Why charities shouldn’t just concentrate on having reserves

Accounting, Charity

Highlighter

Reserves are all the rage in the press, especially following Kids Company, but should charities be fixated on reserves?

The latest NCVO Almanac 2016 reveals that of the 165,000 charities, some 100,000 (or two in three) hold reserves and the remainder do not. Those without reserves tend to be the smaller organisations but they also include charities of all sizes- the detail behind these facts can be found at: https://data.ncvo.org.uk/dataview/distribution-of-reserves-by-size-of-organisation-201314/.

Reserves in the sector equate to some £45.8 billion pounds – and if you exclude the grant makers who tend to hold endowment funds which cannot be spent – then the average amount of reserves per charity is around six months expenditure. However, it needs to be borne in mind that two thirds of the sector have less than six months reserves. So the NCVO Almanac makes interesting reading, as it shows that there are many charities that operate without much reserve at all.

Having worked with many organisations over the years with little reserves, whom have been in this position for many years as they can only generate enough income to keep their services going and are not able to put much aside, the key to their ability to continue was being able to keep a very close eye on future income sources, cash flow, budgets and resources. It is not a nice position to be in where you have to count every penny all the time but does show that organisations can survive on little reserves and deliver fantastic charitable objectives.

Many funders (government, local authority, trusts/foundations and corporates alike) often offer only restricted funding and very little contribution towards overheads which perpetuates this position. So reserves are not the focus of attention but your ability as an organisation to survive and keep going. Having a buffer is nice but can be often result in funds that are overlooked and not utilised.

So why do charities need reserves?

One of the aims of any Trustee is for them to have been seen to look after an organisation during their tenure and to hand over a healthy and thriving organisation to the new Trustees when they retire from their role. Reserves can quite often be seen as monies to be held for a rainy day, a buffer and not to be spent – decreases in reserves can be seen as a negative aspect of their tenure as Trustees and the desire could instead be that they will have grown instead.

Board of Trustees

The level of reserves is often not discussed or considered by the Board of Trustees in their strategic plans – the focus can often be more on the budgeted income, future income streams, surplus or deficit for the year. Reserves are usually considered once a year when the reserves policy is being looked at in the annual accounts and justified at that time without any flow through to the strategy and future plans.

Managing risk

The fact that reserves represent unspent income can often be overlooked. Most charities do not have the power to accumulate funds and should be applying their resources to charitable purposes, or be able to justify why they have not. Therefore when charities hold reserves they are balancing the need to spend on their beneficiaries (or charitable purpose) against the need to hold funds to manage risk. By not spending reserves the charity is depriving itself from being able to apply money to deliver its charitable objectives – which is one of the duties of trustees.

Reserves do have an important part to play in any organisation whether it’s a commercial company or a charity to cope with liquidity and working capital needs, funds for future development, risk assessments and future planning. However, they do need to be considered and assessed. Charities that have undertaken their strategic planning to encompass budgets, future plans, working capital and reserves, have been able to determine how much funds are appropriate to hold and many have been able to free up reserves to use in the charity.

In order to make any informed decisions about reserve levels, the strategic plan needs to consider how the charity is financed. Are funds raised by the charity in advance before being spent – from funders, service contracts or fees? In which case the view may be that the charity operates in a lower financial risk model and the level of reserves needed may be more modest. Or is income received in areas after delivery of the activity with clawbacks or performance criteria dictating the final amounts that may be received? In this is the case the working capital requirements may be higher if borrowings or social investments are not available to bridge the gap.

Reserves need to be managed

The key message is that reserve levels need to be as actively managed as budgets, income and cashflows in the strategic plan so that informed decisions can be made as to when to retain amounts and when to spend. The charity could be using their reserves to fund new development and investment in services for beneficiaries or for income generation plans – do you know if your reserves are all required to be retained or do you have any spare? When you look at your reserves policy do you understand why the policy says what it does? Why, for example, is three months operating costs required not six or two or even none; and is this actually the right reason in the first place?

Therefore, it is important that the charity takes stock once in a while and produces a long term plan which thoroughly reviews the organisation, what it does, how it will be funded, its financial strategy and business model – normally covering no more than five years. These will determine the appropriate level of reserves needed to allow that organisation to deliver the strategic plan. Furthermore, these plans take a lot of effort by the senior management team and the trustees to produce, so it is important that this plan does not just get put on the shelf but is actively reviewed each year to monitor progress, review and realign the plan as necessary.

A good strategic plan will consider various scenarios and timelines – looking at plans for building for the future as well as perhaps maintaining the current position. So there will be an element that may relate to the need for investment. Such investment could be recruiting fundraisers which will need funding until they are up to speed or investment in new buildings or equipment. The investment could well come from the charity’s reserves if the organisation really understands its position and so could grow or become more efficient/effective if it knew it could spend funds.

Therefore make sure that reserves are part of the budget and strategic planning process, not just a number on a balance sheet that needs to be justified once a year in the statutory accounts. Make the reserves work for your charity just as hard as you do.

 

This post was written by Partner, Helena Wilkinson of the specialist Charities and Not For Profit team. For further information you can get in touch with Helena at helena.wilkinson@pricebailey.co.uk.

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