Daniel Ferrell-Schweppenstedde

Former Policy and Public Affairs Manager

Charities Aid Foundation

Charity reserves are in focus more than ever – what have we learned?

1 December 2022

The cost-of-living crisis and gloomy economic outlook are testing the operational endurance of charities, their adaptability, and financial resilience. The current inflationary environment is increasing costs, eroding donations, and increasing the number of people who rely on their services. The Bank of England is now expecting a prolonged recession – which likely means that the high levels of demand many charities are seeing will continue.

How do charities react to financial pressures?

Recent CAF research found that less than a third of charities (28%) have developed a detailed plan to face the cost-of-living crisis. More than half of the organisations surveyed are worried about struggling to survive. Charities are split by the effect of increasing interest rates, with almost half (44%) saying it does not affect them. However, one in ten (11%) said that their rent or mortgage would be likely to increase substantially. But, one in five (19%) expect to have more funds available than projected because of the rise in interest rates. Charities who can manage or invest their assets are likely to be in a better position to benefit from changes to the base rate.

The effect of the pandemic on dynamics of reserves

Before the pandemic, the perceived wisdom was that reserves should be high enough to have a ‘rainy day fund’, but ‘not too big’ to deter potential funders. Income diversification was also seen as important to bolster financial resilience, since multiple income streams could provide protection if one of them were to fall flat.

For instance, during the pandemic, some income streams dropped to zero because of lockdowns and other restrictions. However, charities with income streams based on a limited set of funders might have seen these maintained or even increase their support. These organisations might not have needed to dig as deep into their reserves.

Yet, this does not mean income diversification is still vital. The Institute for Voluntary Action Research (IVAR) found that charities relying heavily on (restricted) grant and contract income, especially when they do not allow for full cost recovery, can often struggle to build up reserves and manage them strategically. Notably, the risks around funding arrangements played out differently in the context of the pandemic.

It should be also noted that when it comes to reserves a one-size-fit-it-all approach does not work and having a reserves policy build on a fixed "number of months" or share of income could be quite static. Charities can take different approaches. Some start by out by separating out general reserves into buildings and cash; something that the SORP does not require. Others internally earmark reserves with some being viewed as quickly available whilst others, if used, represent an existential threat. Others build their reserves policy on risk assessing potential challenges and ensuring mitigating funds are available. There are also examples of having a closedown reserve which gives them the potential to effectively & safely wind down the charity .

Can reserves recover?

Many charities came out of the pandemic with a weakened position. Our polling in November 2021 found that two in five (40%) charities used their reserves to help them through the Covid-19 crisis. Charity Commission data from 2021 showed a lower proportion - around a quarter of charities needed to draw on their reserves to keep operating. But at the same time, the Commission found that the share of charities (with an income above £500,000) with negative or no free reserves more than tripled during the same period.

The lack of breathing time between the pandemic and the cost-of-living crisis biting means that many charities are unlikely to have been unable to build their reserves back up. Recent CAF polling from this month found that half of charities (51%) reported they are using reserves to meet organisational costs. A third (35%) said they are reviewing their reserves policy, and 9% said they are making it easier to access their reserves – this could include liquidating assets to enable easier access.

Charities must continue to make crucial decisions around their reserves. But their ability to do so differs.

The role of funders

CAF found that 48% of charities in November are asking their funders to help them with increased costs. This means that many have not had these conversations. Although the reasons for this are likely to vary, they might not feel encouraged by their funders. It’s likely that both sides need to do more to engage. Then there is the question on how honest these conversations can be and whether reserves should be a part of it. Even funders that pay for core costs might stipulate what they will and will not fund and could exclude reserves.

For some charities, they will need to balance spending funding on services now to ensure their organisation survives and retaining the ability to achieve impact in the future. Funders should help their grantees to manage these trade-offs. Trust- based giving could also be part of the answer. Funders and large donors that trust a charity to receive money in the first place should trust them to make the right decisions – including when to rebuild their reserves.

Where could we go from here?

Adjusting the criteria for funding could go a long way. Quite often grant money cannot be spent on staff costs, which is usually the biggest overhead for charities. In fact, a recent report by London Funders shows that third of funders in London are increasing the value of grants to respond to the cost-of- living crisis. Adjusting contract and grants for inflation can help to relieve pressures on charities who otherwise need to dip into their reserves.

CAF is an advocate for resilience funding which brings a wide range of positive effects for organisations and can enhance the long-term survival and development of grantees. Among other factors, it improves governance and decision- making capability. These are factors needed to ensure long-term financial resilience.

Funders and charities are very likely to be required to pursue an ongoing dialogue around reserves and how they increase financial stability. Getting the balance right is crucial to ultimately benefit those that rely on the charity services during these trying times, and in the long run.

CAF has launched a cost-of-living resource hub with information for charities and funders to help them navigate the challenges.

CAF also offers the Charity Deposit platform, which is tool that can help charities build up their reserves.

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