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Nonprofit finance leaders commonly benchmark reserves in months of operating expenses covered — three to six months is a widely cited target, though the right number depends heavily on how volatile and diversified an organization’s revenue is. An organization living grant-to-grant with one major funder needs a deeper cushion than one with broad, predictable individual giving.

An operating reserve is a board-designated subset of unrestricted net assets, not a separate GAAP category — the board formally adopts a reserve policy stating the target level, what conditions justify drawing it down, and how it gets replenished afterward. Without that policy, a “reserve” is just cash that happens to be sitting around, with no discipline protecting it from being quietly absorbed into general operations.

Building and defending an operating reserve is one of the more durable measures of nonprofit financial health — funders and rating organizations like Charity Navigator increasingly weigh reserve strength alongside program spending ratios.

Calculated straight from the statement of functional expenses — Management & General plus Fundraising, divided by total expenses — the overhead ratio has long been used by donors and watchdog sites as a quick proxy for nonprofit efficiency. A lower ratio is often assumed to mean a “better” nonprofit.

That assumption has been heavily and rightly criticized in the sector as “the overhead myth”: chronically underfunding administrative capacity — finance staff, technology, evaluation — often makes programs less effective, not more, even though it makes the ratio look better. An organization starving its own back office to hit an arbitrary overhead target can end up with worse controls, slower reporting, and burned-out staff.

A more honest use of the overhead ratio is tracking it over time internally, alongside program outcomes, rather than optimizing it in isolation or comparing it across organizations with very different missions, sizes, and stages of growth.