Key items covered in this article:

  • Purpose of a Liquidity Policy: A nonprofit liquidity policy outlines how an organization manages cash flow, handles financial shortfalls, and allocates surplus funds to ensure financial stability and mission alignment.
  • Key Components: Effective policies include liquidity targets, decision-making protocols, and backup resources like reserves or lines of credit, helping nonprofits navigate both tight and surplus cash situations.
  • Ongoing Maintenance: Regular monitoring, board reporting, and annual updates ensure the policy remains relevant and supports informed financial decisions.

A nonprofit liquidity policy is a written document that shows how the organization manages cash and near-term resources. It explains what leadership will do when cash falls short of upcoming obligations and when cash builds beyond operating needs. It also assigns decision rights and outlines the first steps in each case, including when to use reserves and when surplus cash should be moved into short-term investments in line with the organization’s investment policy.

Nonprofit leaders and board members rely on it during financial reviews and major decisions, including hiring, program expansion, and sudden changes in funding. This guide explains why liquidity matters, what a strong policy includes, how to develop one, and how to keep it current.

What Is Liquidity and Why Does It Matter?

Liquidity is the organization’s ability to pay near-term obligations using resources it can access within the next 12 months. It comes down to two important questions. Can the organization cover payroll, rent, vendors, and program costs? And if cash exceeds those near-term needs, what is leadership expected to do with the surplus funds?

U.S. GAAP requires nonprofits to include liquidity disclosures in their financial statements under FASB ASU 2016-14. These disclosures usually appear in footnotes, and they explain which financial assets are available for general spending within the next year. A liquidity policy also helps leadership use that same lens internally, not just at audit time.

The challenge is that the balance sheet can overstate what is usable in either direction. Donor restrictions, board designations, endowment rules, and conditional grants can limit what is actually available. On the other side, a temporary cash influx from one-time funding can look like “extra money” when it is really earmarked for future needs. A liquidity policy helps leadership sort out what is truly available, what must be held back, and what can be moved into reserves or investments.

What a Liquidity Policy Usually Covers

Before drafting anything, it helps to understand what a liquidity policy typically includes. Most policies pull from a few common building blocks, both quantitative and qualitative.

A typical policy clarifies available resources over the next 12 months, separating usable cash and near-term assets from amounts that are restricted, delayed, or otherwise unavailable, with some narrative context. It then defines liquidity targets, often in months of operating expenses, and identifies key metrics to monitor, such as months of cash on hand, current ratio, and available net assets.

It also states decision-makers and approvals for cash actions, including when the finance committee or board steps in, and documents back-up liquidity sources such as reserves or a line of credit. Many policies include a simple decision tree that lists first steps when cash is tight (speed up collections, pause discretionary spending, revisit payment timing, confirm credit access) and the actions leadership takes when liquidity is strong (rebuild reserves, expand programs, follow investment policy).

How to Develop a Liquidity Policy

Developing a formal liquidity policy means managing financial sustainability with mission delivery. A nonprofit team can start building a liquidity policy by working through the following steps:

Review examples and current disclosures. Pull audited financial statements and the liquidity footnote. Review how other nonprofits describe liquidity in practice, including national organizations such as United Way, the Red Cross, and Feeding America.

Assess cash flow patterns. Review cash flow over the last 12 to 24 months. Chart reimbursement patterns and any seasonal factors.

Calculate key metrics. Calculate current ratio (short-term assets vs. short-term liabilities), months of cash on hand (how long unrestricted cash can cover expenses), and available net assets (spendable resources).

Identify potential resources. List lines of credit, board-designated funds, and short-term investments, along with access conditions and who can authorize actions in a shortfall or surplus situation.

Set targets and thresholds. Define target reserve levels and identify thresholds that trigger action, such as accessing cash reserves or acting on the organization’s investment policy.

Draft the policy. Create a document with both quantitative charts (definitions, metrics, thresholds) and a narrative that explains how leadership interprets the numbers. Keep it consistent with financial statement disclosures.

Obtain board review and approval. Bring the draft to the finance committee and board for approval, and assign an owner for ongoing updates.

Note: Nonprofits will have different liquidity policies because each organization has different spending and reserve strategies. Large organizations will need more substantial policies and smaller nonprofits may have a more basic version.

Maintaining the Policy Over Time

An effective liquidity policy requires regular monitoring throughout the year. First, the policy works best when it is part of daily financial management. That includes following the liquidity policy for spending/investment approvals and reporting liquidity status to the board on a regular basis.

Second, leadership will want to compare key metrics monthly or quarterly next to policy targets. When reserves are below or above target levels, the policy should guide the next steps.

Finally, the policy will need to be updated annually, usually during budgeting or strategic planning. This is the time to update reserve targets, confirm available resources, and adjust procedures based on what happened during the year. If the organization added programs or changed its funding mix, the policy should reflect that.

Looking Ahead

In addition to supporting FASB compliance, a formal liquidity policy helps nonprofit leaders make informed decisions about spending, reserves, and growth. That leads to stronger day-to-day operations and mission alignment. For more information on developing and maintaining a policy for your nonprofit, contact PBMares Not-for-Profit Partner Bo Garner.