two to three years. 

All other funds should be placed in short-term investments with little or no risk to principal.  There are basically five short-term investments nonprofits should consider. 

Bank checking deposits should be held by every nonprofit.  These deposits are immediately available, pay little or no interest, and are insured by the Federal Deposit Insurance Corp. up to certain limits. 

Bank certificates of deposit (CDs) pay interest for a specified period of time, often ranging from one month to several years.  In general, these funds cannot be accessed before the maturity of the CD without significant penalties. The principal is insured by the FDIC up to certain limits.  Multiple CDs can be assembled with sequential maturities so that funds can become available weekly, monthly, or quarterly. 

Money market deposit accounts (MMDAs and not to be confused with money market mutual funds MMMFs) are bank deposits that are immediately available subject to monthly limits on the number of withdrawals and pay interest that can vary.  The principal is insured by the FDIC up to certain limits.

To determine the extent of insurance coverage for a nonprofit’s total bank deposits, go to http://www.fdic.gov/edie for an estimator of coverage.  A nonprofit can expand its insurance coverage by holding deposits in more than one bank.  This is most practical for CDs, which can be acquired from multiple banks through a brokerage house.  Just be sure to have in writing from the broker the name of each bank issuing each CD, the exact date of maturity of each CD, the method of interest calculation, and proof of FDIC insurance coverage for each bank.

Treasury bills are Federal government securities that have maturities ranging from four weeks to 52 weeks.  The majority of Treasury bills issued mature in 13 weeks, often called 90-day T-bills.  They are sold at a discount from the face value paid to the holder at maturity. 

There is no market risk to principal if the security is held to maturity.  T-bills can be purchased directly from the Treasury or from a broker.  They can be sold prior to maturity only if purchased through a broker but the market value will vary from the face value.  Like bank CDs, T-bills can be assembled with sequential maturities. 

Money market mutual funds are mutual funds sold by brokerage houses.  The brokerage house promises but does not guarantee that balances are immediately available and that principal will be protected.  Historically these promises were firm; however, in the market turmoil of 2008 several money market mutual funds failed to make funds available or to protect principal.  The Federal government instituted a temporary principal guarantee program ending September 2009.  These accounts do not have FDIC insurance and purchases after 2008 are not eligible for the federal program. 

These five short-term investment vehicles are appropriate for certain funds.

For immediate needs bank checking accounts and money market deposit accounts are most appropriate. 

Reserves against accounts receivable should be held and they should be held only in bank checking accounts and money market deposit accounts.  If a nonprofit typically has grants or contracts that pay by reimbursement, it needs working capital to cover its expenses while waiting for reimbursement.  Some nonprofits see delays of three to five months after the expenses are incurred.  Since the nonprofit is essentially a lender to the grantor, it needs to have sufficient deposits to cover this implicit loan, and these funds need to be risk free and immediately available.

Escrowed funds can be appropriately held in bank checking accounts, money market deposit accounts, and CDs.  Escrowed funds, such as tuition or subscription receipts, are monies that would have to be paid back if performances didn’t occur or enrollment was cancelled.  These funds need to be free of principal risk but the time line is more certain so that the longer maturities of CDs can be appropriate and may boost income.

Reserves for seasonal fluctuations can be held in bank money market deposit accounts, CDs, or T-bills.  Seasonality is fairly predictable so the liquidity of checking accounts is unnecessary and the higher income available from these investments is valuable.  Because the size of these reserves is large but expenditure fairly certain, FDIC or federal guarantee of principal is essential, ruling out the use of uninsured money market mutual funds. 

Reserves for revolving internal development and reinvestment can be held in CDs, T-bills, or money market mutual funds.  These reserves set aside funds in one or more years in order to accumulate enough for reinvestments in programs or facilities that are more expensive than could be paid for from one year’s revenue, including receipts from capital campaigns.  The longer holding period for these funds warrants taking higher liquidity or principal risk in order to earn extra income.  However, because of the certainty of spending the funds within a few years, longer-term investments are inappropriate.

Rainy Day reserves can also be held in CDs, T-bills, or money market mutual funds. 

A nonprofit has many needs for holding money that can be safely and reliably available.  The investment markets are not appropriate for these funds because the risk exceeds the benefit from higher income. 

Allen J. Proctor was formerly chief financial officer of Harvard University and is the author of Linking Mission to Money® Finance for Nonprofit Board Members. Subscribe to his free newsletter at www.proctorconsulting.org.

Copyright 2009. Reprinted with permission, Business First of Columbus Inc.