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Judging how much cash a charity should hold

Charities may have a range of sources of income, including investments in a portfolio, income from property, a government grant, and donations and legacies. Accumulated cash – which represents unspent past income – can be used to fund future expenditure – for example a major project or to permit services to continue when current income falls short of requirements.

But the question of how much cash to hold may not be as simple as it at first appears. Getting the answer right depends on good governance, a solid understanding of risk – and an awareness of the charity’s legal obligations.

Charity trustees have a legal duty to act in the charity’s best interests, manage the charity’s resources responsibly, and act with reasonable care and skill. According to the Charity Commission, trustees who act in breach of their legal duties can be held responsible for consequences that flow from such a breach and for any loss the charity incurs as a result. The Commission has the power to disqualify individuals from trusteeship if they feel this is warranted.

Taking stock of charities

To work out how much cash to hold, it is necessary to consider the charity’s operating expenses, any investment portfolio (particularly if it contains cash separately to that held as working capital), sources of income and the extent of future obligations. The right level of cash will depend on how the charity funds its activities. 

For example, a charity which receives rental payments from the properties it owns (houses, buildings, land, etc.) will receive a regular income and therefore may not need to hold a great deal of cash in reserve; conversely, a charity which is funded by donations may have sporadic and unpredictable income and would be expected to hold higher cash reserves. Similarly, a charity which is undertaking a capital project (for example, refurbishing a building used by its beneficiaries) would also need an extra cash allocation to the project.

Figures provided by the Charity Finance Charity 250 Index suggest that charities which have strong governance (including appropriate cash allocation) can expect strong results. In the most recent numbers available, which cover the year to 30 June 2016, the index reported that over a third of its members experienced double-digit income rises. The largest rise was recorded by Horder Healthcare, with income up by 19% to £29.9 million over the same period.

The Commission's expectations

The Charity Commission expects trustees to implement and monitor a reserves policy; trustees are also expected to explain the policy and compliance with the policy on an annual basis. Reserves are defined by the Commission as "unrestricted funds that are freely available to spend on any of the charity’s purposes" (generally referred to as “free reserves”). These differ from "restricted reserves" such as endowments. In general, free reserves would be expected to be largely represented by cash or near cash (such as low risk listed investments which could be readily converted to cash).

Some charities may receive "lumpy" or unpredictable income, such as legacies arising from a death or an annual grant. Trustees should take this into consideration and remember that a charity’s expenses will typically be regular, so maintaining sufficient cash in reserve to meet periods of reduced income is paramount, especially if the charity is providing life-affecting services.

“Deciding the level of reserves that a charity needs to hold is an important part of financial management and forward financial planning,” notes the Commission in its Charity reserves: building resilience document published in January 2016. “Failure to do this may result in reserves levels which are either higher than necessary, limiting the potential benefits a charity can provide; or too low, increasing the risk to the charity’s ability to carry on its activities in future in the event of financial difficulties, and increasing the risks of unplanned and unmanaged closure and insolvency.”

Be mindful of risks

Although some of the top charities have reported rising incomes in recent years, charity incomes as a whole are dropping, particularly for smaller charities. According to the Small Charity Index, statutory income (i.e. government grants) has dropped nationally by 8% over three years. Some charities are using their reserves, or borrowing money, to invest elsewhere to gain an income.

Where a charity lacks the free reserves it thinks it needs (including cash allocation), the Commission warns that the charity is exposed to greater risk. The Commission expects trustees to be actively addressing this, by implementing a reserves policy, raising the necessary funds, diversifying its funding base and mitigating the risks that might arise if the charity has to close suddenly.

The Commission also warns that in the case of an investigation against a charity, the Commission may take into account evidence that trustees have exposed the charity, its assets or its beneficiaries to harm or undue risk by not following good practice. Insufficient cash over a prolonged period of time can be one of the most significant factors in coming to this conclusion.

The example of Broken Rainbow, a defunct charity which provided support to the LGBT community, provides an illustration of the risks of poor governance. Investigations into the charity’s finances after its insolvency revealed that Broken Rainbow’s trustees had spent virtually all its income (from grants) within three days of receiving them. The money was being used to fund past expenses, leaving little or nothing to fund present or future needs. In the two-year period leading up to its closure, the charity had less than £500 in its bank account on an average day.

Charity trustees should also be aware that because interest rates are currently lower than inflation, holding large quantities of cash for the medium to long term could cost the charity a significant amount of money. Alternatives options should be considered – which might include investing the cash in a portfolio.

Charities in the spotlight

Charities are facing increasing scrutiny from the Commission, which is gaining greater influence. Under the Charities (Protection and Social Investment) Act 2016, the Commission gained the power to issue official warnings, which supplements its existing powers to carry out statutory investigations in the public interest.

The Commission issued its first official warning on 3 July 2017. The warning was given to the National Hereditary Breast Cancer Helpline (NHBCH) after the charity found itself in financial difficulty and failed to comply with the regulator’s action plan. According to the Commission, “[the] charity and its assets had been exposed to undue risk through a lack of appropriate financial controls and its financial model was unsustainable”.

These two cases illustrate the importance of maintaining sufficient cash to cover both working capital needs, and any unforeseen expenses. A charity which runs down the amount of cash it holds in reserve risks opening itself up to financial difficulties and regulatory scrutiny. The NHBCH incident was also significant because it confirms that the Commission is now selecting and checking charities in England and Wales to ensure they operate according to best practice and the Commission’s own guidelines.

Too high allocation

Conversely, a charity’s cash allocation may appear to be too high. If this is the case, donors, beneficiaries or the Commission may raise questions about the way the charity is being managed. Typically this can happen for two reasons: either the trustees have not sufficiently explained why they are keeping reserves, or because they are having difficulty in using their funds. The Commission states that:

“A charity with excess reserves or unspent funds should consider whether they could be effectively spent on the charity’s purposes. If a charity has more resources than it needs to fulfil all of its purposes then the trustees must consider whether the purposes of the charity should be amended to enable the charity to operate more effectively.”

Adding to the pressure on charities to comply with best practice, from May 2018 charities with “extremely aggressive” fundraising practices could be fined up to £25,000 if they do not crack down on nuisance calls, emails or letters. This regulatory change comes into effect under the EU’s General Data Protection Regulation, which is due to replace the existing Data Protection Act.

Although the UK is currently in the process of leaving the EU, the Great Repeal Act includes the same provisions as the new regulation, so it is still likely to become UK law. Charities within the scope of the new rules must comply with new data protection legislation and provide marketing opt-outs.

New project funding

Given the pressure on charity funding and the increasingly prescriptive regulatory environment, charity trustees should ensure that adequate funding will be available for any new project - quite often, this will require that they raise the necessary funds prior to commencing the project. Available assets, including cash, should be held securely with reputable organisations and risk should be given serious consideration.

Some years ago, Icelandic banks offered customers attractive interest on any savings held in an account; but their collapse in the autumn of 2008 caused considerable disruption and loss for depositors.

Charities come in a range of shapes and sizes and they operate in very different ways. The amount of their future commitments, both to beneficiaries and for overheads - such as staff salaries, rent and other fixed costs, should be reflected in the amount of cash they hold.

Strong governance and regular oversight should also be employed to ensure that a charity correctly uses any lump sums it receives, and plans effectively for its future needs. As the Charity Commission notes, a reserves policy will “give confidence to funders by demonstrating good stewardship and active financial management".

Serving the best interests

Ultimately, good governance and oversight are a key part of ensuring that a charity serves the best interests of its intended beneficiaries. Whether holding a large amount of cash or a little, the first step should be to consider whether that sum is appropriate to its needs. If not, trustees should take further action to redress the balance, either by moving any surplus cash to where it can generate the most benefit, or by taking steps to ensure that sufficient cash is gathered to safeguard the charity’s operations for the foreseeable future; for example, by cutting costs or fundraising.

Smith & Williamson's Adrian Wild - the Charity Commission expects trustees to implement and monitor a reserves policy; trustees are also expected to explain the policy and compliance with the policy on an annual basis.
"A charity which runs down the amount of cash it holds in reserve risks opening itself up to financial difficulties and regulatory scrutiny."
"Strong governance and regular oversight employed to ensure that a charity correctly uses any lump sums it receives..."
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Understanding VAT and charities

Do charities pay VAT? This is a common question, and the answer is “yes”…but it’s not simple. Mistakes are easily made, so it is useful to have a broad awareness of the rules so you can identify situations or transactions that might need further consideration or professional advice.

There is no automatic, blanket VAT relief for charity purchases. Yes, there are certain specific, targeted VAT reliefs that apply to certain supplies to charities, but nothing that allows all purchases to be VAT-free. There is also the need for specific declarations/certification to be issued by a charity in order to benefit from the VAT reliefs that are available.

VAT registration rules

The same VAT registration rules apply to charities that apply to any business. They must register for VAT if their taxable supplies exceed the VAT registration threshold (currently £83,000).

Some charity income is outside the scope of VAT, such as grants and donations, and monies obtained from the supply of education or welfare services. Other income, such as that from trading activities, would be subject to standard rate, reduced rate or zero rate VAT. So even deciding if you have to register is complex.

In some cases, a charity may wish to register for VAT voluntarily, as it can recover VAT paid on its costs and could expect a net VAT reclaim from HMRC. As long as the taxable supplies made are only to customers able to recover their input VAT in full, then the need to charge VAT will not add to customers’ costs.

Another situation where VAT registration may be beneficial is if the charity makes taxable sales that are subsidised, and will be able to recover more VAT as input tax than the output VAT it needs to charge.

Trading activities are often channelled through a trading subsidy. This can mean that both a charity and its trading subsidiary are required to be registered for VAT. Sometimes a VAT group registration might be a better option.

VAT grouping is not something to be rushed into, but it does allow supplies between a charity and its subsidiaries to be disregarded for VAT purposes. Also, when there are significant taxable supplies made through a subsidiary, grouping can boost the total VAT recovery rate for the group’s overheads.

Is a charity in business?

"Business" is an important concept in VAT as it determines if VAT must be charged and if it can be recovered. The normal approach taken by the courts is to look objectively at what a charity does. If it is providing goods or services in return for a consideration (usually, but not necessarily, money) then it is seen as being in business.

If an activity is wholly funded by income that is outside the scope of VAT such as grants or donations it will be a non business activity. VAT is not charged - but neither can VAT be recovered on the costs incurred.

Subsidised activities, where an activity is partly funded by grants and partly by taxable charges or fees, do give entitlement to VAT recovery, but HMRC will sometimes seek to apportion the input VAT recovery. Sometimes, even though an activity is subsidised, it can still be deemed to be a wholly business activity.

VAT and grants and contracts

As can be seen, many scenarios are hybrids and fall between the two extremes of wholly business or wholly non business.

It is often the case that certain arrangements are not correctly described. Just because funding is called a “grant”, if it is actually a payment for something specifically supplied in return, it is not a grant for VAT purposes. Whatever the intention, the facts are also critical.

Another incorrect description is “minimum donation”. If it is a donation, it is freely given, voluntarily. If there is a compulsory minimum required, it is a charge or fee!

A subsidised service where charges are made to customers is still a business activity for VAT purposes. Some HMRC officers try and demand a VAT restriction when they come across any outside the scope income, but this is wrong and should be challenged.

Difficulties can also occur with sponsorship income if the donor insists on recognition. Here it is often arguable whether VAT is chargeable. HMRC will generally not see a dedicated grant making organisation (such as national lottery funding) as receiving a supply, but might well take a different view if the funder is a commercial organisation which benefits from the publicity.

Charity VAT recovery

Charities can rarely recover all of the VAT they incur, but the calculation of recoverable input tax is not an exact science.

The first hurdle to calculating input tax recovery is to ensure that the accounting system is able to identify the VAT incurred, and to allocate the VAT in accordance with whether it can be fully recovered or whether it needs to be subject to a restriction for non business use and/or partial exemption.

If the posting of the VAT incurred is wrong, then the whole calculation of recoverable VAT will be undermined – it’s a case of GIGO – garbage in, garbage out!

Do remember that there is no set method for non business apportionment, but it does have to be fair and reasonable. However, HMRC do like there to be some logic involved and will want to be able to verify the figures. For example, they are unlikely to accept a time based apportionment (staff time).

While an income based method may be an easy, one-step calculation from easily identifiable figures, it might not give a fair or favourable result. It can be hugely distorted by large, one-off transactions such as legacies. HMRC will often agree that such transactions can be excluded from an income based, non business apportionment, but it is best to get this confirmed in writing by HMRC.

VAT reliefs for income

There are too many to list all possible VAT reliefs here. If you want the whole picture or have specific issues, then the HMRC website is a good place to start. I will highlight some pitfalls though!

Charity fundraising events

There is a VAT exemption for charity fundraising events. This allows all supplies made at an event to be treated as VAT exempt, unless they are zero rated (such as programmes).

The exemption can be applied to up to 15 events of the same type, in the same place each year – but if there is a 16th event, the exemption will not apply to any of them!

This exemption is available to charities whether they are registered for VAT or not but beware, the events must be fundraisers, not social occasions.

Sale of donated goods

Charities can sell goods donated to them at the zero rate. However, charity shops are increasingly also selling new goods and moving onto a retail Gift Aid scheme.

The zero rate does not apply to the retail Gift Aid scheme, as in this case the charity is receiving a monetary donation from the donor, on whose behalf the goods have been sold, rather than actually selling donated goods. The retail Gift Aid scheme produces a very different VAT treatment for what was traditionally a charity shop selling only donated goods.

Premises and VAT

Some charity construction work can be purchased free of VAT – usually a new build or self contained annex. The rules here require that the building be used solely for a charitable non business purpose. This is a much stricter interpretation than merely a charitable purpose. In practice, HMRC may allow up to 5% business use.

Similar to the relief for certain construction services, a charity buying or renting premises intended for use for a charitable non business purpose can confirm this to the vendor/landlord and the option to tax will be disapplied. This means that no VAT will be charged on the supply. This option does not apply to retail premises.

Working together and mergers

As charities take on more diverse activities, with both central and local government contracting out services, there are big risks if VAT aspects are not considered correctly. I have seen a charity which sub-contracted to a commercial provider and so incurred an additional 20% VAT cost making the whole project uneconomic.

The merger of two or more charities can also trigger VAT problems. Is there a transfer of a business as a going concern? Are there any options to tax or capital goods scheme items taken on? Are there assets that may cause a VAT cost due to change of use?

From outside the UK

Don’t forget that if a charity receives supplies or services from suppliers based outside the UK, it has to account for the VAT that would have applied within the UK. 20% VAT must be declared as both output tax and input tax, and it may not be fully recoverable. Also, the value of reverse charge services received from abroad can trigger a requirement to be registered as their value counts towards taxable turnover.

As I said…it’s complicated!

Knill James' Alison Sampson - some charity income is outside the scope of VAT, such as grants and donations, and monies obtained from the supply of education or welfare services.
"A subsidised service where charges are made to customers is still a business activity for VAT purposes."
"Charities can rarely recover all the VAT they incur, but the calculation of recoverable input tax is not an exact science."
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The right financial information for the right trustees

Getting the right financial information to the right people (and one could add: at the right time) is fundamental to the smooth running of a charity. So how is this best done? To answer that question, we can start by ascertaining who “the right people” are. And this will depend very much how your charity is structured. But understanding the organisation and its structure may not be that straightforward with some types of charity.

To step back for a moment, there are various models used in charities. These will include:

  • Just a board of trustees, where all trustees have a similar level of interest in the charity’s finances. In this case the trustees will have a shared responsibility for finance.
  • Board of trustees, where one trustee is very interested in the figures and the others look to him or her for leadership on the issue. It is essential to understand that the other trustees cannot actually delegate their responsibility to this lead trustee as such, but there is a recognition that this one particular person is more knowledgeable than the others.
  • A finance and/or audit committee with terms of reference, reporting through to the whole board. Within this structure there may also be one person who is very knowledgeable and interested in the finances, so the other committee members will look to him or her for leadership.

In the circumstances where there are just one or two interested people to whom the others look for a lead, the detailed financial information could just go to them.

Understanding trustees' ability

In deciding who the right people are and how to present the information to them, you need to understand their ability. For example, are they accountants, or do they have a particular skill with financial information? Are they still active, or are they retired with out of date knowledge? Are they business people or directors with a working financial knowledge? Knowing your “client” or trustee in this instance will serve you well in determining the appropriate level of financial communication.

Having said this, it is valuable to recognise that non-financial people will still require at least an overview of the charity’s finances, in order that they too can make informed decisions.

There are other factors to consider also, such as the size and complexity of the organisation, and the number of key income streams. With income, most charities normally only have one main revenue stream (even if they would like more), so income reporting can be quite straightforward.

A charity’s objectives also need to be taken into account, as there may be three or four key types of charitable expenditure - so summarising these is a constructive exercise.

Reliable information

Financial information has to be reliable, which means it must be up to date, be sourced from relevant and authentic accounts, and has been properly prepared by financially competent people.

In most cases, trustees will need this information so that they can be fully aware of the charity’s financial position, and make informed and sometimes quick decisions. Trustees want to be able to trust the information they are given and not be questioning its reliability. If the information is not reliable, it will have to be improved as a matter of urgency, as misleading data can result in poor decision making, and may even be masking potential internal fraud.

Information to be provided to trustees should go through a review process before being passed to them. Notes should also be added to the information to clarify any salient issues and to explain any key unknowns or uncertainties, and to highlight where any assumptions have been made.

In reviewing the reliability of financial information, you need to understand the abilities of your finance team and how much you can trust what they produce. You need to be clear on what basis the schedules have been produced: have they been prepared using accruals accounting, or are they on a cash basis? You also need to be sure that the charity’s bank accounts and other control accounts reconcile and that there is a system in place to check that they actually do.

Ultimately, in checking the reliability of financial information there is an acid test you can use once a year: would a trustee be able to reconcile the final management information from the last financial year to the audited financial statements?

Relevant information

Trustees need and want pertinent information that gives them a clear overview of how their charity is performing, rather than being swamped with too much data. If they have an overview and they understand it, strategic decisions can be properly made.

In this regard, you need to ask the trustees what they think of the financial information they currently receive. You can also ascertain what additional data they would like to see as well as what pages, schedules and documents they use most, and whether they would prefer the information in a different format.

Some trustees may not fully understand key schedules, so further explanations may be required where necessary. Consider also changing the format of schedules to make key points clearer. Many of the trustees that I deal with are happy to say that they don’t understand a certain document when asked; this is easy to remedy.

Sometimes information is produced because it has always has been done that way, but this does not mean it cannot be challenged or improved. I had one client that always produced a lengthy cash flow statement, because eight or nine years ago they had had major cash flow problems. On reflection, when we reviewed the information being presented to the board, it was revealed that as there had not been any cash flow issues for over five years, so the collection of cash flow spreadsheets were being ignored by the board members!

The quantity of information should be kept under review. One sees a range of report sizes, from just a single page summary, right up to full bound booklets. You need to consider the number of pages being made available, the time available for the recipients to read them, the level of detail on each page, and whether a one-page dashboard summary would also be useful.

You should also consider including key performance indicators (KPIs) in the financial information, if the charity has them. If there are no KPIs, are there other ways for the trustees to gauge how they are performing? Any KPIs that do exist, even if they are not financial, should appear in the information given to trustees.

Relevant schedules

There is no one-size-fits-all prescription for the amount of information to be given to trustees, as every charity is unique. Having said that, you may wish to include in the trustee pack, where relevant, the following: an income and expenditure summary (which could include several supporting pages if there are several income streams and include comparisons to the budget), a balance sheet, a cash flow statement, and a schedule of performance against KPIs.

You may also wish to include some narrative to explain key variances from expectations or from last year’s figures. If a charity has significant restricted funds, these should be separately identified and you should ensure that the trustees can understand how these funds are being used.

Frequency of information

Financial information should be provided on a regular basis, such as monthly or quarterly. If you have quarterly trustee meetings, some “flash” summary figures in the intervening months will often be useful. And on the subject of meetings, you should make sure that information is provided in advance of these events (usually a week beforehand) so that trustees have time to consider the figures before they meet.

Trading subsidiaries

Where the charity has a trading subsidiary, you will need to consider how you report the results of this, particularly where the numbers going through it are significant.

A trading subsidiary will often have a separate board from the trustees, and with its own separate meetings. In this case, you will need to consider all of the above points relating to charities as they will apply to this separate legal entity, with different people in charge.

A close eye

Charities need to keep a close eye on their financial position to help them remain viable. Where there is uncertainty over any factors affecting the charity’s income, aims and obligations, a measure of clarity over cash flows as well as the profitability of any trading subsidiaries will be important.

Where information is not available to trustees through accurate and up to date accounts, decisions will either be made under a greater degree of risk or will have to be delayed. Only once the relevant and reliable information is to hand can the financial implications of any decisions on such matters as major expenditure, investments and recruitment be fully understood.

Being able to anticipate any short term cash flow shortages allows trustees to take early action, whilst projected cash flow surpluses will assist in deciding when to action new investment, expenditure and recruitment plans.

Having real-time financial data to hand, backed up with cogent narrative, gives charity trustees the best chance of securing success for their organisation. Trustees must remain in control of a charity’s financial position, and the best way for them to do this is through regular access to the right information.

Bishop Fleming's Joe Scaife - where there is uncertainty over any factors affecting the charity's income, aims and obligations, a measure of clarity over cash flows as well as the profitability of any trading subsidiaries will be important.
"In deciding who the right people are and how to present the information to them, you need to understand their ability."
"Information to be provided to trustees should go through a review process before being passed to them."
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