There is no single level that will be considered appropriate for all charities. Naturally, all charities are different and their needs and financial positions are different.
Each charity will need to assess its own situation and decide on an appropriate level of reserves at a particular point in time, taking into account the various risks to its financial position.
On one hand, having no or little reserves may be detrimental to a charity. A low level of reserves may place a charity’s operations at risk if it is face with sudden unexpected costs. Also, having low levels of reserves may affect staff morale as there may be concerns that their continued employment or entitlements could be at risk if adverse events occur.
On the other hand, accumulating a high level of reserves without a clear explanation or justification may adversely affect the public’s perception of a charity. Unjustifiable stockpiling of reserves may also cause concern for the regulator that charitable assets are not being used for a charitable purpose. Charities should be focused on pursuing their purposes and using their funds to do so, rather than stockpiling reserves unnecessarily. Appropriate notes in a charity’s financial statements should provide justification for high levels of reserves.
A charity should clearly explain to the public, regulators and potential funders what it considers to be an appropriate level of reserves and why. This statement should be updated to reflect any changes in the charity’s reserves and its reserves policy
How should a charity determine an appropriate level of reserves?
To determine an appropriate level of reserves, it is important for the responsible persons of a charity to analyse the charity’s situation and determine the risks it faces. This should include all aspects of running the charity: its operations, governance, staffing, clients, funding landscape, liabilities and the external market.
There are a number of questions the responsible persons of a charity should ask (and answer) to help determine an appropriate level of reserves (although this will help shape a charity’s approach, this is not an exhaustive list):
- What liabilities (current and future) does the charity have?
- What staff entitlements (current and potential) exist?
- What changes in the funding or political landscape may affect current and future income streams?
- What external trends may affect the public’s willingness to give to the charity (both time and money)?
- What external events may affect the charity’s service (such as natural disasters)?
- What compliance issues (current or potential) need to be addressed?
- Are there any potential legal claims that could be brought that will not be covered by insurance policies?
- What upcoming repairs or upgrades are needed (such as property, equipment, IT systems, etc.)?
Having assessed the charity’s situation and risks, the responsible persons should begin to see a picture of an appropriate level of reserves for their charity.
What can reserves be used for?
A charity must spend its reserves in the same way that any of its funds are spent – in furtherance of its charitable purposes.
Other than that, there are no hard rules about what reserves can and can’t be used for. Exactly how reserves are used is ultimately a decision for a charity’s responsible persons and should be considered on a case-by-case basis.
A charity’s responsible persons may decide to maintain reserves for particular purposes they have in mind (such as for a project, a new paid position or anticipated significant costs), or to keep them as general reserves which cover unexpected costs and help ensure general financial stability and sustainability. Many charities divide their reserves into general ‘rainy day’ reserves and those earmarked for particular purposes or investments.
It is important to remember that bequests or donations that come with specific conditions should not be included in general reserves. To make it clear that such funds are restricted to a particular use, they should be presented as separate line items in a charity’s financial statements.
The responsible persons of a charity should develop and implement a policy that governs their charity’s use of reserves. A policy can provide guidance and rules for the responsible persons which ensure that the charity’s reserves are being used for their proper purposes.
A reserves policy
A charity’s policy for managing reserves should include:
- why it is important for the charity to have reserves
- an appropriate level of reserves for the charity (updated from time to time)
- a clear explanation for how the charity determines its appropriate level of reserves (such as a formula, or a range of formulas)
- a strategy for building an appropriate level of reserves
- a process for reviewing the level of reserves
- the authority within the charity for determining and using reserves
- reporting and monitoring requirements
- how reserves will be identified in accounts and budgets
- criteria by which spending reserves is considered
- a communication strategy for explaining the charity’s reserves to the public
If developing a policy from scratch, it may be useful for the responsible persons of the charity to look at the financial information available for similar organisations on the ACNC Charity Register.