Sector Focus: Ensuring that your reserves don't become endangered

01 Sep 2022 In-depth

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Post-pandemic, there is a large focus on reserves and financial resilience but charities also appreciate that stakeholders are facing financial challenges. As a result, trustee-set policies and reporting against them has become an important way of communicating how the financial foundations of each charity support their priorities.

Looking specifically at charities in the environmental or animal welfare space, it is easy to see the drawbacks of an expenditure-based policy as it doesn’t reflect the varied financial risks facing such charities. For example, if a third of your income is from legacies, and the timing of collection will impact on your liquidity, then a cost-based policy bears no relevance to your working capital needs.

Most charities in this sector have a loyal membership base, and I have found that over the past couple of years the generosity of supporters and the availability of grants and other support measures has led to reserves, in some people’s minds, being embarrassingly high. However, when the reserves and financial position are dissected it becomes clear that the position is not always as it seems and over a longer-term horizon there are challenges. Many struggle to find ways to explain this as funders challenge whether there is a financial need. However, to be effective at generating income, communication and transparency are key.

To do this you need to:

  • Consider the monthly budget phasing of income and expenditure to establish the months where cumulatively cash reserves are at their lowest.
  • Consider existing designations and ensure that all material ones have been made and the levels reserved are sufficient.
  • Examine planned deficits or planned capital purchases to determine how free reserves will be affected.
  • Understand the level of budgeting accuracy in terms of level of unknowns, variability of amounts, timing uncertainty, effect of the economy etc and the level of reserves needed to cover the worst-case scenarios. If you are a March year-end and you approved your budget in January or February, you can be assured that your expenditure budget will need revisiting.

Graphical representation showing historical evidence of the challenges and timing variables is useful.

Trustees should not be afraid to retain more in reserves than has historically been the case. It is true that grant funders look at need when considering applications, but they also consider the likely risk of insolvency (or at least inability to deliver the strategy to which the funding is intended). Presenting a financial position that is resilient is almost more important than trying to demonstrate need. Communication is crucial to get the balance right. To start with, ensure that when you determine free reserves you ensure all other reserves are designated so the number accords with your unrestricted, undesignated funds. Next, give examples in your policy of how things such as the economy, inflation, interest rates, or funding uncertainties can affect the charity. Finally, make it clear how surplus funds are going to be used.

The above is often regarded as layering; it enables free reserves to be built up based on risk and need. It adjusts for timing, uncertainty, budget decisions, cash flow, risk and various other things so that what you have as a policy is both necessary and justifiable. Finally, it shows accountability to your stakeholders. I have set out below an example of this. Although the table will not need to go in the trustees’ report in as much detail, it can be a useful tool. You can add or remove lines to make more relevant to your circumstances and can reserve as much or as little based on your views on financial risk.

Adam Halsey is partner and head of charities at haysmacintyre  

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