Subscribers | Charities Management magazine | No. 116 Autumn 2017 | Page 1
The magazine for charity managers and trustees

Judging how much cash a charity should hold

Charities may have a range of sources of income, including investments in a portfolio, income from property, a government grant, and donations and legacies. Accumulated cash – which represents unspent past income – can be used to fund future expenditure – for example a major project or to permit services to continue when current income falls short of requirements.

But the question of how much cash to hold may not be as simple as it at first appears. Getting the answer right depends on good governance, a solid understanding of risk – and an awareness of the charity’s legal obligations.

Charity trustees have a legal duty to act in the charity’s best interests, manage the charity’s resources responsibly, and act with reasonable care and skill. According to the Charity Commission, trustees who act in breach of their legal duties can be held responsible for consequences that flow from such a breach and for any loss the charity incurs as a result. The Commission has the power to disqualify individuals from trusteeship if they feel this is warranted.

Taking stock of charities

To work out how much cash to hold, it is necessary to consider the charity’s operating expenses, any investment portfolio (particularly if it contains cash separately to that held as working capital), sources of income and the extent of future obligations. The right level of cash will depend on how the charity funds its activities. 

For example, a charity which receives rental payments from the properties it owns (houses, buildings, land, etc.) will receive a regular income and therefore may not need to hold a great deal of cash in reserve; conversely, a charity which is funded by donations may have sporadic and unpredictable income and would be expected to hold higher cash reserves. Similarly, a charity which is undertaking a capital project (for example, refurbishing a building used by its beneficiaries) would also need an extra cash allocation to the project.

Figures provided by the Charity Finance Charity 250 Index suggest that charities which have strong governance (including appropriate cash allocation) can expect strong results. In the most recent numbers available, which cover the year to 30 June 2016, the index reported that over a third of its members experienced double-digit income rises. The largest rise was recorded by Horder Healthcare, with income up by 19% to £29.9 million over the same period.

The Commission's expectations

The Charity Commission expects trustees to implement and monitor a reserves policy; trustees are also expected to explain the policy and compliance with the policy on an annual basis. Reserves are defined by the Commission as "unrestricted funds that are freely available to spend on any of the charity’s purposes" (generally referred to as “free reserves”). These differ from "restricted reserves" such as endowments. In general, free reserves would be expected to be largely represented by cash or near cash (such as low risk listed investments which could be readily converted to cash).

Some charities may receive "lumpy" or unpredictable income, such as legacies arising from a death or an annual grant. Trustees should take this into consideration and remember that a charity’s expenses will typically be regular, so maintaining sufficient cash in reserve to meet periods of reduced income is paramount, especially if the charity is providing life-affecting services.

“Deciding the level of reserves that a charity needs to hold is an important part of financial management and forward financial planning,” notes the Commission in its Charity reserves: building resilience document published in January 2016. “Failure to do this may result in reserves levels which are either higher than necessary, limiting the potential benefits a charity can provide; or too low, increasing the risk to the charity’s ability to carry on its activities in future in the event of financial difficulties, and increasing the risks of unplanned and unmanaged closure and insolvency.”

Be mindful of risks

Although some of the top charities have reported rising incomes in recent years, charity incomes as a whole are dropping, particularly for smaller charities. According to the Small Charity Index, statutory income (i.e. government grants) has dropped nationally by 8% over three years. Some charities are using their reserves, or borrowing money, to invest elsewhere to gain an income.

Where a charity lacks the free reserves it thinks it needs (including cash allocation), the Commission warns that the charity is exposed to greater risk. The Commission expects trustees to be actively addressing this, by implementing a reserves policy, raising the necessary funds, diversifying its funding base and mitigating the risks that might arise if the charity has to close suddenly.

The Commission also warns that in the case of an investigation against a charity, the Commission may take into account evidence that trustees have exposed the charity, its assets or its beneficiaries to harm or undue risk by not following good practice. Insufficient cash over a prolonged period of time can be one of the most significant factors in coming to this conclusion.

The example of Broken Rainbow, a defunct charity which provided support to the LGBT community, provides an illustration of the risks of poor governance. Investigations into the charity’s finances after its insolvency revealed that Broken Rainbow’s trustees had spent virtually all its income (from grants) within three days of receiving them. The money was being used to fund past expenses, leaving little or nothing to fund present or future needs. In the two-year period leading up to its closure, the charity had less than £500 in its bank account on an average day.

Charity trustees should also be aware that because interest rates are currently lower than inflation, holding large quantities of cash for the medium to long term could cost the charity a significant amount of money. Alternatives options should be considered – which might include investing the cash in a portfolio.

Charities in the spotlight

Charities are facing increasing scrutiny from the Commission, which is gaining greater influence. Under the Charities (Protection and Social Investment) Act 2016, the Commission gained the power to issue official warnings, which supplements its existing powers to carry out statutory investigations in the public interest.

The Commission issued its first official warning on 3 July 2017. The warning was given to the National Hereditary Breast Cancer Helpline (NHBCH) after the charity found itself in financial difficulty and failed to comply with the regulator’s action plan. According to the Commission, “[the] charity and its assets had been exposed to undue risk through a lack of appropriate financial controls and its financial model was unsustainable”.

These two cases illustrate the importance of maintaining sufficient cash to cover both working capital needs, and any unforeseen expenses. A charity which runs down the amount of cash it holds in reserve risks opening itself up to financial difficulties and regulatory scrutiny. The NHBCH incident was also significant because it confirms that the Commission is now selecting and checking charities in England and Wales to ensure they operate according to best practice and the Commission’s own guidelines.

Too high allocation

Conversely, a charity’s cash allocation may appear to be too high. If this is the case, donors, beneficiaries or the Commission may raise questions about the way the charity is being managed. Typically this can happen for two reasons: either the trustees have not sufficiently explained why they are keeping reserves, or because they are having difficulty in using their funds. The Commission states that:

“A charity with excess reserves or unspent funds should consider whether they could be effectively spent on the charity’s purposes. If a charity has more resources than it needs to fulfil all of its purposes then the trustees must consider whether the purposes of the charity should be amended to enable the charity to operate more effectively.”

Adding to the pressure on charities to comply with best practice, from May 2018 charities with “extremely aggressive” fundraising practices could be fined up to £25,000 if they do not crack down on nuisance calls, emails or letters. This regulatory change comes into effect under the EU’s General Data Protection Regulation, which is due to replace the existing Data Protection Act.

Although the UK is currently in the process of leaving the EU, the Great Repeal Act includes the same provisions as the new regulation, so it is still likely to become UK law. Charities within the scope of the new rules must comply with new data protection legislation and provide marketing opt-outs.

New project funding

Given the pressure on charity funding and the increasingly prescriptive regulatory environment, charity trustees should ensure that adequate funding will be available for any new project - quite often, this will require that they raise the necessary funds prior to commencing the project. Available assets, including cash, should be held securely with reputable organisations and risk should be given serious consideration.

Some years ago, Icelandic banks offered customers attractive interest on any savings held in an account; but their collapse in the autumn of 2008 caused considerable disruption and loss for depositors.

Charities come in a range of shapes and sizes and they operate in very different ways. The amount of their future commitments, both to beneficiaries and for overheads - such as staff salaries, rent and other fixed costs, should be reflected in the amount of cash they hold.

Strong governance and regular oversight should also be employed to ensure that a charity correctly uses any lump sums it receives, and plans effectively for its future needs. As the Charity Commission notes, a reserves policy will “give confidence to funders by demonstrating good stewardship and active financial management".

Serving the best interests

Ultimately, good governance and oversight are a key part of ensuring that a charity serves the best interests of its intended beneficiaries. Whether holding a large amount of cash or a little, the first step should be to consider whether that sum is appropriate to its needs. If not, trustees should take further action to redress the balance, either by moving any surplus cash to where it can generate the most benefit, or by taking steps to ensure that sufficient cash is gathered to safeguard the charity’s operations for the foreseeable future; for example, by cutting costs or fundraising.

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