When charity reserves run low

23 FEBRUARY 2021

| 1 min read

The pandemic has had a huge financial impact on the charity sector, and further help from the Government (beyond the £750 million promised last year, and still slowly finding its way to charities) at present seems unlikely, despite the campaigning efforts of many sector bodies.

With a drop in income from fundraising and trading, and increasing demands for services, many charities are having to consider using their reserves to allow them to continue providing services to their beneficiaries, in accordance with the Charity Commission’s coronavirus guidance.

Despite considerable guidance from the Charity Commission on reserves and reserves policies in the past, there has often been a degree of confusion amongst charity trustees over:

What constitutes reserves
What level of reserves should be maintained
What should be done if the levels of reserves specified in a reserves policy is not met, in that a charity’s reserves are too large or, much more likely at the current time, too low

A review carried out by BDO last year showed that the level of reserves before the pandemic at the largest 50 charities had fallen since 2017, with charities included in the review holding an average of two month’s free reserves.

So it may well be the case that many charities facing financial difficulties no longer have significant reserves on which to fall back.

Charity reserves: what charities need to know

What are reserves?
Reserves are defined as the funds that a charity has available (or can make available) to spend for all or any of the charity’s purposes, once the charity has:
- Met any liabilities payable from those funds, and
- Provided for any commitments of the charity or any planned expenditure intended to be met from those funds
Sometimes, these reserves might be referred to as “free”, “general” or “unrestricted” reserves.

Reserves do not include:
- Permanent endowment
- The value of total gift element of permanent endowment together with the unapplied total return where permanent endowment is managed on a total return basis
- Expendable endowment (but not the income from expendable endowment, unless there is a duty or power exercised to add income to that endowment)
- Properly justified designated funds
- Fixed assets held for the charity’s use which could only be realised by disposal
- Material restricted income funds – which the Charity Commission advises should be treated as separate charities with their own justified and explicable reserves policy
A fairly common error discovered by the recent Charity Commission review of reserves policies and reporting was that, when calculating reserves, a significant number of charities – almost a third – seemed not to have deducted the value of fixed assets held for the charity’s use, and / or designated funds.

It also found that a much smaller proportion of charities reviewed – 3% – included restricted income funds in their calculation of reserves, and that a sizeable number of trustees of the charities included in the review appeared to think that reserves were the same as total unrestricted funds.

Errors in understanding what constitutes reserves, such as those set out above, may lead some charities to the conclusion that their reserves are larger than they actually are.
Why might a charity need reserves and what level is appropriate?
Deciding what level of reserves a charity may need is an important part of the financial management of a charity There are probably almost as many good reasons to hold reserves as there are charities, and what level of reserves are required will very much vary depending on the charity and its activities.

Common reasons, however, for holding reserves include:
- Adversity reserves: funds available to deal with unplanned but foreseeable future expenditure– such as the replacement of an asset that the charity needs to carry out its activities, like a vehicle or property
- Opportunity reserves: to allow a charity to make the most of a future opportunity that might arise, maybe a new project or joint venture
- Cessation reserves: to allow a charity to close, ensuring all obligations are met and steps taken to protect vulnerable beneficiaries
- Income risk reserves: as a means of addressing future financial uncertainty, if, for example, a source of grant funding is not renewed
- Working capital reserves: to provide working capital in the event that expenditure is needed before income is received
The level of reserves that a charity needs will require careful consideration by the charity trustees of:
- The charity’s income forecasts for the present and future years, including the reliability of the various sources of income, and the likelihood of developing new sources of income
- The charity’s expenditure forecasts for the present and future years, based on its planned activity
- An analysis of the charity’s future needs, opportunities, risks and commitments where future income may fall short of the expected costs
- An assessment of the likelihood of a shortfall arising that requires the use of reserves, based on the best evidence available, and the consequences of the charity being unable to make up any such shortfall
- If the level of reserves are low, what will be done to ensure an orderly closure in case of insolvency, with protection of any vulnerable beneficiaries a priority
The level of reserves is often expressed as a target figure or target range. There is, however, no rule of thumb for charity trustees to apply, and it is important for charity trustees to be able to justify the amount of funds held as reserves based on the circumstances of their charity in particular.
What legal obligations and duties do charity trustees have in relation to reserves?
Charity trustees are generally under a duty to expend income funds received by their charity to further the purposes of their charity within a “reasonable time” of receiving them, and there is no legal obligation for a charity to hold reserves.

There is also no legal obligation for a charity to have a reserves policy, although there is a legal obligation to for trustees to disclose in their annual report if they have no reserves policy.

Despite the lack of legal obligations, however, it is likely to be in most charities’ best interests for some reserves to be retained. Charity trustees are under a duty to act in their charity’s best interests, and to manage its resources responsibly, and – except in rare cases – the holding of at least some reserves is likely to be an important part of managing risk to the charity.

And, in practice, it may be difficult for trustees to justify significant unspent unrestricted funds in the absence of a reserves policy, and a failure to justify such funds may lead to the conclusion that charity trustees have failed to comply with their duty to expend funds received by the charity within a reasonable time of receipt.

It is advisable that charity trustees, therefore, in order to comply with their duties to spend income funds received to further the purposes of their charity within a reasonable time and to manage their charity’s resources responsibly, should:
- Consider their charity’s needs for reserves
- Establish an appropriate reserves policy for their charity
- Be able to justify and explain that policy
- Make sure the policy is used
- Regularly monitor and review the effectiveness of the policy taking into account the present circumstances of the charity
In order to ensure the charity is accountable, they should also publish the reserves policy.

A charity’s reserves policy should be reviewed at least annually by the charity trustees, as part of their planning processes, and the amount held in reserves should be monitored during the course of the year as part of the charity’s budgeting processes.
What should charity trustees do if their charity’s reserves are lower than that specified in the reserves policy?
Generally, charity trustees should be aware of the target set in their charity’s reserves policy, and should make sure they monitor the level of reserves held during the course of the year.

If there is a significant difference, they should find out the reason for this, determine whether it is a short term or long term issue, and take steps to replenish the reserves if appropriate.

If the issue is a longer term issue, the use of reserves may trigger a broader review of the charity’s finances and its reserves policy.

With reduced income streams at present, replenishment of reserves may prove difficult. The Charity Commission accepts that some charities may be able to justify a certain level of reserves, but be unable to build up reserves to the target level.

In such circumstances, the Commission would still expect the charity to have a reserves policy, and also for the trustees to be actively addressing the issue by planning how to:
- Implement the charity’s reserves policy
- Raise necessary funds
- Diversify the charity’s funding base, and / or
- Mitigate the risks of the charity having to close suddenly
It may also be of some comfort to some trustees, facing the dilemma of trying to replenish reserves or helping vulnerable beneficiaries in dire need during the pandemic, that the recent Kids Company judgment contained a suggestion in its section on reserves that a decision by trustees to prioritise spending on charitable purposes rather than building up reserves is one that, in some circumstances at least, could be reasonably reached.
The ramifications of no or “negative” reserves

If a charity has run down its reserves so that it has no or “negative” reserves (as in, the charity’s liabilities exceed the assets held by the charity as unrestricted funds), this should prompt the charity trustees to look very carefully at their charity’s financial position.

No reserves mean that a charity is vulnerable to disruption caused by unexpected expenditure or an unforeseen fall in income, and is likely to require an immediate broader review by the trustees of the charity’s finances and expenditure.

“Negative” reserves may suggest that the charity is no longer a going concern. In such circumstances, the charity trustees should seek professional advice as soon as possible. It is possible for charity trustees to face personal liability in some circumstances in relation to insolvency, in particular if the charity is unincorporated.

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When charity reserves run low

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