• Contingency Fund - getting it right with financial reserves

Contingency Fund - getting it right with financial reserves

03 October 2016

For not-for-profit organisations, balancing the need to have enough money in reserve as a contingency with being able to achieve their mission can be a tricky business.

But, it’s a critical thing to get right given the different forces at play in the current market: low interest rates, highly competitive funding, financial reporting regulations to name a few…

At a practical level, once in place, this contingency of ‘financial reserves’ can help an organisation weather unexpected financial crises such as loss of income; meet capital costs as required; cope with a tax audit, make investment decisions … the reasons are numerous.

And critically, funders and donors want to see that a charity has enough money set aside to be financially robust whilst not sitting on unspent cash without good reason.

As an accountant with a special interest in the not-for-profit sector and as the chair of my children’s school board of trustees, I’m often fielding questions around how to get it right, some from organisations with nothing set aside, whilst others might be sitting on a few million.

To get a better grasp of sector knowledge and views on financial reserves BDO ran a short online survey which received an impressive 470 responses.

We found that around half of the respondents were not aware of an organisational financial reserves policy being in place – which shows there’s plenty of room for improvement.  

Pleasingly, 94% of respondents were receiving regular reporting on their organisation’s financial performance and position, linking to the fact that nearly 75% had a clear understanding of how their reserves would be utilised in the future. That’s good news.

However, when it comes to getting the balance of funds in reserve right - most respondents felt their reserves were insufficient, with only 3% saying they had too much in reserve and 4% saying they didn’t know.

This all highlights the critical need a for robust approach to financial reserves policy and planning - especially for those organisations with volatile income streams - which is the case for most in our survey. Only 30% of respondents had a stable revenue stream with the remaining 70% a mix of volatile to moderately volatile revenue.

Why does that matter? Organisations with stable income have greater planning certainty, which in turn supports financial reserves planning and policy. Whereas those with a lumpy income will struggle to build the necessary significant contingency reserves to cover down-turns in future revenue, while still providing enough for their day-to-day community outputs.

So what does this all mean for NFPs?

The overarching message is that most NFPs struggle to fully manage their financial reserves - balancing the need for a sufficient contingency fund with achieving the organisation’s mission. 

It’s critical to do that for the reasons outlined already, but also a financial reserves policy provides wider benefits as a framework for internal decision-making and externally, as a point of reference to support funding applications and donor appeals.

How do you get it right?

As a flow on from the survey we held focus groups in Wellington and the Waikato with key stakeholders in the sector, delving into the specific issues NFPs face and the different ways to address them.

We came up with a comprehensive set of advice covering key areas: cash reserves versus net asset reserves, setting minimum and target reserve levels and developing and implementing a financial reserves policy through to monitoring of and reporting on key criteria. These are all outlined in the white paper, along with illustrative case studies.

Telling a convincing story

Perhaps the most compelling piece of advice beyond the technicalities of financial reserves planning and management, is convincing your funders that you’ve got it right.

That means learning how tell a convincing, transparent story about the work your organisation does to your funders, donors, and other stakeholders. So it’s about linking financial data with the non-financial measures to tell that story.

Certainly, reserves are a key part of the financial data, but when viewed in isolation they do not convey the wider story, the organisational narrative that is so central to everything it stands for.

However, when read alongside the non-financial metrics of an organisation, a convincing and coherent narrative can emerge. 

Some of the questions that could be asked during this linking process include:

•             Does the reserves story you are currently telling grab the imagination? 

•             Is it inspiring, while being strategic?

•             If you were a funder/donor, would you give money if you were presented with that story?

A visual narrative within the annual report, such as a reserves thermometer, could be one way to graphically display this information.  Personalised stories about the impact of a particular project could also be incorporated.

And, board members should have a good understanding of the policy and be able to tell the story of why the funds are there or being built up.

Ultimately, whilst financial reserves may be something that sits in the background for many NFP organisations, the reality is that it serves not only as a contingency, but a properly formed policy can play a core role in the sustainable operations of an organisation.

About the author: Justin Martin is a Chartered Accountant and Senior Manager with BDO Wellington.

For more information, please contact your local BDO adviser.