Introduction
For any not-for-profit (NFP) organisation, managing charity reserves is a vital component of good governance, playing a critical role in ensuring long-term financial stability and sustainability. Despite their importance, a common myth that charities should not hold money in reserve can hinder responsible financial management and jeopardise an organisation’s future.
The responsibility for overseeing this charity money falls to the board and committee members, who are required under ACNC Governance Standard 5 to manage the charity’s financial affairs with care and diligence. This guide provides essential information for those operating as an NFP, outlining the fundamentals of building and managing reserves to secure your organisation’s mission and uphold the principles of governance for good.
Understanding ACNC Charity Reserves & Their Importance
Defining Charity Reserves for Your Not-for-Profit Organisation
For any NFP organisation, charity reserves are the funds set aside to cover unexpected costs. These reserves serve as a:
- ‘Rainy day’ fund
- Financial ‘cushion’ that helps navigate sudden financial challenges
In a technical accounting sense, these are commonly called ‘operating reserves’.
A charity can and often should make a profit, which is also known as a surplus. However, any surplus must be used to further the charity’s purposes, and building reserves is a key way to ensure the long-term financial stability and sustainability of the organisation.
It is important to distinguish operating reserves from other assets and funds that are not available for discretionary use. The following items are generally not considered part of a charity’s reserves:
| Item Not Considered a Reserve | Description |
|---|---|
| Tangible assets | Physical items like land, buildings, and equipment that are used to deliver the charity’s services. |
| Restricted funds | Funds donated or raised for a specific purpose, as specified by a donor or a particular fundraising appeal, which cannot be used for general operational costs. |
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The Role of Reserves in Financial Stability & Sustainability
Charity reserves play a critical role in the overall financial management and long-term health of an NFP organisation. Maintaining an appropriate level of reserves is a sign of good governance and responsible financial management, allowing your charity to continue its work even when faced with unforeseen events.
By having a healthy level of reserves, your charity can better manage risks and meet its commitments. This financial cushion helps to ensure the organisation can continue to deliver its services without interruption.
Furthermore, maintaining adequate reserves can significantly benefit your charity by:
| Benefit of Adequate Reserves | Explanation |
|---|---|
| Attracting funding | Many funders and grant-makers view a level of reserves favourably, as it indicates the charity is well-managed and sustainable. |
| Providing assurance | Reserves offer confidence to lenders, members, and other stakeholders that the organisation is financially stable and capable of meeting its obligations. |
| Building public trust | A well-managed financial position, including reserves, can enhance public trust and confidence in your charity’s efficiency and capability. |
The Responsibility of Your Board & Committee Members for Charity Money
The Duties of Board Members Under ACNC Governance Standard 5
A charity’s board and committee members, referred to as ‘Responsible People,’ are collectively responsible for the organisation’s financial health, which includes the strategic management of charity reserves. This responsibility is embedded within their legal obligations under ACNC Governance Standard 5, which requires them to act in the best interests of the charity and its purpose.
While Governance Standard 5 outlines several duties, the management of reserves is directly tied to specific obligations. These include:
| Duty under Governance Standard 5 | Description of Responsibility |
|---|---|
| Acting with reasonable care and diligence | This compels board members to proactively analyse financial risks and determine an appropriate level of reserves to ensure the organisation’s stability and sustainability. |
| Ensuring financial affairs are managed responsibly | This involves creating a clear strategy for building, holding, and using charity reserves to support the NFP mission, going beyond simple bookkeeping. |
Therefore, overseeing the charity’s reserves is not merely a financial task but a core governance duty. It requires board and committee members to provide prudent oversight to safeguard the organisation’s future.
Ensuring Responsible Financial Management & Preventing Insolvency
A crucial duty for a charity’s Responsible People is to ensure the organisation does not operate while it is insolvent, meaning it must always be able to pay its debts as they fall due. Charity reserves serve as a primary tool for fulfilling this legal requirement, acting as a financial safety net for the organisation.
Effectively managed reserves help prevent insolvency by providing the funds needed to navigate unexpected financial challenges. By maintaining an adequate level of reserves, a board ensures the charity can:
- Withstand sudden funding cuts or a decline in donations.
- Cover significant unplanned costs, such as emergency repairs or legal fees.
- Continue delivering services during periods of disruption or increased demand.
The process of determining and managing reserves is a direct expression of responsible financial stewardship. It demonstrates that the board is actively protecting the charity’s assets and ensuring its long-term capacity to operate effectively and achieve its charitable purpose.
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How Your Organisation Can Determine an Appropriate Level of Reserves
Balancing the Risks of High & Low Charity Reserves
Determining the right level of charity reserves requires finding a balance, as both extremes can create problems for NFP organisations.
A low level of reserves puts a charity’s operations at significant risk. When unexpected costs arise, the organisation may struggle to respond effectively, which can:
- Negatively impact staff morale
- Raise concerns about job security
- Increase the risk of insolvency if debts cannot be paid
Conversely, accumulating excessive reserves without clear justification can be equally problematic. This approach may:
- Attract negative attention from the public, funders, and regulators like the ACNC
- Raise concerns that charitable assets aren’t being actively used to pursue the organisation’s purpose
- Create compliance issues, as charities cannot indefinitely accumulate funds
A Process for Your Committee to Analyse Risks & Set Reserve Levels
There is no universal reserve level appropriate for all charities; each organisation must assess its own unique situation. To determine suitable reserves, your board and committee members should conduct a thorough analysis of risks across all operational, governance, and environmental aspects.
This comprehensive process helps ensure the long-term sustainability of your organisation. When conducting this analysis, your committee should consider several key questions:
| Risk Area for Analysis | Key Question for the Committee |
|---|---|
| Liabilities | What are the charity’s current and future liabilities? |
| Staff Entitlements | What existing and potential staff entitlements, such as leave or redundancy pay, need to be accounted for? |
| Funding Stability | Are there potential changes in the funding or political landscape that could impact income streams? |
| External Trends | What external trends might affect the public’s willingness to donate time or money to your charity? |
| Unexpected Events | Could external events, such as a natural disaster, suddenly increase demand for your charity’s services? |
| Compliance | Are there any current or potential compliance issues that need to be addressed? |
| Legal Risks | Are there any potential legal claims that might not be covered by existing insurance policies? |
| Infrastructure Needs | What upcoming repairs or upgrades are needed for property, equipment, or IT systems? |
Creating a Reserves Policy for Good Governance
Essential Elements to Include in Your Charity’s Reserves Policy
To ensure good governance and responsible financial management, your NFP organisation’s board and committee members should develop and implement a formal reserves policy. This policy provides clear guidance and rules, ensuring that charity reserves are managed properly and used for their intended purposes, which contributes to the long-term stability and sustainability of the organisation.
A comprehensive reserves policy should outline the following key components:
| Policy Element | Description / Requirement |
|---|---|
| The purpose of reserves | Explain why it is important for your specific charity to hold reserves, linking them to your mission and financial stability. |
| The target level of reserves | Define an appropriate level of reserves for your organisation, to be reviewed and updated periodically. |
| The calculation method | Provide a clear explanation for how the target level is determined (e.g., formula or risk-based calculations). |
| A strategy for building reserves | Detail the plan for accumulating funds to reach the target level of charity money. |
| A process for review | Establish a schedule and procedure for regularly reviewing the level of reserves to ensure it remains appropriate. |
| Authority for use | Specify who within the charity has the authority to make decisions about determining and using reserves. |
| Reporting and monitoring | Outline requirements for reporting on and monitoring reserves, including how they are identified in accounts and budgets. |
| Criteria for spending | Define the specific criteria under which spending from the reserves will be considered and approved. |
| A communication strategy | Detail how your organisation will explain its reserves policy and current reserve levels to stakeholders. |
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Communicating Your Reserves Policy to Funders & the Public
Transparency is crucial for maintaining public trust and confidence in your charity. Your organisation should be prepared to clearly explain its approach to charity reserves to the public, regulators like the ACNC, and potential funders. This communication helps justify your financial position and demonstrates responsible governance.
It is important to be able to provide a clear rationale for the level of reserves your charity holds, especially if the amount is significant. This justification should be readily available and included in your charity’s financial statements. By making an effort to explain why you need reserves and the reasons behind your decisions, you reinforce your organisation’s commitment to its charitable purpose and its long-term sustainability.
Conclusion
Managing charity reserves is a crucial component of good governance, ensuring the long-term financial stability and sustainability of any NFP organisation. By understanding their responsibilities under ACNC Governance Standard 5 and implementing a clear reserves policy, board and committee members can safeguard their charity’s mission and operate with confidence.
For tailored charity and not-for-profit guidance on establishing strong governance frameworks and managing your charity money effectively, contact the experts at LawBridge. Our specialised NFP legal services can help your organisation navigate its obligations and secure its future today.
