Charity Reserves for Your NFP: How Much Is Too Much

Introduction

For any not-for-profit organisation, holding reserves is integral to ensuring long-term financial stability and sustainability. While many in the sector fear that generating a surplus may attract backlash from donors, operating with little to no cash reserves can put a charity’s good work and longevity at risk. However, accumulating an excessive level of charity reserves without clear justification can create its own set of significant challenges.

This guide provides essential information for your charity on navigating this financial balancing act, which is a crucial element of good governance. It explores the potential risks of holding too much charity money—from damaging public trust to attracting ACNC investigations—and offers practical guidance on how to determine an appropriate level of reserves that aligns with your organisation’s purpose and the expectations of the Australian Charities and Not-for-profits Commission (ACNC).

The Risks of Holding Excessive Charity Reserves

Damaging Public Trust & Donor Confidence

Accumulating a high level of charity reserves without clear justification can significantly impact public perception. This erosion of trust and confidence creates several challenges:

• It gives the impression that the charity is stockpiling funds rather than fulfilling its mission
• Potential donors may question the need for additional funding
• This perception can lead to resentment among stakeholders
• Future contributions may be deterred as people believe the organisation doesn’t require their support

When a charity appears to have large cash reserves, supporters might conclude the organisation is not using its resources effectively. This damages the relationship between the charity and its donor community, potentially affecting long-term sustainability.

Attracting Scrutiny from Funders & Regulators

Holding significant charity money in reserve without a well-defined purpose draws unwanted attention from both funders and regulatory bodies. This scrutiny manifests in several ways:

• Regulators like the ACNC may become concerned that charitable assets aren’t actively pursuing the organisation’s purpose
• Funding providers might view high reserves as an indication that additional funding is unnecessary
• There may be a perception that the organisation isn’t delivering services to the fullest extent
• Both current and future funding opportunities could be jeopardised

The core issue is that excessive reserves without clear justification contradict the fundamental requirement of operating as a not-for-profit: actively using resources to achieve charitable objectives.

Jeopardising Your NFP’s Tax-Exempt Status

Sustaining high cash reserves creates legal risks that could put your organisation’s income tax exemption in jeopardy. While Australian not-for-profits can accumulate income and generate a surplus, there are important restrictions to consider:

• Accumulation must have an identified purpose aligned with the charity’s objectives
• Under Division 50 of the Income Tax Assessment Act 1997 (Cth), a not-for-profit must apply its assets solely toward achieving its stated objects
• Every charity must demonstrate how retaining cash reserves directly connects to furthering its mission and purpose

Failure to establish this connection between reserves and charitable purpose could threaten the organisation’s tax-exempt status, creating significant financial and operational consequences.

The Australian Charities and NFPs Commission’s Stance on an Appropriate Level of Reserves

Why the Australian Charities and Not-for-profits Commission Does Not Set a Specific Level

The ACNC does not mandate a single, specific level of reserves that is appropriate for every not-for-profit organisation. This approach acknowledges that all charities are different, with unique characteristics that influence their financial stability and sustainability, including:

• Financial positions
• Operational needs
• Risk profiles

The appropriate level of charity reserves is unique to each organisation and depends entirely on its individual circumstances. Indeed, a one-size-fits-all rule would be impractical, as each charity must assess its own situation to determine what constitutes a suitable financial cushion.

The Expectation to Use Funds for Charitable Purposes

While the ACNC avoids setting a specific figure for reserves, it is clear about its core expectation: a charity must use its funds to pursue its charitable purposes. It is generally considered good practice for a charity to make a surplus, as this is important for:

• Financial viability
• Building a reserve for future expenses

However, a not-for-profit cannot accumulate funds indefinitely, as this would not be seen as actively furthering its mission. Any surplus or profit a charity generates must be used to advance its objectives rather than being stockpiled without a clear and justifiable purpose.

How to Determine an Appropriate Level of Reserves for Your Organisation

Key Factors & Risks for Your Charity to Consider

To establish an appropriate level of reserves, your charity’s Responsible People must conduct a thorough analysis of the organisation’s specific situation and the risks it faces. This review should cover all aspects of the not-for-profit, including its operations, governance, funding, and external environment.

Key questions and factors to consider include:

Factor / Risk Area	Key Considerations
Liabilities and Entitlements	Assess all current and future liabilities, such as staff entitlements for leave, long-term rental leases, and any potential charity and NFP disputes not covered by insurance.
Funding Stability	Consider potential changes in the funding landscape that could affect income streams, such as the loss of a major donor or the non-renewal of a government grant.
External Trends and Events	Evaluate how external factors might impact your charity, including shifts in public willingness to donate, the financial effect of losing volunteers, or sudden increases in demand for services due to events like natural disasters.
Operational and Capital Needs	Identify any upcoming costs for repairs, maintenance, or upgrades to essential assets like property, IT systems, and equipment.
Compliance and Legal Issues	Address any current or potential compliance matters or legal claims that could create unexpected financial burdens for the organisation.

Aligning Reserves with Your Organisation’s Strategic Plan & Risk Appetite

A charity’s reserves policy should not be a standalone document; it must be directly linked to the organisation’s broader strategic plan and risk management strategy. This ensures that the level of reserves is purposefully aligned with the not-for-profit’s long-term goals and operational realities.

The board’s risk appetite is a critical factor in determining what constitutes a sufficient level of liquid assets. An organisation with infrequent or unpredictable income streams may have a lower risk appetite, necessitating a higher level of cash reserves to ensure it remains solvent and can cover liabilities as they fall due.

The policy should clearly articulate the level of financial coverage the board deems necessary to maintain financial stability and sustainability.

The Importance of a Clear & Justifiable Reserves Policy

Key Elements Your Charity’s Reserves Policy Must Include

A well-documented reserves policy provides essential guidance for your not-for-profit organisation and justifies its financial decisions to stakeholders. Your charity’s policy should be comprehensive, outlining the purpose, management, and review process for its cash reserves.

According to ACNC guidance, a robust reserves policy should include several key elements:

Policy Element	Required Content / Description
The Rationale for Reserves	Clearly state why it is important for your charity to hold reserves, linking them to financial stability and sustainability.
Target Level of Reserves	Define an appropriate level of reserves for your organisation, which should be reviewed and updated periodically to reflect current needs.
Method for Determining Reserves	Explain the formula or range of formulas used to calculate the appropriate level of reserves.
Strategy for Building Reserves	Outline the plan for accumulating funds to reach the target level of charity reserves.
Process for Review	Detail the procedure for regularly reviewing the level of reserves to ensure it remains suitable for the organisation’s circumstances.
Authority and Use	Specify who within the charity has the authority to determine and use reserves and the criteria for spending them.
Reporting and Monitoring	Describe the requirements for reporting on and monitoring the reserves, including how they will be identified in accounts and budgets.
Communication Strategy	Include a plan for explaining the charity’s reserves policy and its justification to the public and other stakeholders.

Communicating Your Reserves Policy to Stakeholders

Once your not-for-profit has established its reserves policy, it is crucial to communicate it effectively to all internal and external stakeholders. This transparency helps build trust and confidence by providing a clear understanding of the organisation’s financial strategy and governance.

A clear explanation of your charity reserves prevents stakeholders, including donors, funders, and regulators, from misinterpreting your financial position. By contextualising your cash reserves, you can demonstrate that the organisation is well-managed and that its financial decisions are aligned with achieving its charitable purpose over the long term.

Conclusion

Holding the right amount of charity reserves is a critical governance challenge, as having too much can damage public trust and attract regulatory scrutiny, while having too little threatens financial stability and sustainability. The key to navigating this is not a magic number but a strategic and well-documented reserves policy that aligns with your not-for-profit’s specific purpose, risks, and long-term goals.

If your not-for-profit needs guidance on developing a robust and justifiable reserves policy, contact the experts at our not-for-profit law firm, LawBridge, today. Our specialised legal services can help you navigate ACNC expectations and ensure your organisation’s financial governance supports its long-term mission and sustainability.

Frequently Asked Questions