Charity Reserves Policy: Everything You Need to Know

All you need to know about a charity reserves policy and how to set a charity’s reserves level

Greetings to all the dedicated souls who work tirelessly to make a positive impact through their charitable endeavors! Today, we delve into a topic that holds paramount importance for every UK charity – the charity reserves policy. While it might sound a tad technical, fear not! I’m here to guide you through every nook and cranny of this essential aspect with warmth and clarity.

Let’s jump in: here’s everything you need to know about charity reserves and how to write a charity reserves policy according to best practice.

What Are Charity Reserves?

Imagine charity reserves as your rainy-day fund, your safety net in the unpredictable world of charitable work. These reserves are essentially funds that charities set aside to ensure they have enough financial stability to weather unexpected storms, or to seize unforeseen opportunities. Just like squirrels gather acorns for the winter, charities create reserves to secure their long-term sustainability.

A charity accumulates reserves by setting them aside from their yearly surplus: just like you may transfer some of your income to savings, the charity Trustees agree on a set of parameters to decide how much of the charity’s surplus should be allocated to the reserves, and how much should be re-invested in the charity’s operations.

As a reminder, a charity absolutely can’t distribute its surplus to its directors or employees: that’s why I’ve been calling it surplus instead of profit. A profit made by a commercial organisation can be distributed to the company’s stakeholders. However, a charity can’t use its funds to distribute them in any way: they need to be either set aside as reserves, or employed to fulfil the charity’s charitable objectives.

Types of Charity Reserves

Charity reserves can take on various forms, each tailored to suit different needs:

• General Reserves: also called Free Reserves or Operating Reserves. These are your go-to fund for the unknown. Is is the amount of cash readily available for the charity to spend however it sees fit: it therefore excludes any funds locked in assets, or restricted funds. It provides flexibility to manage unexpected challenges or grab exciting chances without causing financial strain.
• Restricted Reserves: this is money earmarked for specific purposes, like future projects or commitments. Normally, restricted funds come with a written agreement by the funder, who expects the donation or grant to be put towards a specific project or outcome. You can’t spend these reserves on anything else, unless you agree it with the funder.
• Designated Reserves: these are funds your charity decides to set aside for a specific purpose in the future, like expansion plans or major investments. For example, Trustees might decide to designate a certain amount of funds to a relocation, or a restructuring of the charity’s assets. This is different from receiving a restricted fund, as the restriction isn’t bound by an agreement, but rather it’s an internal decision made by the company’s directors.

The Meaning of Negative Reserves

In a nutshell: your charity’s expenses exceed its assets. That’s when you find yourself with negative reserves. While this isn’t a favorable situation, it’s not the end of the world: this can happen in moments of economic crisis, or heavy investments being made and before reaping their financial benefits.

During and after the pandemic, many charities’ reserves dipped into being negative, which essentially means that you owe more money than you have gained or put into reserves. During the touch times of lockdowns and restrictions, many charities had to close down, and they have had to deal with a recession, rising overhead costs, and a tough fundraising landscape. This caused many charities to have to dip into their reserves more and more, while dealing with an economic environment that makes it very difficult to build them back again.

Negative reserves signify a need for careful financial management and perhaps some strategic decisions to bring the ship back on course. Trustees should meet to discuss risk-mitigating actions, such as the reduction of overheads, diversification of income streams, and responsiveness to the current social and economic climate.

Charity Commission Reserves Policy

Ah, the regulatory touchstone! Essentially, no matter how small or large your charity is, it should have a reserves policy. 

The Charity Commission for England and Wales suggests that charities should create a reserves policy tailored to their individual circumstances. This policy should detail how much the charity aims to have in reserves and the considerations behind that figure.

Charity Reserves Policy Best Practice

Creating a reserves policy can feel a bit like giving a stab in the dark, especially if it’s your first time being responsible for doing it, and if you don’t have a lot of financial experience under your belt. But worry not: here are some guiding lights:

Assess the Charity’s Needs.

Understand your charity’s financial risks and aspirations. Grab the most recent organisational’s risk register and see what you should be prepared for in the near future, and where the major areas of risk are. This will help you decide the appropriate level of reserves to maintain.

Useful questions to ask to assess charity reserves levels:

• What is our main source of income?
• What would happen if that source fell through?
• What is our biggest financial risk?
• What should we be prepared for?
• How many months do we want to be able to operate, if one of these risks becomes a reality?
• Do we have an overdraft or ways to borrow money? How much do these cost and how can we prevent having to use them?
• What does our income generation trajectory look like for the next 3 years?
• What big financial commitments do we currently have, and which ones do we plan to incur in the next 12 months?

Plan Strategically.

Link your reserves strategy to your charity’s overall strategy. Let it support your long-term goals and the strategic direction you plan to take.

Useful questions to ask when planning for charity reserves levels:

• What is the charity working towards? 
• Are there any multi-year project the charity is about to take on?
• Are any capital works being planned? 
• Is there a growth phase coming up? 
• Are there any investments that the charity will make within the next few years?

Transparency is Key

In the world of charitable endeavors, trust is the bedrock upon which relationships are built and sustained. And when it comes to financial matters, transparency is the magical ingredient that nurtures that trust. In the context of your charity’s reserves policy, being open and clear about your financial decisions can have a profound impact on how your team, donors, and stakeholders perceive your organization.

Charity Reserves Policy Example

Let’s put theory into practice: let’s say that you work at a small charity that over the next couple years will embark into a period of growth by acquiring a building and hiring new staff, for a future period of activity and fundraising growth.

Here is what a reserves policy might look like:

Objective

Maintain financial stability and ensure sustainability.

Components to be achieved by 2026

General Reserves are to be set at 6 months of operating expenses, covering salaries, utilities, and other essential overheads. 

Designated Reserves for future expansion to cover: relocation costs, capital investment of a new building, and recruitment & HR costs for team growth.

Review

An annual assessment of the reserves’ adequacy and alignment with the charity’s goals.

Charity Reserves Policy Template

The reserves policy should be state in the company’s internal governance documents, and in the annual accounts.

Here’s a simple template to kickstart your reserves policy:

• Introduction: briefly explain the purpose of the reserves policy.
• Objective: state the overall goal of maintaining reserves.
• Components: breakdown the types of reserves your charity aims to hold, and by when they should be achieved.
• Rationale: explain the reasoning behind the chosen levels of reserves.
• Review and Adjustments: describe how often the policy will be reviewed and how adjustments will be made.
• Communication: address how the reserves policy will be communicated to stakeholders.
• Conclusion: summarise the policy’s significance and role in your charity’s journey.

Conclusion on charity reserves policy

So there you have it, a heartfelt journey through the world of charity reserves policy. Remember, these policies aren’t about hoarding wealth but about safeguarding your charitable mission and getting you through unforeseen tough times. With a well-crafted reserves policy, you’re better equipped to navigate the waves and continue creating a positive impact in the lives of those you serve. Keep shining, you charitable stars!

Related posts on charity accounting

• Charity Balance Sheet Funds Explained: Guidance and Example

• How to Read Management Accounts: a Guide for New Managers

• 8 Common Misconceptions About Being a Charity Trustee