A recent survey of the Charity commission in negative balance sheets found that 10 percent of the charities they examined were in real financial difficulty. Holding financial reserves has traditionally been seen as a way to manage this risk; but the evidence shows that it doesn’t work for many charities.
In 2012, I helped the Charitable fundraising group produce a short publication entitled Beyond reservations, which examined the levels of reserves held by charities and the policies they had in place to manage them. We found that many charities agreed that there were better alternatives than keeping as much as possible on reserve. Charities need a financial strategy that incorporates risk management and addresses pricing, cash flow, return on investment, and maximizing returns on all assets.
Determine the objectives of your activities
The first step towards establishing a financial strategy is to determine the purpose of each activity carried out by the association and whether its financial objective is to:
a) Make a profit (for example, a fundraising event or a social enterprise created by the charity)
b) Break-even point (e.g. projects funded by earmarked grants)
c) Funding (important activities that achieve the goals of the charity, but which must be funded by discretionary spending from donations or reserves)
This will make it possible to determine attitudes towards risk, a pricing policy and the level of investment suited to the various activities.
Know your business model
It’s also important for organizations to have a good understanding of their current business model – in other words, how the demand for services and their funding fit together.
A charity’s strategic plan is likely based on assumptions about the needs of recipients and how services are funded. However, the priorities of the association’s stakeholders may change depending on the economic environment.
If a service is considered “icing on the cake” it can be removed from the menu as funding is prioritized for essential services. Alternatively, the needs of beneficiaries may increase; charities might therefore need to find creative ways to meet them.
Reassessing the business model will help organizations develop an appropriate pricing policy and decide on the financial goal of each of their activities.
Invest in new activities
There is a lot of interest in creating new social enterprises, but these can often take longer than expected to break even; and there may be strong competition, which makes it more difficult to obtain the desired prices.
New activities require investment. Staff need to spend time developing a new department and building new relationships; and funding may be provided in arrears or depending on results. For each new activity, a clear business plan is necessary to show the profitability of the first years as well as the cash flow profile.
Plan a range of different sources of income
Having a number of different activities with different goals and financial profiles helps manage risk, but the balance has to be right. New activities should be started at different times. The majority of business failures are the result of cash flow problems due to excessive transactions; It is therefore very important to pace the change and to ensure that the change is funded.
Take stock of your assets
Charities often have a traditional view of assets as bricks and mortar, but they can sit on other potential sources of income. You may have developed a unique approach to handling a particular issue or group of clients, but you need to think about how to convert that into a funding stream for your work.
This may include investing in an external evaluation to validate the proposed approach, or hiring help to develop a brand and promotional material such as a website. You can also think about protecting your intellectual property, but to do this you may need to put your process in writing.
It is always important to consider bricks and mortar, as buildings are often underused. With better technology, the need for ownership can be reduced, especially with good connectivity and flexible working. For meetings, buildings can be shared so that organizations pay only for what they need.
Test your new strategy
One way to test the robustness of financial plans and forecasts is to consider the level of uncertainty inherent in them. It also helps charities identify potential trigger points and when action may be needed.
What is the relationship between income and expenses? What are the main drivers? Consideration should also be given to the impact that changes in the external environment could have on costs and revenues.
Different types of income will require slightly different forecasting techniques, but it should be possible to group income into categories: confirmed, probable, possible, and uncertain. Once the format is established, the degree of certainty can be changed to test the impact on income. This can help organizations establish critical points to watch for as early warning signs.
Once a framework for preparing different versions of your financial plans is in place, it can be used to examine different scenarios and consider the consequences. For example, several versions of the budget can be prepared to show the impact of reduced activity levels, reduced income levels, or stopping certain activities.
Establish a strategy for reserves
Having managed risk in other ways, the charities we studied in Beyond reservations found that they did not need high levels of reserves. Working capital is needed, as well as financing for development and investment, but many unspecified risks are now managed through the financial strategy.
Kate Sayer is a partner of the accounting firm Sayer Vincent