This guidance was developed in collaboration with Not-for-profit Law at Justice Connect.
Reserves play an important role in the financial stability and long-term sustainability of a charity. Managing reserves is an important aspect of the overall financial management of a charity, which is a crucial element of good charity governance.
In line with good governance and proper risk management, Responsible People (board or committee members, or trustees) should consider an appropriate level of reserves for their charity's circumstances, and develop a strategy for building up and spending reserves in a way that is consistent with their charity's purposes.
This guide provides general information about charity reserves, including:
- what reserves are
- who is responsible for your charity’s reserves
- why it is important to have reserves, and when they might be needed
- how to determine what is an appropriate level of reserves for your charity.
This guide is not relevant for grant-making charitable trusts and foundations that manage a corpus.
Throughout this guide, we use the term ‘reserves’ broadly to refer to charity funds which, in a technical accounting sense, would commonly be called ‘operating reserves’.
Unless specified otherwise, the use of ‘reserves’ in this factsheet should be read as meaning ‘operating reserves'.
Our use of the term ‘reserves' in this guide does not include 'restricted reserves' (funds set aside as reserves for a particular purpose and not available for discretionary use) or 'revaluation assets reserves' (such as gains or losses on revaluation of unsold fixed assets for the charity's own use).
What charity reserves are
Reserves are funds that a charity sets aside to cover unexpected or sudden costs – often referred to as a ‘rainy day’ fund or financial ‘cushion’.
Typically, a charity will accumulate reserves over time. Although, in some cases, a charity may receive a special grant or donation specifically for the purpose of creating or supplementing reserves.
Reserves are identified as a separate line item in a charity’s financial statements.
When considering charity reserves, it is important to remember that a charity can make a profit. However, the profit, or surplus, must be used to further the charity’s purposes.
It is generally a good thing for charities to make a profit, especially if they are low on reserves.
Developing your charity’s reserves can help to ensure its long-term financial stability, which will help it continue to work towards its charitable purpose.
Generally, items such as:
- tangible assets (such as buildings, equipment and other items used in delivering services)
- ‘restricted’ funds guaranteed or quarantined for a particular purpose (such as specified by a donor or by an appeal of the organisation)
are not considered to be part of a charity’s reserves, although they are relevant to understanding its overall financial position.
Who is responsible for charity reserves
A charity’s Responsible People are, collectively, responsible for ensuring that it maintains an appropriate level of reserves. Responsible People must act in the best interests of their charity – and this includes providing oversight of charity finances and ensuring prudent financial risk management.
Good charity governance also means compliance with the law and legal duties of Responsible People. Under ACNC Governance Standard 5, the duties of a charity’s Responsible People include acting with reasonable care and diligence, ensuring the financial affairs of the charity are managed responsibly, and not allowing the charity to operate while it is insolvent.
A charity is insolvent if it is unable to pay all its debts when they fall due. It must have access to enough cash (including deposits and loans) and expected future income to meet its current and expected future expenses.
A charity’s Responsible People should consider the role of reserves in ensuring their charity remains solvent and financially stable.
As well as supporting your charity's financial stability and sustainability, reserves can play an important role in risk management.
Reserves help to maintain financial stability and allow your charity to meet its commitments. By having reserves, your charity can continue to undertake work and deliver services, even when unexpected events or costs arise.
Having a healthy level of reserves is also a sign of a well-governed and resilient charity. For this reason, maintaining reserves can help your charity:
- attract funding where a level of reserves is required or considered favourable
- provide assurance to lenders and members that it is financially stable
- invoke public trust and confidence in its efficiency and capability.
There are a range of situations that may occur in the life of a charity where reserves may be needed.
Your charity’s Responsible People will need to decide when and how to use charity reserves. And your 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 your charity’s Responsible People and should be considered on a case-by-case basis.
Your charity may decide to maintain reserves for particular purposes (such as for a project, a new paid position or anticipated significant costs), or keep them as general reserves which cover unforeseen costs and help ensure general financial stability and sustainability.
Some examples of how your charity may spend reserves include:
- piloting new programs or initiatives
- expanding to new locations
- improving infrastructure (such as upgrading IT systems or equipment)
- funding a major event (such as a significant fundraising appeal).
Your charity may also need to draw on its reserves to respond to sudden changes in its financial position. For example, it may need reserves to cover unexpected events, such as:
- funding cuts
- significant or unplanned costs, such as the need to move premises due to a sudden termination of a lease
- staff costs, such as redundancies if a major contract is lost
- expenditure, such as an increase in the cost of goods
- unplanned events drawing on the charity’s services, such as a natural disaster requiring extra services with little warning
- downturns in fundraising income
- legal costs.
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 your charity’s financial statements.
Spending all of your charity's reserves
Your charity can spend all of its reserves, but that will place it at risk of being unable to continue its operations or pay its debts if something unexpected happens which affects your charity’s anticipated income.
This places your charity at risk of becoming insolvent.
Having too much money in reserve
Charities cannot accumulate funds in reserve indefinitely.
While reserves are important to have in case of an emergency or unexpected cost, in some cases a charity may be seen as having too much money in reserve.
Because a charity must be pursuing a charitable purpose and must be operating as a not-for-profit, a charity that holds a large amount of money in reserve without a clear explanation and justification may draw attention from funders and regulators.
Where a charity’s Responsible People consider their charity’s level of reserves to be too large, they may need to spend some of it to bring it back to an appropriate level. They could do this through investing in new programs or by donating funds to other charities pursuing the same or similar purposes (a charity should get legal advice before giving funds to another organisation).
It is important to remember that any spending of reserves must be in furtherance of the charity’s charitable purpose.
All charities are different, with unique needs and financial positions. Because of this, there is no single level of reserves that will be appropriate for all charities.
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.
Having little or no reserves may be detrimental to a charity.
A low level of reserves may place a charity’s operations at risk if it is faced 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.
Accumulating a high level of reserves without a clear explanation or justification may adversely affect the public’s perception of the charity. Unjustifiable stockpiling of reserves may 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 more than necessary.
Charities need to find an appropriate level of reserves for their particular circumstances.
How to determine an appropriate level of reserves for your charity
To determine an appropriate level of reserves, it is important for your charity's Responsible People to analyse your charity's situation and determine the risks it faces.
This analysis 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 that you should consider to help determine an appropriate level of reserves, such as:
- What liabilities (current and future) does your 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 your charity (both in terms of time and money)?
- What external events may affect your charity's services (such as a natural disaster)?
- 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.)?
Each charity is different, and these questions (along with other considerations relevant to your charity) will help you determine an appropriate level of reserves.
Your charity should be able to 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 your charity’s reserves and its reserves policy.
You should also be able to provide justification for any high levels of reserves in your charity’s financial statements.
Your charity’s Responsible People should develop and implement a policy that governs the use of reserves. A policy can provide guidance and rules to ensure that your charity’s reserves are being used for their proper purposes.
A reserves policy should include:
- why it is important for your charity to have reserves
- an appropriate level of reserves for your charity (this should be updated from time to time to reflect the current needs of your charity)
- a clear explanation for how your 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 your 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 your charity’s reserves to the public.