What are reserves
Charity reserves are made up of unrestricted funds, which can be freely spent on your charitable objects. Reserves excludes the following items:
- Restricted funds, which can legally only be used for their specific purpose
- Designated funds, which trustees have ear-marked for a specific purpose
- Amounts tied up in tangible fixed assets, as the charity needs these to continue to operate
The remaining amount of funds is termed the ‘free reserves’ of the charity.
Why are reserves important
It is important that all charities maintain a healthy financial position, to meet ongoing costs and support future plans. Trustees are required to act in the charity’s best interest and manage charity resources responsibly, and holding the appropriate level of reserves will help to do this. Reserves are a financial buffer for a charity, they provide support should the charity generate a deficit in one or more years or if the timing of income is variable. Building up reserves also allows for capital investment or expansion plans.
The reserves policy
All charities are required to develop a reserves policy and disclose this in the annual trustee report. If the trustees have decided it is unnecessary to hold reserves, this must be disclosed and explained in the annual trustee report.
Developing a reserves policy is not only an exercise for the statutory accounts. Understanding the reserves available to the charity will assist trustees with budgeting, developing future plans and identifying any risks to operations due to lack of reserves.
The reserves policy will be specific to each charity, but most small charities could consider three to six months of operating costs as a starting point. Trustees should then consider financing upcoming plans, potential redundancy and closure costs and expected or secured income streams. Most charities will find it useful to have a target range of reserves, rather than a fixed figure.
The level of reserves should be compared to the policy at least annually. This is important to ensure that reserves are neither too high nor too low.
Reserves should not be higher than necessary as the charity could be using this money on its charitable purposes. Funders may review the amount of reserves reported in the annual accounts to decide which charities to support. Charities with reserves significantly in excess of policy may therefore be unlikely to attract funding. If reserves are being accumulated at a high level for a specific purpose then this should be clearly explained in the reserves policy. If there is no clear reason that reserves are too high, trustees should consider whether the charity could increase its charitable expenditure and services.
Reserves should also not be too low. Low reserve levels leave the charity’s operations vulnerable to the loss of a funder or unexpected additional costs. The trustees should take action to increase reserves.
Trustees should review the reserves policy at least annually to ensure it remains appropriate, especially if the charity has undergone any changes to operations impacting the amount of reserves required.
Need help with charity accounting requirements?
We have a team of charity experts within West & Berry who can advise on reserves and all other aspects of charity accounting. Please get in touch to discuss how we can help you.