Charity Reserves Research: Does the quality of reserves reporting in the charity sector need to change?

Charities are supposed to explain their reserves’ position in their annual report. But do they? And do they do it accurately? We looked to find out in our fourth survey of the largest charities in England and Wales.

Digging into the detail

Paragraph 1.48 of the Charities SORP states that a larger charity should explain in its annual report the policy it has for holding reserves, the amounts of those reserves, and why they are held (if at all). Reserves policies are therefore intended to tell the reader more about a charity’s needs and stewardship.

We looked at the top 50 charities in England and Wales, excluding universities, by expenditure, as listed on information listed on the Charity Commission’s website. However, for most purposes we have left Wellcome and the Children’s Investment Fund Foundation out of the analysis as they are too large and distorting. According to their own accounts, the unrestricted funds of the remainder amounted to £6,137m, or just under nine months of unrestricted expenditure. Within this, the range extended from minus 13.7 weeks to 313 weeks, or six years.

However, simply looking at total funds, or even total unrestricted funds, is a poor indicator of the actual wealth or needs of an organisation. That is why exercises solely based on Commission data sets can be misleading. The rationale for holding funds is explained in the annual report in many ways, and this needs more detailed reading if the financial position is to be properly understood.

So, in this research we dug into the detail of those policies to try to assess whether they were doing their job - informing the reader of the real needs and resources, and how they are managed.

How did charities do against the three key requirements?

We concentrated on what is colloquially known as the “free reserve”, though this is not a term used in either the SORP or CC19, which instead effectively defines it by describing everything that it isn’t. As a result, the definition of free reserve is somewhat problematic.

For instance, the SORP and CC19 appear to give contradictory advice on whether or not mortgages should be deducted from reserve calculations, some charities set up designated funds for operational fixed assets and some do not, some separately identify revaluation reserves and fair value reserves, and charities often treat pensions deficits differently.

Notwithstanding those problems, the SORP’s requirements can be boiled down into three simple elements:

• What have you got? (ie state the amount of reserves the charity holds at the end of the reporting period).
• How much do you want? (ie compare the amount of reserves with the charity’s reserves policy).
• What will you do about the difference? (ie explain where relevant what steps the charity is taking to bring the amount of reserves into line).

We reviewed the top 50 to see how they did against these requirements. The results are set out in figure one.

1.What have you got?

Six charities did not explicitly state what they held in reserve, and a couple used terminology that was unclear. Even where a charity was apparently compliant, it was often difficult to see where the numbers came from. This was sometimes because of inconsistent figures, sometimes because the charity itself had an unusual structure, and sometimes because the charity was using its own descriptions of fund components that made it difficult to be sure of a correct interpretation.

There is no reason why the figure disclosed in the annual report should not be readily identifiable from the funds analysis notes – anything else is just confusing.

2.How much do you want?

Where it was difficult to tell, both cases related to investment portfolios and the treatments of gains. Sadly, 18% simply did not disclose a target, whether in numbers or in proportions of annual expenditure. Within this category, some discussed it in such vague terms as to be virtually useless: one charity said they would consider a target in future, while another assured readers that it was above its target without telling them what that target was.

It would appear that a significant minority of charities regard this disclosure as optional. It would be surprising if organisations of this size are not undertaking reasonably sophisticated business planning, and so this figure must be available and would be useful to the reader.

Seven charities expressed their targets in terms of weeks or months of expenditure. The rest used absolute figures. Where a time-based target is used it is always more difficult to interpret since it can relate to differing measures of expenditure variously described as “operational”, “unrestricted” and so on. Whether using a time basis or a financial measure, some charities only expressed a minimum target: the SORP does not express itself in that way, since being over-funded is as much an issue as having too little.

We reworked the targets into absolute figures, and took mid-range figures where a range was provided. On that basis, the average number of weeks of target free reserves was 17, say four months, with a wide range from two to 50. Such a range is not unexpected. It may be reality-based on the operational characteristics of the charity, or it may simply be a factor of how a charity presents its other funds, especially designations. We comment on these later.

3.What will you do about the difference?

Included in the compliant category above are those charities whose reserves are on target and therefore have nothing to disclose.

Most of the “difficult to say category” consists of charities making rather generic statements such as “the trustees are thinking about it”. Some readers may consider these are simply non-compliant. If so, then the majority of these largest charities are not telling their stakeholders what they intend to do with their surplus funds other than more generic statements such as holding them in case future risks materialise, or how to address a shortfall.

It is difficult, or impossible, to calculate the value of these funds with no plan attached to them due to the inconsistencies applied to the methodologies between the charities. However, their unrestricted funds which are otherwise undesignated amounted to £1.1m, which seems to be a lot of money with no clear plan attached.

Why are designated funds held?

The free reserve calculation excludes fixed assets (any fund that can only be realised by disposing of tangible fixed assets or programme-related investments) and designated funds (“which the charity considers to be a commitment of the reserves they hold”). This again is a fraught area.

Many charities treat functional assets as a designated fund, whereas others simply analyse it as part of the funds. Having said that, and without commenting on the correctness of the presentation in the reports themselves, out of £6,137m unrestricted funds, £2,927m is presented as tied up in some way (see figure two).

It is not possible to take the above analysis further without detailed work, but it demonstrates obvious difficulties. The requirement for a revaluation reserve obscures the value of the fixed asset reserve. Some fixed asset reserves include funds for future capital purchases and others don’t. Funds broadly described as held for operating or contingency purposes (our words) would suggest that the balance of free reserves should be targeted at zero – but this was not the case.

The Companies Act equity reserves are a requirement of that legislation relating to share capital. There is an inconsistency between charities operating a defined benefit pension scheme, and those who are required to reflect obligations to staff or even beneficiaries, as ordinary liabilities are absorbed within the unrestricted funds.

Assuming the revaluation reserves relate to fixed assets, it appears that just under half of charities’ designated funds are tied up in fixed assets (£1,358m representing 46%).

How accurate are the numbers?

In this analysis we have used the figures given by the charities. We then reworked them from the annual report, following the detail of the SORP requirements. As a result, we identified that in 36 cases the charities were using their own methodologies to arrive at their reported reserves, instead of following the SORP, resulting in substantial over and under statements of the “free reserve”. This is set out in figure three.

Some of these differences are fairly trivial and may be the result of composite roundings. For the others, it is sometimes possible to identify why these differences arise, though the quantification becomes increasingly judgemental. We concluded that the major differences arose from the treatment of fixed assets, treatment of subsidiaries, and either reserve numbers based on home-made liquidity measures and/or use of non-specific designated funds.

Conclusion

It is at least pleasing that all the charities we looked at included consideration of their reserves in their annual report. It is, however, deeply concerning that the detailed compliance with this important requirement is apparently treated as optional by boards and arguably is not being challenged strongly enough by auditors.

This is an area the next SORP could easily address without creating extra work for anyone. At present, the SORP’s requirements for larger charities are a “should” and not a “must”. Charities should be mandated to explain their own financial position within the prescribed framework, rather than change the prescribed framework to suit their own circumstances. Only then will we have more clarity on the sector’s reserves.

Please get in touch if you would like to discuss our charity reserves review or any aspect of your own charity’s reserves.

This article was first published in Charity Finance Magazine, July 2023