A couple of years ago we wrote blog on charity reserves and what they are for. In that article we sought to dispel various myths about reserves. For example. there is no requirement for charities to have at least 3 months running costs in reserves, nor do charities need to hold enough in reserves to meet all costs should they decide to close.

Fundamentally, charities need reserves to:

• Meet known commitments or planned investments.

• Manage cashflow.

• Mitigate risk and respond to issues with financial consequences should they arise.

This can lead to a wide variation in the level of reserves held by charities (when measured using the blunt tool of a number of months’ running costs).

Some need relatively high reserves, for example, because they have significant known commitments (e.g. debts that will fall due for repayment or medium term contractual commitments), or because they are building up funds for planned investments (e.g. a capital project or medium term project).

Others need very little in reserves because they have low fixed overheads, very little unrestricted expenditure and no medium term commitments.

A significant challenge, however, is that many grant funders either explicitly or implicitly have eligibility requirements regarding reserves. This could take the form of a general statement that charities should not hold “excessive” reserves or more explicit (blunt) criteria such as those with more than 6 or 12 months expenditure in reserves are not eligible to apply. Some funders even specify that charities with low reserves (e.g. less than 3 months expenditure) are not eligible to apply. We have even seen applications forms that ask for last year’s reported total expenditure and free reserves (or even total reserves), with an automated calculation to determine eligibility and no opportunity to explain.

Some of our clients have found it impossible to secure grant funding due to high reserves (e.g. when saving for a capital project or because of a recent influx of cash (from a property sale or large legacy receipt).

It is important, therefore, to make sure that your reserves policy is more sophisticated than the blunt approaches often employed, for example by using the headings highlighted above to make an assessment of reserves needed:

• Assess cashflow requirements: how much has your bank balance typically fluctuated in the past? Are there known situations in which significant expenditure will be incurred before income is received?

• Make contingency plans for assessed risks: what would be the likely cash impact if a number of the risks identified in your risk register materialised? Are any significant elements of your fundraising plan particularly risky either in the amount that may be raised or timing?

• What are you known commitments/planned investments: will your charity need funds to meet known or highly likely liabilities or expenditure in the future that cannot easily be met from future income? If so, it is a good idea for Trustees to designate these funds in the accounts so that they do not get counted in the free reserves total (i.e. they are treated like restricted funds and assets rather when calculating free reserves).

Taking an approach like this enables you to tell the story of your reserves in your reserves policy. This means that even if a grant application form does not includes space to explain unusual reserves, there is still a document that provides the explanation (i.e. your Trustees’ annual report and annual accounts).

Of course, if your charity really does have “excessive” or dangerously low reserves then you won’t be able to finesse the story sufficiently for funders who look at these things, and you need to do something about it. Charities should not, anyway, simply build up large amounts of reserves; charitable resources are there to be used for charitable purposes. Moreover, very low reserves expose charities to substantial risk of insolvency should unexpected expenditure or loss of income occur.

Overall, therefore, our advice is to ensure you know what reserves you really need for your charity (using a detailed assessment along the lines outlined above) and that you are able to tell the story of your reserves clearly and convincingly. If you have too little to meet your policy requirement, look at ways to increase income or reduce expenditure to generate surpluses to grow reserves. If you have too much, spent it (wisely).

If you would like to explore how we can help your charity develop a reserves policy that fits better with its circumstances and risk profile, please contact us at julian@almondtreeconsulting.co.uk.