In a muddle about reserves?

Anxiety about reserves was palpable at NPC’s trustee seminar on finance and accounts. Attendees wanted a precise formula for the right level of reserves; but the panel cautioned that there is no one size fits all.

A day later I found myself trying to explain to an agitated journalist that a charity sitting on a cash pile wasn’t necessarily a bad thing. Donors do not like cash sitting around doing nothing unnecessarily; but equally charities must operate responsibly.

So here are some of my thoughts:

How steady and secure is the charity’s income? A charity like Marie Curie Cancer Care, partly funded by  thousands of committed supporters all signed up with direct debits, can afford to keep less in the bank relative to its costs—although it does have a policy that involves ‘assessing … risk of a shortfall in income or an increase in cost’ and so holds back ‘a sum … to cover the potential shortfall for each element of a charity’s income and expenditure’.

A charity that raises all its funds from a single event or period each year (British Legion’s poppy appeal comes to mind) would be sensible to keep back income from one year in case there’s a major international event (natural disaster, death of world leader) that eclipses its peak fundraising moment the next.

How committed are the charity’s costs? A charity with uncertain income that has committed to helping very vulnerable people over several years, would be wise to hold a war chest to cover those commitments in case the money doesn’t come in. The sudden demise of Beatbullying last year left a lot of very vulnerable young people stranded without support. A key lesson here is the speed at which reserves were depleted; three months is no time at all to fix really serious funding gaps.

With £60m of commitments to the charities it supports, and only one night a year to raise the cash, this (partly) justifies BBC Children in Need sitting on £90m in cash. The Gurkha Welfare Trust has committed to providing thousands of former Gurkhas with pensions in Nepal over many years. Its current income is comfortable, but as it gazes into the crystal ball over the next 30 years, this comfort recedes—so putting aside substantial sums for future obligations is prudent. Meanwhile charities with flexible commitments—a charity offering bursaries, say—can more easily cut back on spending in a bad year (albeit reluctantly).

What about the big capital project next year? If embarking on a big capital project, a charity’s appeal fund will be temporarily inflating cash reserves.

What do the charity’s cash flows look like? Charities that tend to get paid six months after delivering the work (not uncommon) would be wise to hold at least six months in reserve, so that payroll can be met while the work is done.

How are the charity’s funds made up? If funds are restricted to projects and there is nothing left over to cover general costs, then a charity will need to find ways of increasing the pot it holds for the salaries of non-project staff, overheads and so forth.

What if the charity is a foundation? Some charities are foundations set up in perpetuity and spend only the earnings its capital makes—occasionally dipping into reserves when times are bad, and rebuilding them when times are good. Other foundations are set up to spend capital over a period. They won’t want to spent it all at once; programmes need to be found and developed, grants made, lessons learnt, new grants made etc.

Ultimately, each charity must analyse its own situation and appetite for risk. The trustees should then clearly state its reserves policy in the accounts, remembering that the purpose of reserves is to spend them when you need them, and replenish them when you don’t.

Sayer Vincent has written a very good step by step guide to help charities go through the process of determining reserves. And NPC’s Keeping account covers this and many other crucial aspects of finance.