By Jayme F. Moore, CPA
Vice President & Director
A nonprofit’s spending policy plays a critical role in balancing current program needs with long-term financial health. The right approach can help ensure your organization has the resources it needs today while preserving assets for the future. If you haven’t reviewed your spending policy recently, now may be the perfect time to determine whether it’s still supporting your goals.
Why Regular Reviews Matter
A spending policy establishes how much of your organization’s investment portfolio can be used each year to fund operations, programs, capital projects, and other expenses. Because nonprofits vary widely in their missions, financial structures, and funding requirements, there is no universal spending policy that works for every organization.
While consistency is important, spending policies should not remain static forever. Boards and leadership teams should periodically assess whether their current policy aligns with the organization’s mission, financial objectives, liquidity requirements, and long-term sustainability plans. Changes in market conditions, operating costs, or strategic priorities may warrant adjustments.
Common Spending Policy Approaches
Most nonprofit spending policies fall into one of several widely used approaches. Understanding the strengths and limitations of each can help your organization make informed decisions.
Fixed-Rate Method. Often called the simple spending rule, this approach applies a predetermined percentage to the investment portfolio’s value at the start of the fiscal year.
The primary advantage is simplicity. However, because annual spending is directly tied to portfolio performance from the prior year, distributions can fluctuate significantly. During periods of strong investment returns, this method may generate larger spending increases, which could reduce long-term portfolio growth if not carefully managed.
Inflation-Based Method. With this strategy, an organization establishes an initial spending amount and adjusts it annually based on inflation. Some nonprofits also use minimum and maximum limits tied to portfolio value.
This approach can make budgeting more predictable and may support long-term portfolio preservation. However, spending levels are often lower than those generated by other methods. Additionally, inflation can fluctuate considerably over time, making periodic reviews essential to ensure assumptions remain realistic and appropriate.
Rolling-Average Method. This method calculates spending using a moving average of the portfolio’s market value, commonly over a three-year period, or other predetermined period.
A rolling average can smooth out annual spending fluctuations and provide greater consistency for budgeting purposes. However, because it relies on historical values, it may sometimes produce spending amounts that are either too high during market downturns or too low when additional organizational support is needed.
Geometric Method. The geometric spending approach incorporates both inflation and investment performance into its calculation.
Although the formula is more complex, it is designed to reduce year-to-year spending volatility and may lessen the impact of market declines. Organizations seeking a balance between stability and responsiveness often consider this approach despite its added complexity.
Hybrid Method. As the name suggests, a hybrid policy combines elements of multiple approaches, typically blending inflation adjustments with a market-value-based calculation.
For example, most of the annual spending amount may be based on the previous year’s spending adjusted for inflation, while a smaller portion is tied to a fixed percentage of portfolio value. Hybrid policies often provide stable distributions while remaining responsive to changing market conditions.
Build in Policy Flexibility to Support Future Needs
Regardless of the methodology selected, many nonprofits include provisions that allow the board of directors or another authorized group to approve spending above the standard policy amount when extraordinary circumstances arise. Having this flexibility can help organizations respond to unexpected opportunities or financial challenges.
A well-designed spending policy should support both your organization’s immediate needs and its long-term mission. If your nonprofit has experienced significant changes in its financial position, strategic objectives, or operating environment, it may be time to revisit your approach.
There’s no one-size-fits-all spending policy. A thoughtful review today can help ensure your spending policy continues to provide the financial support and stability needed to advance your mission for years to come.
Consider GT Reilly’s nonprofit consulting services to assist with your organization’s needs.
