The Earmarked Grant and the Vanishing Reserve
A $4.2M nonprofit serving 1,200 clients annually has a $600K reserve. In Q3, it receives a $500K restricted grant for a new case-management software system, with a 12-month spend-down requirement. The ED wants to use $150K of the grant to cover existing IT staff salaries, arguing they will support the rollout. The finance committee notes that the reserve is already below the 3-month operating target ($350K). The grant also requires a 20% match ($100K) that was not budgeted. The board meets in two weeks. The development director has a verbal pledge of $75K for general operations, not yet documented. The software vendor requires a $200K deposit upon contract signing.
1. What are the key financial risks, and what should the ED recommend to the board regarding the grant and the reserve?
Read the worked answer
Key risks: (1) Restricted fund misuse-using grant funds for existing staff salaries may violate the grant agreement if not explicitly allowed; (2) Match shortfall-$100K match is unbudgeted, and the reserve cannot cover it without dropping below the 3-month threshold; (3) Cash flow-$200K deposit due before the $75K pledge is documented; (4) Reserve erosion-reserve is already at 2.5 months of operating expenses.
Recommendation: Do not sign the vendor contract until the match is secured and the pledge is documented in writing. Request a written clarification from the funder on whether staff salary allocation is permitted. If not, identify $100K in match from a new source (e.g., board-designated funds or a short-term line of credit) rather than the operating reserve. Present a scenario analysis to the board showing reserve levels under each option. If the match cannot be secured within 30 days, consider declining the grant or negotiating a reduced scope.
2. How should the ED handle the $75K verbal pledge in the board discussion?
Read the worked answer
The ED should disclose the pledge as not yet legally binding and therefore excluded from the financial projections until a signed pledge agreement or gift letter is received. The board should treat it as a contingent asset. The ED can present two budget scenarios: one with the pledge and one without. The board should not authorize spending based on the verbal pledge. The development director should be tasked with obtaining written confirmation within 10 business days. If the pledge is not documented by then, the board should assume it will not materialize for cash-flow purposes.