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How charities can better use designated funds

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27th Jun 2017
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Designated funds – an area still sometimes shrouded in a little mystery for charities but, in my opinion, an underutilised tool.

It is still somewhat of a surprise how many organisations are all over their restricted and unrestricted funds, yet few actively engage with the possibility of designating funds. Beyond that there is sometimes even an element of whether trustees and charity finance staff alike are au fait with what designated funds are and how to use them proactively.

What are designated funds?

Designated funds are those unrestricted funds which have been set aside by trustees for an essential spend or future purpose. In a sense, these funds are then ‘ring-fenced’ and no longer form part of your unrestricted general funds.

Typically, a designation of unrestricted funds would be something discussed at board level and formally minuted.

From an accounting perspective, this would translate itself into a transfer from general funds to designated funds during the period in which the decision was made to put funds aside. Ideally, this would be reflected in your regular management accounts but most definitely would need a presentation in your year-end accounts.

For financial statements purposes your year-end funds position would usually, therefore, be analysed as follows:

  • Restricted funds
  • Endowment funds
  • Unrestricted funds
    • Designated funds
    • General funds

Why might you choose to designate funds?

A designation of funds is most commonly seen where a charity has an accumulation of general unrestricted funds, but this is not always the case.

Now, before you guffaw into your coffee and set this article aside with a “show me a charity with surplus funds in the current climate”, let’s look at some of the common practical applications for designated funds:

  • Asset purchase – perhaps your premises lease is due to expire and the trustees feel a property purchase would better serve the interests of the charity long-term. A designation for a future deposit (or indeed the whole purchase price if you’re lucky enough to have that available) could be made.
  • Unfunded essential activity – maybe you haven’t been successful in funding a project which you believe is core to your charity’s identity. Not completing the project is not really an option. The trustees could designate an amount from general funds to ‘top up’ any shortfall on restricted funding received, for example.
  • Restructure – unfortunately funding cuts and reduced availability of core cost grants over the last few years have hit the sector. For some smaller organisations, the prospect of redundancies and urgent streamlining of resources is very real. It might be worth considering what the charity’s exposure would be to redundancy and/ or restructure costs if the organisation’s business model needed to change rapidly to ensure future sustainability. A designation of funds could potentially tell the reader of your financial statements - at a glance - what your ‘worst case scenario’ pot needs to be.

Why might you not want to use them?

As designated funds are (whilst still technically unrestricted funds) distinct and separate from general unrestricted funds, this means that they cannot be included in your calculation of free reserves.

Free reserves are of course calculated as those unrestricted funds not designated or tied up in unrestricted fixed assets – i.e. your liquid funds. It is the magic number which you are expected to cite in your Reserves Policy paragraph each year, benchmarked against your charity’s chosen target – for example six months of core operating costs.

Your residual ‘free’ general funds will therefore be lower following a designation of funds than without. This could be off-putting for some trustees who may be focused on reducing the gap between actual free reserves and the target level, as per the Reserves Policy.

What message does a designation of funds convey?

Whilst the above is true, it also stands that the Charity Commission are looking more and more for a demonstration of proactive governance and sound financial management from trustees.

There is an argument to suggest that by engaging in designating funds it shows that trustees are continually forward-looking, always trying to anticipate where unexpected spend may be incurred or how the sustainability of the charity can be protected. It shows that you have budgeted for the forthcoming period, or at least had an eye on what might be around the corner.

Your Reserves Policy, coupled with the future developments paragraphs in your Trustees’ Report are the place to tell the reader of your financial statements why funds have been designated during the period - to tell the ‘story’ behind how our actual reserves compare with our Reserves Policy. 

Perhaps your organisation is holding funds in excess of its Reserves Policy, in readiness for one of the above situations.  Maybe you are planning a large self-funded income generation campaign the following year and the trustees are committed to investing in fundraising for the future benefit of the charity – adopting a “no pain no gain” strategy.   

Whatever the reason, be clear and transparent about why you might be holding excess reserves. After all, in a time of austerity, who wants to see a charity sat on large reserves for no apparent reason?

Think also about the primary users of your charity’s year-end accounts and what they may be looking for:

  • Charity Commission – best practice financial management and regulatory compliance
  • Funders – levels of free reserves – why should they fund you over another charity?
  • Potential donors – good financial controls could suggest that their donation is in safe hands

Is a designation permanent and what if I change my mind?

As we have already said, funds can only be formally designated following trustee approval at a board meeting. Therefore, as this has been done at the trustees’ discretion, it can also be undone in the same way.

All that will happen is that the trustees minute that the designation is no longer needed, or the amount needs to change, and a released from designated funds back to general funds may occur.

For more practical guidance around managing reserves and Reserves Policy, see our previous article here.                                                               

You can also visit the Charity Commission’s guidance document for managing reserves – CC19: Charity reserves – building resilience - for more information.

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Replies (4)

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By coolmanwithbeard
28th Jun 2017 11:30

A problem I often come across with these is charities not reviewing the designations. So the building project doesn't happen but the funds remain designated.

Additionally some charities that are branches or part of a larger charity in some way contribute part of their unrestricted reserves to the main charity. I have seen local charities designate to reduce their free reserves to save sending money to the centre.

Similarly they can also be used by cash rich charities to reduce free reserves to encourage further giving rather than acknowledge they have too much money and are not using it or have any plans for it.

When I do independent examinations of charities I push quite hard on designated funds and whether the designation is still appropriate.

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By svenhaile
26th Sep 2017 23:57

I have created a control feature in our accounting software to force all charitable activities funded from unrestricted sources to be tracked and reported as designated funds for their specified life time. This is particularly useful to those few trustees like myself who insist on monitoring the unrestricted charitable activities in the same way as the restricted ones. This is how they can enforce proper budgeting and view in real-time any cost overrun by management also in the unrestricted charitable projects.

Sadly, the SORP FRS 102 does not reward those trustees for doing so. I understand that some reporting is simplified and that is very useful. But there is no requirement to report by designated funds, nor is there a practical separation of charitable expenditure, support and governance costs when reporting expenditure for charitable activities. The statement of accounts is stretched across too many tables for the management team to want to keep track of all that data.

From a management accounting perspective of a small charity, this is very inefficent, as management accounts need to be drawn up separately if one or more trustees insist on adequate management accounting reports across all funds.

It is also very dangerous, as charities should be encouraged to understand and manage in detail their unrestricted income for funding charitable activities rather than to ignore or delay the active management and reporting of designated funds.

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By KenStarnes
22nd Jan 2018 16:40

Can someone tell me what is the legal situation if monies left in a will towards a building fund that have been put into a designated bank account were to be used for other purposes? Does this break the terms of the will/bequest?

A church I know is in this situation but it is very unlikely that they will ever buy a building and would rather put the monies to a better use.

Thanks for any feedback.

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Replying to KenStarnes:
By coolmanwithbeard
31st Jan 2018 07:39

Hi Ken

This bequest forms a restricted fund in the accounts and the money can only be spent based on the terms of the bequest. I would advise caution - do you have the wording? Many churches have a buildings fund and more often than not is is for repairs and maintenance not a new/replacement build.

The bank account is irrelevant it could all be in one bank account. It is the fund accounting that is important.

If what you say is true then the building fund should be maintained which may put the general fund into deficit.

The restriction can be lifted (usually with the donor's permission - obviously not possible here - churches don't approve of seances!).

See here for some good CofE guidance on this: http://www.parishresources.org.uk/wp-content/uploads/restrictedfunds.pdf

Mike

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