Guidelines on Reserves Policies for Charities (March, 2012)

What are Charity Reserves?

For the purposes of this document reserves can be understood as income that becomes available to the charity and is to be expended at the discretion of the Board of Directors (or Trustees) in furtherance of any of the charity's objectives ('general purpose' income), but which is not yet spent, committed or designated - it is 'free'.

This excludes the following:

  • Permanent endowment;
  • Expendable endowment;
  • Restricted funds;
  • Designated funds;
  • Income funds that could only be realised by disposing of fixed assets held for charity use.

Why have a Reserves Policy?

There are a number of reasons why charities may hold reserves and these will depend on the type of activity undertaken by the charity and how it operates and funds its operations.

In general, reasons why charities hold reserves can be summarised as follows:

  • To fund working capital;
  • To fund unexpected expenditure, for example when projects overrun or unplanned events occur;
  • To fund shortfalls in income, when income does not reach expected levels.

Income needs to be spent in a particular year unless it has already been agreed with the Revenue Commissioners as to why it will not be spent in that particular year.
A helpful way for charities to view reserves is to see them as the funds they will use to cover expenditure to “buy some time” in the event of reduced income or changes in circumstances. In this way, a charity may foresee that there is a chance that funding from a particular source will be cut. The charity will need reserves to fund the committed expenditure whilst they source alternative funding.

The judgement of how long they will need to find alternative funding will help to inform the size of the reserve needed for this purpose. For example, the charity may assess that it would need six months to replace a major source of funding. The reserves level to cover this contingency would therefore need to be the equivalent of six months’ funding or expenditure.

The Benefits of Developing a Reserves Policy:

  • It is a key element of the strategic plan – without a clear idea of the reserves you need you may not be able to meet your commitments or start new activities.
  • It feeds into the budgeting and decision-making process – the policy will act as a benchmark to ensure that you use your funds to good effect. Without this the danger is that if you have high reserves you may take on projects without detailed planning and with low funds you may be forced to be reactive rather than plan constructively. 
  • It focuses your fundraising activities – the reserves policy will identify your level of need for funds and what they are needed for. This can be fed into your fundraising plans as it is often easier to fundraise for specific items or amounts.
  • It is necessary for communication with those external to the charity – the reserves policy helps to demonstrate that the charity’s money is being used to good effect. Funders, beneficiaries, members and the wider public are entitled to know this and that you have good reasons for maintaining or seeking the certain levels of reserves.

Is There a Problem with a Charity having Reserves?

Charity reserves can be a controversial issue. The media has criticised some large charities for apparently accumulating large reserves while at the same time conducting additional fundraising appeals.  

The Revenue Commissioners have the view[1] that the income raised by an organisation with a CHY number should be spent by the charity on furthering its charitable purpose. Accumulation of income is possible though, for example, to save funds for a future project like construction of a building or to save money in accordance with an appropriate reserves policy. In principle, however, income needs to be spent in a particular year unless there is a good reason as to why it will not be spent in that particular year.

Generally, the Revenue Commissioners will take the approach that a charity needs to think through its reasons for accumulation of funds: the organisation needs to articulate clearly what it is doing in this regard and why, and it needs to communicate this in its annual accounts by means of a reserves policy and associated reserves statement. The rationale behind the accumulation of funds in such a way must be written down, approved by the board, be strongly linked to good governance practice or saving for future expenditure purposes and must be available to the Revenue Commissioners upon request. Once the Revenue Commissioners see evidence of these things happening, and if they agree with the analysis, they tend not to put obstacles in the charity’s way.

Charities should therefore devote their attention to providing accounts that are clear and transparent and also ensuring that they include a reserves statement that conveys to donors and others, what the position is and why the charity needs reserves. This is particularly important because many funders automatically look at the fund balances shown in annual accounts when deciding whether to approve applications for funding.

It is generally assumed that organisations which have a CHY number should not hold onto charitable funds for a long time, since the organisation was granted those funds to provide services. This holds true for charities that are raising funds for meeting these immediate needs. But some charities raise, and are given, funds for current as well as longer term beneficiaries and they need to plan and balance how they spend funds for both today and the future. These competing needs should be seen as part of the risk management process that all Boards should engage in.

What a Reserves Policy Should Cover

In the absence of a Charity Regulator in Ireland, the Revenue Commissioners take the view that organisations with a CHY number need to explain and justify to them the level of reserves they hold. This can most usefully be done through the creation of a reserves policy and associated statement and inclusion of the statement in the director’s report part of the audited accounts. Therefore, in order to be as transparent as possible, even the smallest of organisations that aspire to financial security should have a reserves policy.

There is a temptation to say, "We have got enough reserves to carry us through three months of activities - let's make that our reserves policy", rather than stepping back and making a genuine estimate of needs and then making efforts to achieve those levels. This temptation should be avoided.

A policy on charity reserves should cover:

  • The reasons why the charity needs reserves;
  • The level (or range) of reserves the Board believes the charity needs;
  • What steps the charity is going to take to establish or maintain the reserves at the agreed level (or range);
  • Arrangements for monitoring and reviewing the policy.

Fixing a Reserve Level

There is no absolute level of reserves that an organisation must have and it may help to benchmark against other organisations. To determine the right size of reserves, Board members need to look at their current and future incoming and outgoing resources and ask:

  • How likely is it that our main source of income will change?
  • How would we cope if it did?
  • How would our beneficiaries be affected?

Research conducted in the UK discovered that the most popular techniques used to establish an appropriate level of reserves were:

  • Through a cash flow analysis;
  • Discussions with the management team, treasurer or members of the finance committee;
  • Through an examination of past trends.

As a minimum the organisation should:

  • Forecast its income (this should in any case be done as the most basic part of financial planning);
  • Forecast planned activities and their associated costs;
  • Consider future needs and opportunities, for example, expansion possibilities;
  • Consider various scenarios - asking "What if x happened?”. For example, what if there is a change of government / Minister affecting their area of operations?.

Once the organisation has an idea about what level of reserves it should have, it can compare these with current actual reserves. Most organisations are likely to be facing a shortfall, but it is possible that a long established charity might have, quite literally, “an embarrassment of riches”. 

Summary

The essential steps in developing a reserves policy are as follows:

  1. Review existing funds.
  2. Analyse income streams.
  3. Analyse expenditure and cash flows.
  4. Analyse the need for reserves.
  5. Calculate the reserves level.
  6. Formulate reserves policy.
  7. Presentation of reserves policy in the form of a reserves statement.

The Revenue Commissioners in Ireland are mostly concerned with "free reserves" (that is, not permanent endowments or restricted funds) and they require a justification for their level. The best way to do this is to develop a reserves policy and associated reserves statement and to include this in the audited accounts. Any significant changes to the policy or the practice related to this should be brought to the attention of the Revenue Commissioners. This advice note was approved by the Revenue Commissions in March 2012. 
 

Example of a Reserves Policy:

A formal policy on reserves was agreed at the ____________ meeting of the executive committee/ Board / etc.

It states:

The Board has set a reserves policy which requires:

  • Reserves be maintained at a level which ensures that ________________  organisation's core activity could continue during a period of unforeseen difficulty.
  • A proportion of reserves be maintained in a readily realisable form.

The calculation of the required level of reserves is an integral part of the organisation's
planning, budget and forecast cycle.

It takes into account:

  • Risks associated with each stream of income and expenditure being different from that budgeted;
  • Planned activity level;
  • Organisation's commitments.

The following headings could be used in the policy:

  • Introduction;
  • Current policy: (as outlined above);
  • Risk assessment: against each category of income and expenditure;
  • Future activity level: likely requirements on reserves;
  • Organisational commitments;
  • Current reserves level.

 

Notes:

[1]Section 207 Taxes Consolidation Act 1997 under which charities seek tax exemption covers income that is applied for a charitable purpose only. If a charity has income which is not being applied for a charitable purpose then the tax exemption will not apply to the body and all of its income is taxable.

Sources

The following documents provided the source material for the development of this guideline document:

Further Resources

  1. Download The Wheel's sample template for a typical budget in a community and voluntary organisation (Excel, 57kb)
     
  2. Download The Wheel's Guidelines on Reserves Policies for Charities as a PDF document (182kb)

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