The Charity Commission has recently complained that the standard of reporting on Reserves and Reserve Policies in charity accounts is alarmingly poor with less than a quarter of charities reviewed properly understanding what reserves are.
So what are reserves and why are these necessary? Is setting reserve policies and reporting on reserves not just yet another regulatory burden imposed on a hard pressed sector, a paper exercise to be dealt with and then forgotten about until next year?
This has been the way that many organisations have approached this question but I would argue that having a proper reserves policy is an essential for every not for profit organisation. It is an essential part of its risk management process to ensure it is able to properly maintain its operations in difficult conditions.
So why are reserves so necessary?
Many trustees and executives are anxious in a world of need to wring every last penny out of funding. Leaving income in reserves rather than spending this on the organisation’s purposes goes against the grain, particularly when funding has reduced. This is understandable but the example of Kid’s Company has illustrated just why reserves are so necessary.
Money seems to have been spent by this charity as soon as it came in and when funding dried up the whole operation slid into insolvency as there was no buffer to protect operations. Employees were out of a job, vulnerable beneficiaries were left without support and everyone involved from the Chief Executive, to the board, to the auditor and even the Government Ministers involved were left with their reputations damaged.
Reserves are necessary to provide stability in a changing world.
- Provide working capital
- Give a buffer against loss of income streams, fluctuations in income or exceptional unexpected costs so these do not bring the whole operation to an immediate halt
- Give a fund to enable organisations to fund new opportunities and operations
- Ultimately, leave enough money to ensure that operation can be closed down if necessary in an organised fashion without insolvency
What are reserves?
As noted above the Charity Commission have recently commented on a general lack of awareness in the sector regarding what reserves are, and the reporting by very many charities is seriously deficient. Reserves do not necessarily equal cash or investments or total funds. Reserves will not include any amounts tied up in tangible fixed assets.
Instead, an organisation should start with total funds but exclude:
- Restricted or Endowment Funds as these are committed to be used for the purposes specified by the donor and are therefore not available to be used at the discretion of the trustees
- Designated Funds, which are monies which the Trustees or Directors have set aside for particular purposes and again if these are committed for these purposes they cannot also be used in reserves
- Tangible fixed assets as these monies cannot be spent again as these are already invested in assets.
- Money received in advance of providing services cannot be included (these are included in creditors rather than funds but again this is not money at the disposal of the trustees).
Unrestricted investments should however be included as these are ultimately available to be sold, and the decision as to whether to invest or not invest is an investment decision.
Management should therefore start with their general fund and exclude tangible fixed assets (and possibly any associated long term borrowing).
What are the right level of reserves for my organisation?
This question is often asked with the hope there is a “silver bullet” that will give an easy to calculate formula such as a set number of months’ worth of expenditure. The other mistake that organisations make is to start with the reserves they actually have and then try and justify these.
These are the probably the wrong ways to approach this question. A reserves policy is an important part of your risk assessment process and each organisation needs to consider what ideally it needs to keep in hand to protect the organisation, and then work towards achieving and maintaining this level. Only at that stage should an organisation start thinking about expressing this in months of expenditure.
The “risk” and therefore appropriate reserves will vary considerably between organisations and their respective income and expenditure profiles. For instance, an organisation that has to raise donation income from scratch each year may typically want higher reserves than an organisation which has a stable supporter base paying by Direct Debit. Grant making foundations can in many cases simply reduce grant payments if income reduces, unless for instance it has committed itself to make grants in future years, and may therefore believe its reserves level can be lower. Each organisation should consider what works best for that organisation and be prepared to explain this in its Annual Report.
It may be that when looked at in this way you may come to the conclusion that your reserves are simply insufficient to support the organisation and difficult decisions about retaining surpluses to build up reserves may be necessary.
In conclusion, Reserves Polices and Reserves reporting should not be regarded as onerous compliance tasks but as a vital tool to manage risk and ensure the long-term viability of the organisation. If your Board are not already seriously considering reserves this should be a priority. Unless there are absolutely no threats to an organisation’s financial stability this could be one of the most important discussions you ever have.