The Reserves
‘How should I set my charity’s reserves’ is one of the most asked questions of any charity finance specialist, and the unfortunate answer is that there is no one correct way of doing so – it really is dependent on the charity itself. Reserves refers to unrestricted, undesignated, funds held by a charity as a ‘buffer’ against adverse income or cashflow conditions.
Whilst it is not mandated that a charity has a formal reserves policy it is best practice, and it is mandatory to have a statement on the reserves policy that may or may not formally exist within the annual report as part of the published accounts. So really in practical terms, having a reserves policy is a must.
Reserves are a form of long-term risk management, not a closed pot to be built and never spent. If a charity exists to enable a non-commercial flow of resources from, put crudely, donors to beneficieries, then reserves are the reservoir that ensures that flow can remain steady whatever the rainfall. And, to stretch the hydro-electric anaolgy further, the reserves policy is the dam that monitors and controls exactly what is available, and when it can be relaeased into the river flow.
In a commercial business you would put some capital up front, as a way of ensuring that you can work/produce etc before sales come in to provide profit and fund more work. That initial investment remains ‘in’ the business (and can be topped up via excess profit being re-invested amongst other ways) and represents the ability of the business to pay for things when there are no sales.
A charity doesn’t make sales or profit in the same way, but reserves, usually accrued from donations or unrestricted grants, represent the same element of retained capital – the ability of the organisation to either keep functioning in periods of reduced income or to invest speculatively in it’s own infrastructure. But, as we've mentioned already, reserves still represent charitable rather than investment income, and so the normal rules around furthering charitable objectives still apply to them and I think that can sometimes be the source of trustees' reluctance to release them.
A charity's free reserves, by definition, cannot be restricted or even designated income. Even if the reserve policy was built around the idea that they would be retained for a particular pupose, or category of situation, it is always within the board's remit to spend them in a way that they see fit.
The Policy
A reserve policy should have two main elements – the first is how large the fund should aim to be, both lower and upper limits. The second are the sorts of conditions under which reserve funds should be considered available or potentially available to spend.
Reserves act as a cushion and form of long-term risk management, and what that means is different for every charity. In some instances reserves exist only for very specific purposes and cannot be accessed at all outside of those, in others they provide a guarantee that a project can be funded, allowing it to go ahead before fundraisers have fully covered it, but with the expectation that they probably will.
When setting a policy, a decision needs to be made as to what the basis of the reserve target should be, and that in turn tends to lead to the general agreement as to what the reserves can be used to fund and when. There are a few options usually taken.
1) Many organisations set their reserves on a period of time operating with no income – usually somewhere between 3-6 months, based on what they expect would be the likely period required to regain steady income sources. This is most meaningful where income is derived from short-term service contracts, sales or individual giving.
2) Another basis for reserves is sometimes thought of as the cost of a safe wind-down – which is to say having the money in the bank to, should funding cease, pay all extant commitments and any redundancy due. Usually this is calculated on the basis of an immediate closedown due to catastrophic funding failure, but where a charity is primarily funded by long-term service contracts or rolling grants then renewal dates can be incorporated to the calculation to ensure closedown costs aren't fully incumbent on free reserves but instead can be covered by the last months of the delivery income.
2b) A subset of the closedown reserve policy might be used by a charity with multiple projects and a core administration function. Each project is monitored for viability and closedown seperately, with a much smaller section of reserves in place to cover admin for a fixed period when not supported by project restricted fund allocations.
3) Some organisations might have a policy based on their unique situation. A completely volunteer run organisation that puts on a free yearly event could set its reserves as the cost of running a single event with no external funding. Meanwhile a ticketed yearly event run by a staff team might put their reserves as the cost of retaining the core staff in post in the situation that the event itself cannot go ahead for a year, but will return the following one.
However you set your policy, the most important thing to remember is that it is determined by the needs, funding strategy and objectives of your charity. The Charity Commission doesn't have a 'standard reserves amount', as many people clearly wish it did, for very good reason.