Cash Machinations; why financial reserves are bad for beneficiaries and deceitful to donors
The new research that we released this week shows that, on average, the public think seven or eight months is about the right amount of reserves for a charity to have in the bank. Around half of those who expressed a view thought six months of expenditure or less was the right level. Interestingly though, when the same people were asked how much a £12 million charity should keep in reserve, the average dropped to around £3 to £4 million.
At this stage, readers may think that this puts the public at odds with the Charity Commission. The public want fairly low levels of reserves, while the Charity Commission allows much higher. Before I did my research, I thought so too.
This is because, like many people, I had a vague notion that the Commission says charities should hold between six and 24 months of income in reserve. I have now searched the CC19 guidance and I can’t find that nugget of information.
What is more interesting is that the Commission says quite the opposite - if you haven’t got a good reason to save it, income should be spent. Its summary bullet point of CC19 says the following: ‘Charity law requires any income received by a charity to be spent within a reasonable period of receipt. Trustees should be able to justify the holding of income as reserves. In other words, the Commission says that each charity needs to decide for itself what the right level of reserves is.
So the Commission’s default position for income is that the law says it should be spent, not saved.
The argument against spending rather than saving says that reserves are meant to be there for a rainy day. Well, we have just had the biggest financial crisis in a generation. The external economic climate doesn’t get any worse than this. So if you still have reserves for a rainy day that haven’t been touched after the economic equivalent of typhoon, laced with government austerity, then what kind of economic weather event are you waiting for?
Reserves are meant to be there for other reasons too, such as a dramatic loss of income, unforeseen circumstances and the like (I exclude both grant-makers and charities that have an endowment from my argument). However, I think every charity needs to be very clear what kind of financial catastrophe they are imagining and how likely it is to happen.
I can see why trustees like reserves. They reduce the risk (no matter how small) of not being able to pay the bills. But it’s a comfort blanket, and sometimes a very expensive one. Of course some charities have reserves for capital expenditure, for new ventures, for innovation, for risk-taking and the like. Yet in my experience, they are the exception, not the rule.
So my antipathy to reserves boils down to two reasons. First, they take money that should be used to help beneficiaries and lock it up. A report from the Institute of Philanthropy in 2011 suggested that while the charity sector has an income of £53 billion, it has assets of £128 billion, even once liabilities were taken away. No, not all of those assets will, or could be, reserves. Some will be restricted funds, buildings etc.
However, if we take off half those assets, it suggests that there is at least a whole year of charity expenditure in reserve – and that’s a cautious underestimate. In other words, if those reserves were spent we could get a whole extra year of charity impact. A whole year! A ‘buy one, get one free’ for the whole charity sector for an entire year.
Money in the bank lying unused and unlikely to be used in any foreseeable financial situation is money that isn’t being spent on beneficiaries. Let me say it again – it’s income that is not creating an impact. For me, three to six months of reserves is plenty for all but those with the most volatile or unpredictable of income.
My second reason is that reserves hamper fundraising and create a disconnect between a charity and its donors. It is deceitful to people who make a donation expecting it to be used to deliver services, when in fact it is being put aside for a financial meltdown that will probably never come. It is deceitful to donors to tell them you need their money when you have months or even years of income in reserves. If a friend came and told me they desperately needed my help to pay the bills, I certainly wouldn’t expect them to have a year or two of savings under the mattress.
As we come out of recession, the economy begins to grow again and the storm looks like it has passed, charities should be asking themselves - would the money they keep in reserves be better spent delivering their mission?