Something in reserve
February 2008
Paul Palmer reviews how to create an effective reserves policy...
One of the major issues for a charity is ensuring that it has sufficient resources to meet its aims and objectives. In financial terms this is now correlated with the concepts of reserves and risks, which is why the Charity Commission in its Standard Information Return and through the SORP charity accounting requirements requires charities to have clearly stated objectives and policies on risk and reserves. While research studies on reserves undertaken by the Charity Commission[i] found that the majority of charities are under-reserved, the image persists that some charities actually have too much money, are perhaps ‘concealing’ it and, as a result, not spending it on their current beneficiaries. This is a view not helped by just over a quarter of charities in England and Wales holding reserves who have no policy in place for their management, equalling some £3.6bn or around 10 per cent of charities' total annual expenditure[ii].
With open online access to charity reports and accounts having increased along with the facility to purchase or generate comparative financial reporting data (such as that from CaritasData and Guidestar), I have recently been approached by a number of charities who do not have a reserves policy to advise them on what they should do. At the start of our discussions, I have noticed that the tone tends to be relatively defensive and focused on 'how can we hide our funds'? This is certainly the position that the Charity Commission finds itself having to debate:
‘But underlying much public discussion of charity reserves is the belief, rightly or wrongly, that holding back significant amounts rather than spending it on the charity's current beneficiaries is similar to hoarding. This belief is likely to persist unless charities consistently and objectively explain their reserves position.’ [iii]
The protective nature of trustees?
I have been reflecting on this behaviour and, increasingly, have come to the conclusion that the very nature of trusteeship leads to trustees adopting this attitude. Within corporate governance literature, there are a number of theories that explain and proscribe board relations and behaviour. Agency theory promotes the use of control incentive mechanisms to align the goals of principal (owners) and agent (managers) and thus effective corporate governance. The role of the board (trustees in a charity) in this context is to control top management. Stewardship theory assumes that the conflicts between owners and management are aligned, and the board is seen as having an advisory role contributing to the development of strategy in collaboration with management. Stakeholder theory views organisations as multilateral agreements between the organisation and its stakeholders, where stakeholders are defined as any individual or group who can affect or is affected by the achievement of the organisation's objective. The governing role of the board according to this theory is a co-ordinating one, balancing the conflicting goals of the stakeholders with an interest in the organisation. Balancing these interests will enable the organisation to reach the goals set.
Reserves strategy and policy in practice
So how can charity trustees overcome this inherent problem, particularly given the greater scrutiny they are now facing? Reserves have been defined by the Charity Commission in its guidance note CC19. Although at the time of writing this is temporarily withdrawn pending the publication of revised guidance the definitions are worth recalling.
Reserves are income which becomes available to the charity and is to be expended at the trustees' discretion in furtherance of any of the charity’s objects (sometimes referred to as ‘general purposes’ income); but which is not yet spent, committed or designated (in other words it is ‘free’).
This definition therefore excludes:
- Permanent endowment
- Expendable endowments
- Restricted funds
- Designated funds
- Income funds, which could only be realised by disposing of fixed assets, held for charity use.
It is important to remember that the accounts and annual report are the trustees’ document and as such it is they who will be open to regulator, press and public scrutiny if it is difficult to see the true level of a charity’s reserves. The Commission does state in RS3a back in 2003 that it has observed ‘a number of trustees inappropriately use accounting conventions such as designated funds to distort the presentation of their reserves level’. And it goes on to recommend ‘trustees should not…attempt to hide or reduce the appearance of reserves in their accounts’. So what should charities do?
All charities, even small ones, should have a clear reserves policy in place. This is because:
- To be effective a charity needs to plan because contingencies do arise;
- It is essential that a charity provides cover for all its commitments;
- It is important to have transparency and accountability to supporters;
- It demonstrates good financial management;
- It can justify why reserves do exist.
A reserves policy should contain the following information:
Author: Paul Palmer
Paul Palmer is professor of voluntary sector management and charities course director at the Cass Business School. He also acts as independent charities consultant to UBS Wealth Management
There are no comments on this article. Be the first to comment.