Reserves: is it surprising that some charities are taking a conservative approach?

Lucy Rhodes, Associate, and Laura Soley, Partner, Bates Wells discuss the complex choices charities face when it comes to reserves.

Post byGuest blogger

Charities face complex choices when it comes to reserves.

By law they are required to spend income within a reasonable period of receipt unless they can justify retaining it in line with a reserves policy as being in the charity’s interests.

Working out how much income to set aside is not a straightforward exercise and charities can be publicly censured for holding too much or holding too little in reserve. In the 2016 PACAC inquiry into Kids Company’s closure, William Shawcross, then Chair of the Charity Commission, said “We advise charities that they should spend their money, and at the same time they must have adequate reserves, so it is quite a hard act for them to follow”.

More recently a number of military charities came under the media spotlight for holding high levels of reserves. As David Ainsworth pointed out in a recent CFG blog, large military charities often have complex, costly and long-term commitments to their beneficiaries. They also face the challenge of forecasting the future needs of military personnel and their families in an unpredictable landscape. Given the complexity of this exercise, who other than those with oversight of the charity can say what would be a reasonable level of reserves to hold?

Determining an appropriate reserves policy is a matter for trustees and involves assessing the charity’s current and future commitments and prospects, as well as the risks and opportunities that it faces. Given the complexity of this exercise, the reality is that some charities will set their reserves policy at 3 or 6 months’ operating costs, which is commonly perceived as an appropriate yardstick. However, here is no legal minimum or limit to the amount of reserves that charities should hold. The appropriate level of reserves needs to reflect the circumstances of the charity.

The 2008 financial crisis led many charities to take a more cautious approach to reserves management so that, in times of austerity, they might be better able to withstand a drop in funding or increase in demand. High public and regulatory expectations of charities (and trustees in particular) and a succession of recent bad news stories may also play a part in this shift. A regulatory inquiry or media storm can have a significant, immediate impact on the public’s confidence in the charity and on fundraising income. With ‘black swan’ events in the sector now becoming more common, should we be surprised if large, high-profile charities choose to take a more risk-averse approach to reserves – preparing for cover in the event of a storm, and no longer just a rainy day?

Sometimes charities may not be holding as much in reserve as it might first appear. Last year the Charity Commission stated that over three-quarters of charities surveyed by the Commission reported incorrect reserve figures. A significant number had not deducted fixed assets reserved for charity use, designated funds and restricted funds in their calculations.

Other charities with high reserves might face obstacles to spending their income, for example, because their charitable objects are out-of-date or overly restrictive. Charity trustees should ensure the effective application of their unrestricted, as well as restricted income, funds. If they cannot find a use for their income such as through service expansion or collaboration with other charities within their existing objects, it may be prudent to take steps to alter their objects so they can use their funds more effectively.

If a charity anticipates significant future expenditure or threats to its future sustainability, there may be alternative models for raising funds available. With an expendable endowment fund, for example, a charity can grow a capital fund over time to ensure that it has a ready source of long-term or future support. As the trustees can opt to spend all the capital, if needed, they could spend out the entire fund. But they are not subject to an obligation to do so and the capital will not form part of the charity’s reserves. This vehicle is particularly attractive to charities which want to raise funds for major projects or to provide a reliable long-term income stream to support the running costs of charity.

Whatever proportion of its income a charity decides to hold as reserves, provided that a charity has a reserves policy which is properly considered, justified and clearly communicated, as with other financial decisions, we should trust charities to be best placed to know what is right for them.

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