Pesh Framjee: How should we set our reserves policy?

In the first of a regular series of articles, Pesh Framjee considers how charities should set their reserves policy

Pesh Framjee
Pesh Framjee

Q. We are comparing our reserves with other charities and there does not seem to be much comparability – is this okay? How should we set our reserves policy?

A. Each charity will have different nuances that will impact on their reserves policy. There are many factors that must be considered when a charity is trying to decide what level of reserves is appropriate. But the essentials boil down to these four: income – how volatile is it and what is the level of at risk income; expenditure – what is its nature and can it be cut back easily; the nature of the reserves – consider liquidity, what is their ability to be realised and what is the impact of doing this; and sensitivities and risk associated with assumptions made.

It is also important to understand that while in certain cases it may appear that reserves have gone up or down it makes little or no difference on the operating reality. I continue to see ill-informed comment on reserves that does not seem to understand this. The timing of the recognition of income or expenditure will lead to an increase or decrease of the overall reserves as at the balance sheet date. However, this makes no difference to a charity’s operational reality. For example, a charity that recognises legacy income at the time of probate will show higher reserves than one that recognises the income when estate accounts are settled. Similarly, many charities have started recognising a liability for holiday pay and this will reduce the reserves as presented. However, none of these scenarios means that the charity has more or less funds available to spend nor does it imply that the safety net is stronger or weaker.

There are concerns that the latest version of the Charity Commission’s guidance on reserves has led some charities to think they should have reserves to cover unplanned closures. This is not what is intended. Charities must of course consider different scenarios and have back up plans but most charities consider that they are going concerns and there is no need to hold reserves to finance a closure if this is not seen to be likely.

Having said that, uncertainty is a key factor in present decision making. Charities have to forecast based on certain assumptions and these have inherent risk and their validity must be rigorously examined. It is important to consider both the ‘what if?’ and ‘how likely’ questions. Look beyond the obvious and there should be action plans for different scenarios, and it is useful to monitor trigger points and trend analyses to enable the charity to decide when plan A or plan B needs to be implemented. For example, if income looks like it is going to drop by X, we will do Y.

It is important to revisit the reserves policy in the light of the new challenges. This requires a review of all funds including restricted and designated funds to consider what resources can be used to meet necessary expenditure.

A number of charities have set their reserves policy to justify their present level of reserves. Don’t do this. Consider the risks and opportunities facing your charity and your plans for the future be ready to identify if there is a difference between the target level of reserves and the actual level. Explain what you are trying to do to bridge the gap.

Pesh Framjee is head of the not-for-profit unit at Crowe Clark Whitehill

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