Which charities are too rich?

In this article, I set out some rules for determining whether a charity is too rich. If you would like to see a list of charities which are too rich according to these rules, we could scour through our databases and the Charity Commission data and we could create such a list. If you would like to see this, email me.

In the meantime, here are the guidelines you should follow if you want to assess this yourself for a specific charity:

• (1) Find out the amount of reserves held by the charity; this is roughly the same as how much cash it has sitting in the bank. Read more below to find out practically how to do this.
• (2) Compare it to the amount of expenditure. Read more below to find out practically how to do this.
• (3) If its reserves are more than 1.5x the annual spend, it's probably too rich; if it's more than 3x the annual spend, it's almost certainly too rich. For most charities, the reserves will be less than the annual spend. Read more below to better understand the rationale, and the circumstances under which this conclusion might be questionable

Note that this approach is written without taking permanent endowments into account.

(1) Find out the amount of reserves held by the charity

A charity's reserves are (more or less) the amount of cash it has sitting "in the bank" as rainy-day money, to (for example) help out with liquidity issues or unexpected costs. Holding some reserves is good financial management. Holding huge amounts probably means they are too rich.

To find out how much a charity is holding in reserves:-
- first download their accounts (instructions for how to do this in the appendices below)
- go to the balance sheet (you can find this usually by doing a search for the words "balance sheet", or alternatively scroll down about halfway through the document -- it will probably be lurking just after the statement of financial activities
- the balance will typically include a section which shows how much restricted and unrestricted funds/reserves the charity holds (it will sometimes also include a line for how much "designated" funds it holds)
- the amount of unrestricted funds is the number you are after

Alternatively, you could just ask them!

One more thing to bear in mind is that if the charity has plenty of money, but they have plans to spend some of that, then accounting guidelines indicate that they should treat those funds as "designated", not "unrestricted". Important caveat! It is not unknown for a charity to have spending plans for its funds but to still not designate. If that's the case, then the charity's failure to account accurately for its funds will lead to it being harshly treated under this analysis.

(2) Compare it to the amount of expenditure

To work out whether the amount of reserves held is "too much", it doesn't make sense to just look at the absolute amount. A charity that normally spends £40,000 per year would be obscenely rich if had £400,000 sitting in the bank doing nothing, but a charity that normally spends £40 million a year is probably cutting it unwisely fine by just having £400,000 of reserves.

So we normalise by dividing the reserves by the amount the charity spends. Often charities will refer to their reserves targets as a multiple of the number of months of "operating expenditure" (which may not be the same thing as the total spend). There is no universally accepted/adopted definition of operating spend, so we at SoGive simply look at total spend. If the thing we're looking for is charities who are too rich, this is the more generous approach.

(3) If its reserves are more than 1.5x the annual spend, it's probably too rich

At what level do we decide that a charity's reserves are too high? This is not a straightforward question; after all a charity's board could argue that it is very averse to the risk of the charity going bankrupt, and this could explain the high reserves level.

To determine a suitable level, here are some considerations:
- peer review
- scenario planning
- risk factors

Peer review: when I look at the sector as a whole, I largely find that reserves typically are around 3 months' of expenditure (i.e. a quarter of the annual spend) or 6 months' of spend or sometimes around 1 year's worth. So the sectors norms are largely in line with the view that 1.5 years or above is high. And 3 years is very high. This logic has the disadvantage of herd mentality though (i.e. what if everyone is wrong about the correct level of reserves to hold?)

Scenario planning: imagine that the charity's funding all dried up suddenly (for most charities, there is some diversification in funding sources, so this is an unrealistically pessimistic scenario). Having enough money set aside that the charity could continue to fully function (without needing to tighten its belt at all) for a full year seems long enough that it should be possible for the charity to fund new funding sources.

Risk factors: Good financial management would suggest that charities should determine their reserve levels based on the risks they are exposed to. However my experience in the sector suggests that this is not often what actually happens. Typically instead a charity will determine its target reserve levels by looking at the amount of reserves it currently has and anchoring relative to that. However if a charity did decide to use a better approach to determine its reserves, here's a list of risk factors it could consider:

·         Contingent liabilities (e.g. redundancy)

·         Beneficiary needs

·         Variability of income / dedication of your funders

·         FX risk

·         DB Pension scheme

In case you want to know more about these, I quote at length below a passage which explains more about these risk factors (see appendices)


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APPENDICES


How to find a charity's accounts
This document is often findable by simply googling the name of the charity together with the word "accounts", but if that doesn't work, if it's a charity registered in England and Wales or Scotland follow these steps:

- Go the website of the regulator (apps.charitycommission.gov.uk/showcharity/registerofcharities/RegisterHomePage.aspx if it's registered in England and Wales or https://www.oscr.org.uk if it's registered in Scotland)
- search for the charity; you could search by name, but it normally works better to go to the charity's website, scroll down to the bottom, pick up the charity registration number, and then search for the registration number
- for an England & Wales registered charity: the menu on the left will usually include an item called "view accounts" which will normally have all the accounts, if the charity has income > £10,000 (sometimes it's right there on the landing page)
- for a Scottish registered charity: just scroll down the page and you will normally find a link


Risk factors when calibrating reserve levels

Below I quote at length from a document which I share with charities who are choosing their reserve levels. Although for charities rather than donors, it should give an indication of how to interpret each risk factor.

Contingent liabilities

This fancy language just means liabilities (i.e. a requirement on the charity to make payments) that arise in certain circumstances (or in certain contingencies). The contingency you’re most likely to be thinking of is the wind-up of the charity (try to think of any other contingencies you should be ready for too, although in my experience so far the wind-up of the charity has been the only one).

Try to consider the costs that might arise in the case of a wind-up of a charity. These may include:

-          Legal and accounting costs

-          Redundancy costs

-          Any leases (e.g. on the property or any office equipment) which can’t be terminated immediately

When setting your reserves policy you should do a review so that you know how much redundancy costs you would pay in the event of having to wind up the charity and see whether you have any leases on any equipment. I have never actually checked the costs of legal and accounting work in the event of a wind-up (perhaps I should have!) – I just guessed that if I allow around £5k, that should be enough.

Once you have determined how much these contingent liabilities are, you should calibrate your reserves policy thresholds accordingly. In my opinion, it makes sense to set the threshold between the green zone and the yellow zone to be at least as high as the amount of the contingent liabilities. One option is to express that threshold as (e.g.) 6 months’ expenditure and then check it includes enough funds for the charity to operate for 2 months or 3 months and still have enough money to fund the contingent liabilities. Alternatively, you could express that threshold as 3 months’ expenditure + contingent liabilities.

Beneficiary needs

For some types of charity, they may be providing services to beneficiaries in such a way that a sudden interruption to the work may be considered particularly bad, and this may make you particularly averse to the risk of having to close down the organisation.

Example: if your charity does counselling for vulnerable people, you may worry that prematurely ending a contact (e.g. because of the winding up of the organisation) could be quite damaging for a client. In this case, you might want to estimate the amount of time needed between the decision to wind down the organisation and the time when you can safely end the counselling relationship, and ensure that your reserves policy allows the charity to function for that time.

Variability of income / dedication of your funders

If an organisation has lower risk income sources, it can afford to hold less reserves. More volatile income would lead to more reserves being needed. To determine how volatile your income is, looking at how income has varied over recent years will help, but more important is to look at the structure of the current funding streams and how well positioned your organisation is to access new sources of income.

A linked question is who your funders are, and how dedicated they are to your organisation and your cause. Some organisations are fortunate enough to have a number of supporters who are big believers in their work and what they do – if these supporters are likely to step in to bail out your organisation if you were in trouble, you should be more inclined to set a lower target for your reserves policy.

FX risk / currency risk

Be aware of if you take currency risk. This could arise if, for example, your organisation is receiving a big grant from (say) the EU (postscript: this was written pre-Brexit) which is denominated in €, but your expenditure is in £. Or if you fundraise in £, but spend in Zambian Kwacha / Ghana Cedi / whatever.

Currencies are a notoriously volatile asset class, so holding some extra buffer is wise if you have currency risk.

DB pension scheme

Note that this item applies specifically for defined benefit pension schemes – those schemes where the employer takes on risk. If your pension scheme was set up within the last 20 years (e.g. if you have a pension scheme because of auto-enrolment) it is likely to be a DC (defined contribution) scheme, which means that the employer takes on no risk, so you don’t need to worry.

If your organisation has a DB pension scheme, you are essentially holding (probably risky) assets within the pension scheme in order to be able to pay pensions to people for many years in the future. Because this involves taking risk, it makes sense to hold more cash in reserves. This is actually somewhat debatable -- after all the scheme's actuaries should be ensuring that the scheme is adequately capitalised so as to not need recourse to the charity. However residual risks will remain. The size of the scheme relative to your organisation will be a factor to consider.