Managing director Gerrard Financial Consulting
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Charity reserves: Not just an annual affair

17th Jan 2017
Managing director Gerrard Financial Consulting
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Real time financial visibility is increasingly becoming a necessity for the sector. With regulator enquiries on the rise and media coverage of recent high profile cases, such as Kid’s Company, a trustee’s responsibility for safeguarding their charity’s assets and beneficiaries is firmly in the spotlight.

What does financial visibility look like for a charity?

How does a charity demonstrate sound financial visibility? In my opinion this encompasses the following:

  • Annual budget, prepared and signed off in advance of the new financial year
  • Access to a real-time rolling cash flow forecast, updated regularly
  • The ability to produce a funder report showing actual spend versus planned spend instantly – whether that be at the organisational, project, department or fund level
  • Ability to monitor and review the organisation in line with relevant, pre-determined financial Key Performance Indicators (KPIs)
  • Knowing in real time how much you have left on each restricted fund and/ or project
  • Sight of your free reserves throughout the year, benchmarked against your charity reserves policy (see below)

How to set a robust reserves policy

The financial management of a charity is underpinned by its trustees’ reserves policy. I’m sure you’re all familiar with that paragraph that finds its way in to your annual report. A robust policy should include:

  • Reasons why the charity needs reserves
  • What level of free reserves the charity believes is required (stated as an absolute amount and/ or as a proportion of expenditure)
  • Assumptions behind the calculation of free reserves – for example are you basing it on a number of months’ core costs.
  • Steps to be taken to maintain reserves at required level

Questions I like to pose to my clients – typically in advance of a new financial year and around the time the draft organisational budget is tabled - include:

  • Are you clear on what constitutes core costs for your organisation based upon your draft budget?
  • Is a target reserve of three or six months of core costs (for example) suitable for your charity in light of planned activity levels?
  • What contractual commitments do you have which, in the unfortunate event of winding up, might need to be honoured. Would a property leasing commitment, for example, be covered by a three-month reserve of working capital?

By including reserves policy as an agenda item it gives the opportunity for the trustees to have a focused discussion, demonstrating (and documenting) best practice financial governance.

Free reserves – the calculation

Free reserves are defined as unrestricted funds available for spending and are therefore calculated by taking the total unrestricted funds of a charity and deducting any balances not available for spending (such as assets, investments and designated funds).

As the calculation is related to unrestricted funds only it already excludes consideration of any restricted funds held.

Unfortunately we regularly come across cases where board discussions are focused around the levels of cash at bank. Whilst working capital management and cash flow are important, it is equally vital that trustees take on board that the bank balance is not a measure of a charity’s free reserves as the cash at bank might comprise free reserves + restricted cash funds, for example.

Not just an annual affair – importance of regular reviews

The reserves policy should not be an annual consideration. Having reviewed and set the policy for the forthcoming year, the trustees should look for the annual budget to align with their policy. Any forecast deviations from the policy – whether that be surpluses or deficits – should be discussed, with appropriate action points being built in to the charity’s strategic objectives.

Perhaps that translates through to the charity’s fundraising strategy or even prompt a review of cost control measures.

Throughout the financial year, we recommend that each set of management accounts includes a free reserves calculation, presented with explanations in support of variance to budget and/ or policy.

Food for thought

The Charity Commission for England and Wales has updated their guidance in this area – you can read CC19 Charity Reserves: Building Resilience for more details here.

If the above has left you feeling that your charity’s financial visibility is lacking – particularly if a free reserves calculation seems nigh on impossible each month without significant time and effort – then perhaps now’s the time to propose a review of your finance system.  

Many of today’s cloud-based financial solutions offer charity-friendly reporting and financial visibility at your fingertips – relatively inexpensively compared to traditional desktop packages. Speak to your accountant or professional advisors and ask them to signpost you. You never know, a new finance system might just rock your world and deliver the financial visibility your organisation deserves.

Replies (1)

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By D V Fields
12th Oct 2017 21:18

I'm not sure the "cloud based" systems offer the functionality that charities require. I am certain that they claim they do. Evidence suggests otherwise. One "popular" system offers a "SOFA" code as its cutting edge technology. In reality it's a field to enter 1 to 23 to represent line items on a report - be impressed if you will!

If a charity has anything more than unrestricted reserves then it may well need to produce a trial balance per fund (or even per project). Much will depend upon the complexity and the risk of unrestricted costs being met out of restricted cash funds. Traditional accounting systems will not provide a trial balance per fund and the few systems geared towards charity accounting are not perfect.

A charity with high overheads, restricted funding and limited free reserves is in danger of funding those high overheads from restricted cash balances, being a misappropriation of funds. It is important that trustees recognise this and the importance of (discussion for another day) full cost recovery.

Sadly many are oblivious to these complexities and sometimes ignorance is bliss. But of course "MTD compliant software" will solve this overnight - surely?

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