I recently spoke at two round tables hosted by Quilter Cheviot on the subject of reserves and what struck me most was how many of the charities around the table had reserves policies that were based on 3 – 6 months of operating costs.
Why is this odd, I hear you say. My answer would be that this type of calculation does not take into account the different types of income or expenditure a charity has. Nor does it take account of any element of risk.
What’s the Charity Commissions view?
In its guidance CC19, the Commission states that “Reserves are that part of a charity’s unrestricted funds that is freely available to spend on any of the charity’s purposes. The starting point for calculating the amount of reserves held is therefore the amount of unrestricted funds held by a charity. However, some or all of the unrestricted funds of a charity may not be readily available for spending. This is because spending those funds may adversely impact on the charity’s ability to deliver its aims.” but in a review last year of the reserves policies of large charities the Commission found that less than a quarter of larger charities accurately reported the level of financial reserves they hold in their trustees’ annual report.
Why is this important? It’s important because, in the words of the Charity Commission “A reserves policy explains to existing and potential funders, donors, beneficiaries and other stakeholders why a charity is holding a particular amount of reserves. A good reserves policy gives confidence to stakeholders that the charity’s finances are being properly managed and will also provide an indicator of future funding needs and its overall resilience.”
So how do you go about calculating your reserves?
Well, a starter for ten would be asking the question “Do you need reserves?” The handy graphic below should help answer this question to some extent.
If you have a high fixed cost base and unpredictable income then you will probably need more free reserves than say a charity with no staff members and regular predictable income.
It’s also useful to know what the minimum level of reserves your charity would need should the worst happen and you needed to close. This would include redundancy costs plus other items, eg any payment for notice periods on contracts etc.
Once you have this minimum level then it’s time to look at your income. I’ve found it useful to look at this in a risk-based way, taking account of the amount of each item of income, the certainty/predictability of it and the period of time you will have this for. You can make up a matrix for this ranking items 1 to 5 on each of these factors.
If you find you have a large amount of income that is not certain and is short term but your costs are fixed and high then you may have a problem.
By doing the above you will be able to establish reserve levels that are personal to your charity.
The key is then to review this at least annually as part of your budget processes to ensure that it always reflects your charities reality.
Good luck
Emma
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