A grip on reality

May 2009

Cash is king and in tough times charities need a proactive approach to cashflow management, says Rohan Hewavisenti

In boom years it was easy to take cash for granted, but in these illiquid times cash appears more kingly than ever and the saying ‘income is vanity, profit is sanity and cash is reality’ seems especially apposite.

Accounting for cash

A pure focus on the bottom line profit may be misplaced. Companies can generate income and profits but still go under due to lack of cash. Everyone understands cash but can be led astray by management accounts and statutory accounts. Most organisations adopt the convention of accruals accounting – one version of accounting reality. Cash accounting means ignoring accruals, prepayments and depreciation. It focuses on cash going in and out. Cashflow forecasts showing your anticipated cash position is more important than knowing what’s happened historically.

Cash squeeze

What can charities do to manage their cash flow? The channels for incoming cash need to be streamlined. Fast processing of donations needs to be prioritised. Sales/contract invoices should be sent out on a timely basis. Grantmakers need to be gently chivvied along. Charities rightly focus on the delivery of the work but can fail to charge as much as they should and sometimes do not invoice quickly enough. Another area to consider is legacies. A large proportion of charities’ legacy income is from residuary legacies comprising residential property and sometimes shares. With the state of the property and equity markets, professional advice may be to hold on to assets until the markets recover. Although this may be appropriate advice for maximising income it can have negative consequences for cashflow.

Charities and impact

Charities are in the business of creating impact which often has a long lead time between investment and the generation of benefit. The focus on resource allocation and return on investment is crucial and some tough decisions may need to be made. With contractual work, the ideal is full cost recovery plus some profit contributing to future developments. Contracts need to be terminated where there is no contribution to overheads. However, where there is a contribution it is worth continuing contracts in the short term as it helps with cash flow and basic survival.

For many fundraising charities, the main cash outflows are salaries, property costs and the charitable activities e.g. grants made, charitable services. Checks and balances may need to be added to slow cash streaming out. Capital expenditure can be monitored with a view to reducing or deferring. Long-term plans and projects established in the past could be revisited in better times.

Working capital

Effective cash management requires an understanding of working capital requirements with regular forecasting of income and expenditure along with appropriate risk management. Commercial companies regularly access bank financing, loans and overdrafts. Most charities have a cultural aversion to such overt forms of lending but are prepared to take on debts if it is called something such as ‘leases’. Taking on increased financial risk could promote greater dynamism in the sector.

Risk management

In the last few months, risk management and investment theory relating to cash have been turned on their heads. Risks of holding cash became similar to equity risks and hedge fund risks. Without the backstop of government bail-outs, many of us could have lost large cash holdings with highly rated reputable banks. We all now recognise that cash is no longer zero risk. More attention is rightly focused on capital preservation than on returns achieved through interest.

Base rates are now at a historically low 1.0 per cent. Inflation at 0.1 per cent, is heading towards deflation later in 2009. Charities need a treasury function which is not feasible for the vast majority of organisations but could be outsourced to specialist cash managers. Alternatively you can tap into money market or liquidity funds that will spread the risk or you will need to spread deposits across a number of banks. It should be noted that there is no guarantee of capital preservation.

Collective responsibility

Everyone needs to understand the role they play in preserving the cash position of the organisation. The reserves that charities had built up over the last few years need to be used wisely now to smooth the effects of the recession. I suspect it will be a decade or so before we forget the current crisis and hear people complaining that organisations are holding too much cash.

Author: Rohan Hewavisenti

Rohan Hewavisenti is director of finance and business development at the British Red Cross Society and a trustee of the Charity Finance Directors' Group.

www.cfdg.org.uk
www.redcross.org.uk

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