A couple of years ago, the Charities Commission carried out a review based on the reserves policy of a random sample of charities with income over £500,000. Within this review, the Charities Commission wanted to ensure whether charities had:
- explained their reserves policy; and
- stated their level of reserves correctly
The Charities Commission found that only 22% of the charities reviewed had accurately included the above information in their reserves policy.
Typically, charities will hold high levels of reserves which will be displayed in the financial statements. In some instances, a significant portion of these reserves can represent the charity’s fixed asset carrying values and therefore are not freely available for spending. As a result, the term ‘free reserves’ is often used within the reserves policy.
Free reserves can be defined as the charity’s unrestricted funds that is freely available to spend on any of the charity’s purposes. Free reserves are calculated by taking the total unrestricted funds and deducting the total fixed assets value. As mentioned above, many charities carry substantial values of fixed assets (such as properties) which contribute to high levels of reserves. As a result, detailing the free reserves within the reserves policy is crucial as users of the financial statements can often misconstrue the total unrestricted fund figures.
What to include in a reserves policy
When creating a reserves policy, it is important to firstly consider these points:
- Nature of the charity’s income / charitable objectives
- Budgeted expenditure for the next financial year
- Risks to which the organisation is exposed
Once these points are considered, the free reserves figure needs to be calculated using the current year financial information, as well as quantifying a target free reserves figure.
Finally, when creating the reserves policy, the following points need to be followed:
- State the total funds held at the end of reporting period which includes the total of unrestricted funds and free reserves
- Identify and explain any material amounts which have been designated
- Compare the current amount of reserves with the charity’s target reserves figure
- If the current amount of reserves does not agree to the target reserves figure, an explanation should be included to explain why it doesn’t and how the charity is aiming to reach the target level of reserves
The above reserves policy is crucial to the charity as it also helps during fundraising appeals and grant bids. Grant funders often process multiple grant applications daily, so large levels of funds without explanation can be detrimental to charities who are trying to obtain funding. If a reserves policy explains the charity’s financial situation, then this can be more attractive to funders.
One recent example is the Covid-19 impact on charities. Multiple grants were paid to charities during the pandemic however many charities also had to close their services. As a result, the free reserves of those charities increased above and beyond the charity’s reserves policy. Therefore, an explanation on how Covid-19 impacted on the free reserves would provide the funder with an understanding of the substantial reserves balance.
In summary, creating a policy through the viewpoint of the users of the financial statements is crucial to developing and creating an attractive charity to fundraisers and volunteers.
If you would like professional help preparing your charities financial statements, you can reach out to the author of this blog Liam Crowe here: firstname.lastname@example.org