Charity Reserves Policy: Building a stronger and more resilient charity

In this guest post Steven Richardson, Partner at Haines Watts Newcastle, outlines the importance of charities having a robust reserve policy.

In recent years, the Charity Commission has highlighted the increasing need for charities to have a strong reserves policy in place. Given the current political, economic and social climate, this need has never been more important.

However, as someone who advises charities on finance, almost on a day-to-day basis, this is still something I find many are neglecting. Charities do not adequately disclose their reserves policy, or, where disclosed, the notes are confusing. In particular there does not seem to be clear disclosure on ‘free reserves’ or the definition of what is included as ‘free’.  At a time when public trust is vital for the progression of the sector, charities must properly address their reserves policy to ensure the long term needs of their beneficiaries are properly met. 

What are reserves?

The Charity Commission defines reserves as that part of a charity’s unrestricted funds that is freely available to spend on any of the charity’s purposes.  Free reserves should exclude restricted funds and funds designated for specific purposes. They should also exclude fixed assets (in particular land and buildings) as these assets are not freely available to contribute towards working capital requirements.

Why are they so important?

Reserves are all about making your charity resilient. They protect your organisation against unplanned falls in income, or unforeseen increases in expenditure. Think of them as a buoyancy aid to keep your charity afloat in the event of troubled times. Low reserves can mean charities are left vulnerable, leaving them at risk of financial difficulty or insolvency.  

Several years ago, the high-profile story of Kids Company gained much media attention for all the wrong reasons. The charity functioned on a ‘hand-to-mouth’ model, in which it catered for the needs of all who needed the organisation’s help and only considered the costs afterwards. Indeed, in their 2013 report, the charity’s trustees stated they were aware of the lack of reserves in place but that their ‘business model is to spend money according to need.’  When asked about a safe level of reserves in an enquiry, the charity’s auditors suggested £12m (6 month expenditure) would be suitable. In reality, the last available balance sheet showed its unrestricted reserves were £434,282. If the charity had the correct reserves policy in place and disclosed free reserves, perhaps it could have withstood the financial pressures and difficulties it encountered?

How should a charity set up a reserves policy?

Defining the amount a charity should have in reserves is a difficult thing to do. It varies case-by-case, and there are multiple factors which influence the ultimate amount a charity should have at hand. However, as a general rule of thumb, it is said that anywhere between 3-9 months’ income is a good amount. The Wise Owl Partnership has put together a useful reserves calculator for non-profit organisations trying to work out how much funds should be held in reserve. 

A charity’s reserves policy should fully outline why reserves are or aren’t being kept. It should be properly justified with risks and opportunities, while looking at both the charity’s current situation and future needs. It is also important to review past trends to help predict any volatility. This reserves policy must then be communicated openly with stakeholders to ensure maximum clarity. 

A reserves policy can play an important role when applying for charitable grants, and if done improperly (i.e. too much is being kept) it can deter big donors away from your charity. Equally, charities should always be looking to make their reserves work harder. This means moving away from a risk-based approach and instead taking a strategic approach to financing. Where appropriate, this could mean using cash held in reserve to invest in new ways of diversifying income. For example, could your charity tolerate a dip in its reserves to invest in a new charity shop which could in the long run increase income?

A good starting point is to identify your free reserves using the following table as a guide line:

Total funds of the charity

X

Less: restricted funds

(X)

Less: endowment funds

(X)

Less: designated funds

(X)

Less: tangible fixed assets hold for charity’s own use

(X)

Available free reserves:

X

Disclosure of free reserves in the financial statements is fundamental to ensure that readers of the accounts have a clear understanding of your financial position.

Conclusion

While the primary aim of a charity is to provide for the needs of its beneficiaries, it must consider the ultimate long term stability of its operation and its duty to stakeholders. A charity cannot control the environment in which it operates. It must ensure it has resources to support itself in the event of unforeseen circumstances.

5 points to consider:

  • Review your charity’s positon, taking into account risk and opportunities, both present and future
  • 3 to 9 months is a rough indicator of how much should be held in reserve, though the ultimate decision must be justifiable
  • The policy should be agreed by the trustees and the board minutes should record any decisions reached
  • Once in place, a reserves policy must be communicated clearly and effectively with stakeholders
  • Reserves should be monitored throughout the year and policy should be reviewed accordingly to keep up with the charity’s changing needs 

*

Steven Richardson, Haines Watts North East

As one of Haines Watts’ longest serving Partners, Steven has worked with some of the region’s best known voluntary groups and organisations, so fully understands the issues around governance and securing funding. He is also a trustee at VONNE, where he holds the position of treasurer.