From now on you must keep six months of operating costs as a minimum level of reserves…
Pause for a moment. How did you react to the above statement? Fear? Bemusement? Agreement? Perhaps you thought this was already the case. Maybe you thought "what does that mean - what are operating costs anyway"?
However you reacted, you can relax -there is currently no requirement for a minimum level of reserves. But the question of whether the Statement of Recommended Practice should mandate a minimum level may well make its way on to the agenda in the light of such high-profile collapses as Kids Company. If it does, what should the answer be?
In my view, we shouldn't mandate a minimum level of reserves. If we do, we will have fallen into the trap of seeking a simple answer to a more complex question. "Simple" should always be pursued if the result is a straightforward and uncomplicated approach, capable of predominantly bringing about a sensible outcome; more often than not, "simple" really means naive, crude and unsophisticated.
There has long been a myth that the Charity Commission requires charities to hold six months of operating costs in reserve. The reality is that its CC19 guidance actually confirms that charity law requires us to spend money unless there is a good reason to hold on to it. The cases where it is prudent to plan to hold no money in reserve are limited, but it is likely nonetheless that many charities do operate entirely hand to mouth, with no reserves, and do so continuously.
Is it therefore a question of size - the bigger you are, the harder you fall - and thus the more essential reserves become? There is some truth in that, I suspect, but size is not really the determinant either. So what is?
Charities can really only set their appropriate levels of reserves, achieving balance between spending and retaining, when they understand their financial strategies, business models and the risks inherent in both. The assessment of the right level for any individual charity has to be something that both the trustees and the executive agree upon. It's critical, for example, that the board understands where the executive has already built in measures to balance risk into the budgeting. Otherwise money that could otherwise be supporting beneficiaries can be tied up unnecessarily.
The notion that you should retain sufficient funds to pay everyone off in the event of collapse is also flawed. For most charities, significant financial distress does not happen overnight. A well-managed charity should be able to pre-empt problems such as the loss of a major income stream. But even if there is little or no warning, the charity's work is unlikely to all end at once. Expenditure can be curtailed, staffing restructured and activities prioritised. Reserves clearly have a role to play in such circumstances, but tying up more funds than is necessary can perversely leave you more vulnerable to failure, not less.
The CFG (with partners) published our guide Beyond Reserves in 2011. It's well worth a read, especially if you want to challenge the thinking around your policy. After all, the most important part of having one is not the figure you settle on or even how much you currently hold relative to that figure, but whether you can explain why.
Caron Bradshaw is chief executive of the Charity Finance Group