Charity finances: Securing the future
If the charity sector is to be rebuilt, it needs a sound financial foundation, with an appropriate reserves policy and effective management and control, writes Sean Rodwell
It is fair to say that charities have had something of a turbulent time recently. Public confidence in the charitable sector is at a low following the fundraising scandal and the fallout from the failure of Kids Company. Now that the dust has settled and the regulators have had a chance to respond to these high-profile cases, it's over to the charities themselves to begin to repair the damage
and restore public faith.
The Charity Commission released updated finance guidance in January, with an emphasis on trustees taking responsibility for the finances of their charity. This doesn't mean that trustees have to involve themselves in the day-to-day finance duties; rather, they should have a more active role in the monitoring process. The guidance hasn't been designed to create more work for trustees, but is intended to support them in their role and improve their understanding of charity finances. It also stresses that the finances are the responsibility of all trustees, not just those on the audit, resources, or finance committee. One of the key points highlighted within the guidance is how trustees should set and monitor their charity's reserves policy. This is specifically dealt with in the 'Charity reserves: Building resilience' (CC19) guidance.
The reserves policy gives trustees an opportunity to demonstrate that they have considered the future financial needs of their charity and how these needs can be met. Typically, in the past, reserves policies have included a bland statement expressing how trustees aim for the charity to hold a number of months' worth of expenditure in reserves, followed by a statement on whether this has been achieved or not. This was the case with Kids Company, where the accounts regularly reported that reserves were below the desired level. While it is essential for trustees to establish an appropriate level of reserves, it is more important to consider what is being done when reserves aren't at this level.
The latest charities statement of recommended practice requires trustees not only to compare the amount of reserves with the charity's reserves policy, but also to explain what they are doing to bring the level of reserves in line with the amount set out in the policy. This doesn't simply cover the situation when reserves are below the desired level; it also applies where the charity is holding more reserves than its stated policy. As trustees of a charity, you may know the exact reasons for holding a certain level of reserves, but external users of the accounts will only know these reasons if they are communicated effectively in your reserves policy. With charity accounts coming under greater scrutiny, this is of increasing importance.
Trustees must first understand what comprises their reserves, since generally they aren't the same as the charity's funds. The Charity Commission guidance defines a charity's reserves as 'the part of a charity's unrestricted funds that is freely available to spend on any of the charity's purposes'. It also permits charities to exclude tangible fixed assets, programme-related investments, and designated funds from this figure when calculating reserves.
Trustees must consider the frequency with which they review the charity's reserves and if this is appropriate for the effective management of the charity. It shouldn't only be a year-end procedure - it should be an ongoing process throughout the year to ensure that reserves are sufficient. If at any point during the year the level of reserves falls below the amount stated in the policy, the trustees should act quickly to assess the cause of this. They should also consider whether it is simply a short-term problem or a more serious long-term issue. Such regular monitoring is an important part of the financial management of the charity, which is an important part of the trustees' responsibilities.
The Charity Commission has also updated its guidance on 'Managing a charity's finances: Planning, managing difficulties and insolvency' (CC12). This provides direction on what is expected of trustees when dealing with the charity's finances. All trustees should be aware of their legal duties and a fundamental part of fulfilling these duties is to safeguard the charity's finances. Trustees are expected to act in the interests of their charity and its beneficiaries, to protect and safeguard the assets of their charity, and to act with reasonable care and skill.
Since trustees are not involved in the day-to-day running of the charity, this can be a difficult task, particularly as they are often relying upon financial information provided to them by staff within the charity. Despite this, there are a number of processes that trustees can put in place to promote effective financial management.
The budgeting process should be a fundamental part of the management of the charity's finances. Since charities are run on limited resources, budgeting and forecasting form an essential part of deciding whether the delivery of services is affordable. When preparing budgets, it is important to ensure that they are realistic and achievable. They should be based on expectations, using previous experience and knowledge of the sector. Budgets should not simply be last year's figures plus a few per cent for inflation: they should challenge the charity to become more efficient and more effective at delivering results.
While a budget is usually set and approved before or at the start of a financial year, this is not the end of the budgeting process. The budget is a working document. It should be continually compared to actual figures throughout the year and, where appropriate, updated for any new information or changes in assumptions to ensure meaningful comparisons. The reasons for variances between actual and budgeted figures should be investigated in a timely way and, if necessary, appropriate actions taken.
Charities often fail due to a lack of cash-flow forecasting. While budgets are likely to be prepared on an accruals basis, this doesn't take into account the cash resources required to meet future plans. For example, a charity may budget for the provision of a new service, which if delivered will produce an increase in income and a healthy surplus, but first the charity must consider if there is sufficient cash available to fund any start-up costs, such as training and equipment. There may also be projects that the charity undertakes where funding is received in arrears, so cash-flow forecasting will be critical for identifying any shortfalls in cash. Payment-by-results contracts are a typical example of such projects.
Much like any other business, it is fundamental that charities are run with robust financial procedures and systems to assist in the prevention and detection of fraud. Effective financial systems can also help to promote efficiencies throughout an organisation by encouraging consistent practices. While a significant proportion of charities are subject to a statutory audit, this process isn't the most effective at detecting financial mismanagement since testing is often done on a sample basis. While external audits may provide trustees with a number of recommendations to improve the charity's systems and controls, this is only effective if they are actually implemented. As the audit is generally an annual process, it can take a year before the auditor determines whether this has been done or not.
A financial control that is often overlooked is the internal audit function. It is a common perception that most charities are too small to warrant an internal audit, but it does not have to be a complex or expensive arrangement. Academy schools are required, along with the statutory audit, to have a process in place for the independent checking of financial controls, systems, transactions, and risks. This has often been achieved through the work of an internal audit service, either in-house or bought-in, with quarterly reports submitted to the board.
A charity may have a trustee or volunteer with sufficient financial expertise who would be willing to perform monthly or quarterly checks in accordance with instructions received from the trustees. As well as helping to identify internal control weaknesses, such checks also act as a deterrent to internal fraud and can allow a charity to address any issues as they arise, rather than shutting the stable door after the horse has bolted.
Charities' finances continue to come under increasing pressure, with many charities relying upon single funding streams. Despite this, charities will be used more than ever to provide services that the public sector can no longer afford to deliver. Clearly, these services can only be delivered if supported by a sound financial foundation - a foundation that all charities and their trustees must ensure is in place if the charity sector is to be rebuilt. SJ
Sean Rodwell is a senior auditor at Kreston Reeves