Charity reserves: Debunking the myths

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Are you up to speed on charity reserves? When was the last time your charity paid attention to its reserves position and policy?

In our experience, there’s a widespread misunderstanding of charity reserves and yet this is an area of vital importance to all charities.

Some charities don’t give much time and attention to the topic; others have a burst of discussion and activity, but it doesn’t impact their day-to-day.

A reserves policy is not supposed to be a ‘one-and-done’ thing, but should have an ongoing, active role in running the charity and informing future plans and developments. Reserves should be managed and utilised, just as property, assets and people resources are.

What are reserves and why have them?

CC19 Charity reserves: building resilience is key guidance that all charities should read and seek to understand. CC19 defines reserves as:

“…that part of a charity’s unrestricted funds that is freely available to spend on any of the charity’s purposes.”

This definition therefore excludes any funds held by the charity that is either restricted for a specific purpose, or otherwise committed or not readily available, such as those funds tied up in the value of fixed assets used in the charity’s work or already earmarked for a particular purpose (e.g. a designated fund).

But why have reserves?

Broadly speaking, charities have reserves in order to both manage uncertainty and to be able to proactively plan for future developments. More specifically, reserves are held because of the following:

  • Working capital needs: There is a need for funds to help deal with the day-to-day ups and downs of cashflow patterns. For example, a charity may need to spend money in advance of receiving the next instalment of grant funding.
  • Income risk: For example, a charity may face the reality of a major stream of funding not being renewed. The presence of reserves ‘buys time’ for the charity to reshape its activities or find additional income sources.
  • Unplanned adverse events: A charity may need to deal with unforeseen costs or incidents that have a funding application. For example, a key member of staff may be taken ill and temporary staff may need to be recruited to cover their role, or perhaps a charity receives a huge, unexpected bill.
  • Unplanned closure: A sudden need for a charity to close will have a significant impact on beneficiaries and staff. Reserves help to responsibly provide for the obligations arising under such undesirable circumstances.
  • Emerging opportunities: We live in a society that is changing rapidly and charities will often have new opportunities to serve and deploy their effort. Even if the work of your charity is fairly static, the environment you are operating in is unlikely to be. Reserves are not just ‘funds for a rainy day,’ they are funds to pursue the sunny days ahead for your charity.

Common myths

“The Charity Commission recommend that charities have 3-6 months of expenditure in reserve”

This is a statement that seems to come up again and again. We don’t know where it came from, but it represents a fundamental misunderstanding. The Charity Commission do not recommend a particular level of reserves. Every charity is different and has a unique risk and opportunity profile. Whilst the Charity Commission don’t prescribe a standard level of reserves, they do expect trustees to proactively plan and report on the level reserves that is needed for their charity.

“Trustees have a duty to maximise the charity’s reserves”

Charity reserves are not just about resilience and avoiding insolvency. If reserves are higher than necessary, the potential benefits that can be provided by the charity are limited as a result. Holding too much in reserve can have a negative impact on both the reputation and public support for a charity.

It might be a completely valid policy for a charity to aim to hold zero reserves. For example, where a grant making charity decides to award only what it receives as income, has no staff and no ongoing commitments and faces minimal costs of unplanned closure, a zero-reserves policy may be completely valid. It all depends on the charity’s unique circumstances.

“When fundraising, potential funders will want to see [low/high] levels of reserves”

Some people think that funders want to see high reserves; other people think that funders want to see low reserves. Which is correct?

In reality, both views are valid. A funder seeing a high-level of reserves may conclude that your charity doesn’t need its support. Alternately, other funders might look at low reserves and have concerns that the charity is stable and sustainable.

Here’s the most important point: it’s not the level of reserves that matters but the clarity with which we explain what we need. This is where a policy is vital.

What do you need to do?

All charities should have a reserves policy. It is a very important tool that serves two key purposes:

Management tool

A reserves policy helps trustees and management in their decision-making and to spot any issues as they arise. Consideration of reserves is a cornerstone of setting annual budgets. Will we set a deficit budget to spend down excess reserves, or do we need to set a budget that allows reserves to be built up towards our target?

Communication tool

A clearly articulated reserves policy and transparent reporting of actual levels of reserves held is vital in giving confidence to your charity’s stakeholders. It demonstrates proactive financial management and gives assurance to donors, funders, beneficiaries, lenders, the regulator and the general public. Making sure you ‘explain and justify’ well in your public reporting will help mitigate reputational risks and people jumping to conclusions. Ensure you tell your story before someone else tries to tell it for you.

A possible approach

For a small charity, consider the following in order to develop a reserves target:

  1. Understand your income, expenditure and funds held
  2. List the principal reasons why you need reserves (refer to your risk register, if you have one)
  3. For each reason identified, consider the amount needed to address that reason or risk
  4. Aggregate these amounts and consider expressing the target as a range rather than a single figure

Clearly document your considerations and start tracking your actual reserves against this target.

And finally…

Whatever you do, make sure that your reserves policy is not static. Keep it under regular review and assess it formally at least once a year. Review your actual level of reserves against your policy each time you look at the charity’s financial performance and position. Doing so will help you identify issues as they arise and help you respond with agility to needs, risks and opportunities.

Need some support?

Burton Sweet has a longstanding commitment to charities and civil society organisations, offering practical, professional and passionate support. We want to assist you, so you can deliver effectively for the communities you serve and show the good you do.

We can advise on or review your reserves policies, helping you to tell your story well in your public reporting, developing a risk management process, as well as board development training and much more…

If you would like some guidance on any aspect of running your charity, please get in touch with our Senior Charity Adviser, Ed Marsh.

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