A charity guide to prudent reserves

It might not set pulses racing, but establishing a prudent reserve is one of the most important things a charity leader can do. Without a proper prudent reserve, a charity’s operations will be precariously financed, and charity leaders may find themselves under serious scrutiny should disaster strike.

 

 

What is a prudent reserve?

 

A prudent reserve is a financial term used to refer to any money set aside by an organisation to protect its operations in the face of a drop in income, to mitigate a disruption to fundraising or other operations, or to allow the organisation to capitalise on unforeseen opportunities.

 

Reserves function as unrestricted funds – this means that financial decision-makers are allowed to spend them in any way they see fit. They are not ‘restricted’ to being spent for a specific purpose.

 

However, responsible governance would dictate that charities impose some internal regulations on how these funds will be spent. If you are unsure what to set aside funds for, then designating the prudent reserve as existing to ensure continuity of service is a solid starting point.

 

 

Why should charities set aside a prudent reserve?

 

The main benefit to establishing a prudent reserve is that it can allow charities to navigate a disruption to everyday operations – in the form of a disruption to fundraising activities, or to general service delivery.

 

The pandemic has illustrated the precarious fiscal situation that many charities find themselves in. Charity leaders cannot be expected to foresee every possible disruptive event. But they are expected to plan for some degree of disruption: the ability to weather these storms is defined as ‘resilience’ by the Charity Commission, who advocate the establishment of prudent reserves for these types of events.

 

The Charity Commission’s regulations for trustees set a number of duties for charity leaders. These include legal duties to:

• Act in the interests of their charity and its beneficiaries
• Protect and safeguard the assets of their charity
• Act with reasonable care and skill
• Ensure that their charity is accountable

A prudent reserve can be a useful tool in any effort to fulfill these duties. Reserves are essential to ensuring continuity of service. Any organisation that found itself unable to fulfill its obligations due to financial hardship in the absence of a reserve would face scrutiny.

 

Charity leaders would be asked why they had not set money aside to maintain essential services for beneficiaries and offset any unplanned closures or unforeseen liabilities.

 

Prudent reserves are also stipulated as a necessary requirement by the Charities Statement of Recommended Practices (SORP). Any charity operating without a prudent reserve is obligated to disclose this fact in their annual report. Such a disclosure may be off-putting to potential donors, who are likely to view it as fiscally irresponsible.

 

 

How to set a prudent reserve

 

First you must establish how much your organisation will hold in reserve. Then you must set out the reasons why you have made this decision and specify the circumstances in which you would consider using this money.

 

You should also determine who will be responsible for managing the prudent reserve, what financial strictures they will operate under, and how often the policy will be reviewed. For information on establishing financial policies and procedures, view our guidance here.

 

It is important to incorporate prudent reserves into strategic planning: reserves function as unspent income, and they must be treated as such.

 

The Charity Commission stipulates the following: “Charity trustees have a general legal duty to spend income within a reasonable time of receipt. Trustees may spend this income to fund charitable activities, in acquiring assets to use in the charity’s work, and in meeting the day-to-day running costs of the charity.

 

“To hold income in reserve rather than spending it, trustees rely on an explicit or implicit power to hold reserves and they must use that power in the charity’s best interests.”

 

Charity leaders tend to be conservative when it comes to maintaining reserves. While this is responsible, it does ignore the strategic value of leveraging prudent reserves to gain access to new streams of income, or as part of a project-related investment.

 

Consider freeing up some of these unrestricted funds to capitalise on new opportunities as they arise. With the proper planning, a prudent reserve can be a powerful strategic enabler for a well-run charity.

 

 

Who should be responsible for setting a prudent reserve?

 

Your prudent reserve should be subject to the same level of scrutiny as your other fiscal policies – preferably at a trustee level.

 

Your trustees annual report should tell donors, funders, and other stakeholders why you have set this money aside, how much you hold in reserve, how this specific amount was arrived at, and in what circumstances you would consider spending this reserve.

 

 

How much should you set aside for a prudent reserve?

 

There is no one-size-fits-all approach for charities to follow when setting a prudent reserve. The amount you will need to set aside depends on you the kind of work that you do.

 

It is usually suggested that charities set aside between three to nine months operating expenses as a prudent reserve. For organisations with exceptionally low overheads, then a prudent reserve of as little as one month’s operating expenses may be sufficient.

 

For charities operating on a longer-term project basis, you may want to evaluate the benefits of a prudent reserve of more than nine months expenses.

 

There are several factors you should consider when determining how much to set aside for a prudent reserve:

• How much are one month’s operating expenses for your organisation?
• Do you have any special projects planned? Do these have their own budget, or are they factored into the monthly budget?
• How regularly do you deliver services, and at what level?
• How much would it cost you to run your services at a stripped-down ‘bare bones’ level?

The Charity Commission offers guidance on internal financial controls for charities.