Tag Archives: reserves policy

Fund accounting for charities – the importance of monitoring restricted funds

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One of the ways in which charity accounts are ‘different,’ is the use of fund accounting.

Fund accounting splits income and expenditure into different pots depending on the purpose of the donation.

There are four types of fund:

1. Unrestricted or general funds – these are funds that a charity has received from a donor and which are not held for any particular charitable purpose. They can be spent as deemed fit by the trustees.
2. Designated funds – these are unrestricted funds that the trustees have set aside for a particular purpose. Such funds can be undesignated or re-designated.
3. Restricted funds – restricted funds have been given to a charity for a particular purpose and can only be spent on that purpose.
4. Endowment funds – these are funds received by a charity that represent capital. Charity law requires trustees either to invest such funds, or to retain and use them for the charity’s purposes.

Knowing the position on each of a charity’s funds at any point in time is an essential part of a charity’s financial management. In particular, there is a need to be able distinguish between unrestricted (including designated) funds and restricted funds. Restricted funds can only be spent in accordance with the requests of the donor; failure to do this may be a breach of trust.

So why else is it important to monitor restricted fund balances?

Planning and budgeting – not identifying restricted funds at time of donation and not allocating expenditure to restricted funds until the year-end can have a distorting impact on your planning and budgeting processes. This may give rise to the expectation that available funds are greater than the true position.
This could result in:

  • Encouraging you to plan additional activities thinking the reserves are available to fund them – yet once the fund allocations are done, it may indicate highlight that reserves are lower and so these extra activities may put additional pressures on fundraising or cash flow
  • Indications that your reserves policy is not appropriate (see below)
  • Indications that your income streams are not sufficiently diverse – for example tracking funds during the year may help to highlight that most of your income is received in the form of restricted grants and therefore there is a need to look at other sources of funding

Reserves policy – every charity needs to develop its own reserves policy that establishes an appropriate level of reserves for the charity to hold. Restricted funds fall outside of the definition of free reserves – but they still impact a charity’s reserves policy.

If the nature of a charity’s activities is such that significant levels of its income and reserves are restricted, then the level of unrestricted reserves the charity should hold may be reduced. However, if restricted fund balances aren’t being monitored, then the reserves policy established may not be appropriate and the charity may be holding too high, or too low, a level of unrestricted reserves.

Keeping track of restricted funds during the year will allow better monitoring of financial performance, unrestricted reserve levels, and the level of unrestricted funds needed – and will help to drive review and setting of the reserves policy.

Donor reporting – it is often the case that that when restricted funds are awarded to a charity, the donor specifies that a report be provided on how these funds have been spent. Such a request may be made for unrestricted funds too. These donor reports will not necessarily coincide with your accounts year-end.

Many charities, both large and small, perform the analysis and allocation of expenditure by fund as part of the annual accounts process. Therefore, you need to make sure that you can easily identify the expenditure connected to each restricted fund at any time during the year. Ensuring that your accounting system allows allocation of income and expenditure to a particular department/project/cost centre should make extracting the information for the donor report more straightforward.

Accounting system and resource –good questions to ask include: does the absence of monitoring funds during the year indicate that your charity has outgrown your accounting system? Is the system still fit for purpose? Does it highlight a training need for your accounts team? Are the trustees receiving the financial information they require?

Overheads – unrestricted funds are often seen as the holy grail of charity financing as they can be spent as the trustees deem appropriate. There can be the belief that “unrestricted funds = overheads”, and that restricted funds cannot be used towards overheads or support costs.
However, this is a slight misconception. Donors are aware that projects and activities don’t just happen – for example, a charity might need premises to carry out its activities so it’s only right that a proportion of premises costs relate to the projects funded by the restricted reserves.
Not tracking restricted funds until the year-end may mean that overheads are not apportioned until the year-end – by this time, the restricted funds may have been spent, resulting in support costs being funded out of unrestricted reserves.

It may also indicate that support costs are not being allocated appropriately – a charity’s activities are likely to change over time (either in terms of what activities are carried out, or the way in which they are carried out). Therefore, previous methods of support cost allocations may not continue to be the most appropriate method.

The above are just a few reasons as to why restricted funds should be monitored on an ongoing basis – but it’s certainly not a definitive list!

Reviewing your charity’s processes around tracking reserves is an important exercise and shouldn’t be dismissed as a year-end accounts process.

Do get in touch if you have any questions on how your charity can best monitor its funds.

Charity Trustees’ Responsibilities – A review of key areas following Kids Company – Part 2

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Forecasting

In a recent blog, I started to look at some of the financial management and governance areas and responsibilities that charity trustees need to focus on.  These are not new but their importance has been heightened in light of the collapse of Kids Company.

This blog considers three more key financial areas for trustees:

1. Budgeting and Forecasting

Trustees should ensure that full budgets have been prepared, reviewed, and approved. These should be realistic and based on reasonable assumptions.

Budgets should be monitored and compared to actual performance regularly, which can help to identify as early as possible any potential risks on the horizon. They should also be flexible –  if activities change or certain funding is lost, budgets and forecasts (including cash flow forecasting) should be updated accordingly.

Whilst not limited to the budgeting process, consider your funding mix and whether there is a reliance on one particular source. Have contingency plans been considered if this source disappears, and if so has this been factored into budgets?

2. Cash Management

Cash flow management is essential with both cash balances and future cash needs being monitored. Furthermore, for accounting periods on or after 1 January 2016, larger charities (ie those with income over £500,000) will have to include a cash flow statement in their annual accounts, in accordance with the Charities SORP.

Cash flow forecasting should be carried out and this should reflect the charity’s strategy and budgets, and relate to the planned activities.

Sufficient levels should be maintained to cover any shortfalls if urgent expenditure arises, or funding is received late. As with other budgets, these forecasts may need to incorporate contingency plans or “what if?” scenario planning.

3. Manage reserves

Charities are required to set a reserves policy and monitor the level of reserves held against this policy. An explanation of the charity’s reserves policy must be included within the Trustees’ Annual Report, as required by the Charities SORP, together with details of the level of reserves held and why.

There is a balancing act between holding too high a level of reserves that future donors may be put off, and holding too few reserves that the charity cannot weather a storm.  There is no hard and fast rule – setting the level of reserves requires judgement but should be appropriate to the size and nature of your charity.

For example, a grant making charity with low overheads may not need high levels of reserves that cover many months / years of core expenditure. On the other hand, a charity that is providing important frontline services to vulnerable beneficiaries may need to hold a slightly higher level of reserves to ensure that, in event of a funding cut, they can continue to meet the needs of their beneficiaries in a short-term whilst it sources new funding or adjusts its activities gradually to avoid an instant decline in services.

The reserves policy and the level of reserves should both be reviewed regularly to ensure that the policy is still considered appropriate, and that the actual level of reserves is within the policy.

As with the topics discussed in the first blog in this series, all areas should be considered and planned in accordance with the specific circumstances of your charity – one size doesn’t necessarily fit all.

Please do get in touch with any queries you have about your own charity. In the next blog in the series, I will consider some non-financial governance topics.