Two recent studies have highlighted how important cash reserves are for a charities long term risk management and financial resilience, while also revealing a worrying number of UK charities lack sufficient reserves.
According to a report by international development network Bond and accountants haysmacintyre charities need to build up their reserves in order to prevent programme closures and job losses as well as to weather future financial shocks.
The report – Building financial reserves for resilient organisations – warns that NGOs in the UK will continue to face challenging financial conditions due to the UK’s economic downturn, cuts to the aid budget and a potential reduction in official development assistance (from 0.7% to 0.5% of gross national income).
The report also found that, before the Covid-19 pandemic, most of the charities in the UK lacked sufficient reserves – with the average level of charity reserves covering just two months of running costs.
The two main barriers to building a reserve, cited by the report, were a lack of opportunity and concerns over donor perceptions. 64% of survey respondents said that ‘lack of opportunity prevented them from building up their reserves, while 45% were worried about what donor attitudes would be if they built up their reserves.
A similar study by a team of researchers from the University of Southampton and University of Birmingham found that over 20% of charities in England and Wales had less than one month’s expenditure in reserve at the beginning of the pandemic.
The researchers used financial data from 12,700 charities for the years ending in 2018 and 2019 and found that around 10% of charities had only a few days’ reserves or less.
To help charities develop an effective reserves policy, we’ve put together the below guide. If you require any further information or advice, please contact us here.
What are reserves?
Reserves are the part of a charity’s unrestricted funds that is available to spend on any of the charity’s purposes and are a charity’s financial ‘safety net’, available to cover any income shortfalls or to cover any unexpected expenditure.
However, not all of a charity’s unrestricted funds is readily available for spending, as spending those funds may adversely impact the charity’s ability to deliver its stated aims. The items that should be excluded from reserves are:
- Tangible fixed assets – such as land and buildings used to carry out the charity’s activities
- Programme-related investments that are held solely to further the charity’s purposes
- Funds designated to help meet essential future expenditure
- Any other commitments that have not been provided for as a liability in the charity’s accounts
The items that commonly included as a part of a charity’s reserves are:
- Unrestricted current assets (debtors, cash, stock)
- Unrestricted current liabilities
The importance of having a reserves policy
A reserves policy is a key component of a charity’s financial management and planning, helping to:
- Inform strategic decision-making e.g. whether to fund new activities using reserves
- Develop the charity’s budget for the year
- Identify potential cashflow issues or other areas of financial risk
A reserves policy also explains to existing and potential donors, funders, stakeholders and beneficiaries why the charity is holding a particular amount of reserves. A good reserves policy therefore shows that the charity’s finances are being managed properly and also provides an indicator of its overall resilience and future funding requirements.
It is a requirement if the Charities Statement of Recommended Practice (SORP) that all charities should have a reserves policy that is clearly explained in their annual report. If a charity decides to operate without a reserves policy in place, then this must be stated clearly in the charity’s annual report.
How to develop a reserves policy for your charity
There is no single way or method to developing your charity’s reserves policy, as it will depend on factors such as the size of your charity, the complexity of the activities you undertake, the legal structure of your organisation and the nature of how funds are received and held by your charity.
As a starting point, your reserves policy should set out:
- How much your charity needs to hold in reserve, and the reasons why
- How and when your reserves can be spent
- How often you will review the policy
You can specify money that is set aside to meet a potential need, such as an unexpected drop in income. If you set aside funds for a specific purpose, such as building works, then you should make it clear that this is separate from the charity’s general reserves.
The reserves policy should identify a target figure or range to hold in reserve. If the charity trustees decide not to hold reserves, or to hold a particularly low level of funds in reserve, then the policy should make it clear how the charity will ensure the sufficient care of its beneficiaries and an orderly closure in the event of insolvency.
The key to developing an effective reserves policy is to find the right balance between maximising the delivery of your charity’s services and activities without jeopardising the long-term sustainability of the charity.
For more help with developing a reserves policy, read the Charity Commission’s advice: Charity reserves: building resilience (CC19)
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