New Charity Commission guidance on reserves

January 29, 2016 at 14:50

By Kate Sayer, Partner, Sayer Vincent

The Charity Commission has today published a revised version of CC19. It has a new title – ‘Charity reserves: building resilience’ which strongly suggests that this is a reaction to events in 2015.

Importantly, the new version expects charities to hold reserves for an ‘unplanned closure’.  In the key messages for trustees, this is mentioned twice:

“Trustees should develop a reserves policy that…

  • reflects the risks of unplanned closure associated with the charity’s business model, spending commitments, potential liabilities and financial forecasts
  • helps to address the risks of unplanned closure on their beneficiaries (in particular, vulnerable beneficiaries), staff and volunteers”.

Clearly trustees should be responsible, and no-one is suggesting that they should take inappropriate risk. However, this is muddled thinking. The revised CC19 will encourage trustees to adopt an approach whereby they develop their reserves based on an estimate of the closure costs.

If a charity calculates the level of reserves it needs by reference to the redundancy and closure costs, then this is the antithesis of a reserves policy – it is a closure plan. The reserves policy is designed to provide the charity with a safety net in the event of short-term income shortfalls.

A reserves policy is not an alternative to having a sustainable business model. Any charity that suffers significant damage to its reputation, for example, will not have sufficient reserves to manage the financial consequences. And nor should it. It would not be appropriate for a charity to hold back funds to manage unforeseen major risks instead of fulfilling its charitable objectives.

Andrew Hind wrote in 1995: “A charity should hold reserves for only one reason. That is to ensure, as far as is reasonably possible, that the charity’s future expenditure objectives can be met, given certain assumptions made about future income streams.” (Governance and Management of Charities p.154)

The reserves policies that meet this objective are based on an assessment of the risk that an income stream might be interrupted or stopped. The charity estimates the time it might take to replace that funding and how much is needed to fund the activity in the meantime. In practice this would provide the charity with time to make decisions and manage an orderly closure of the activity if necessary.

Reserves are needed to provide working capital and to cover other identified financial risks that cannot be mitigated by other means. Reserves are the last resort in terms of the strategic and tactical tools available to the finance manager. In financial planning, you should aim to adopt a sustainable business model and match the timing of receipts to payments as far as possible. You try to reduce the need for financial reserves to cover risks.

There is a further problem with widening the purpose of reserves. The underlying premise of a reserves policy is that the charity is a going concern.

If this concept is not applicable then the methodology recommended by the Charity Commission is not appropriate. For example, the definition used for reserves correctly excludes properties used in the charitable activities as these are not funds available for spending. However, if the charity does have to close activities, then the properties become available as collateral or can be sold to realise cash.

There will continue to be unplanned closures of charities, just as there are companies that go bust. It is unfortunate, but inevitable. History has shown that charities are remarkably good at stepping in and helping the beneficiaries when other organisations close. The best example of this was the sudden closure of the private care homes operator Southern Cross, when many charities found residential places at very short notice.

The underlying reasons for sudden closures are more commonly issues such as an unsustainable business model, over-reliance on a single source of funding, failure to recognise poor standards of delivery leading to termination of contracts, and poor risk management. These are not problems that are solved by holding large reserves.

 


Sayer Vincent publishes free guidance to charities “Reserves policies made simple” available to download from their website.

CFG, ACEVO, Institute of Fundraising and Sayer Vincent have also produced ‘Beyond Reserves: How charities can make their reserves work harder’, which is available as a free download (.pdf).