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Financial management and funding

Information about managing charity assets and resources effectively.

Overview

One of the duties of charity trustees listed by the Charity Commission is to use charitable funds and assets reasonably, and only in furtherance of the charity's objects. They must avoid undertaking activities that might place the charity's endowment, funds, assets or reputation at undue risk.

The Charity Commission has identified one of the hallmarks of an effective charity as being that it has the financial and other resources needed to deliver its purposes and mission, and controls and uses them so as to achieve its potential.

Another of the hallmarks of an effective charity identified by the Charity Commission is that it is financially sound and prudent. Trustees are required to use charitable funds and assets reasonably and only in furtherance of the charity's objects, and to avoid undertaking activities that might place the charity's endowment, funds, assets or reputation at undue risk.

Financial responsibilities

The trustees are required to ensure that the charity’s assets are properly used, that its funds are spent effectively and its financial affairs are well managed. The measures that they will need to consider to achieve this will depend on the size and nature of the charity, but common features of all well-managed charities are clear financial strategy and objectives, stated policies for risk management and reserves, careful forecasting, planning, and budgeting, and thorough monitoring of actual results against budgets.

Sound financial management involves an understanding of the sources and reliability of the charity’s funding and the nature of its expenditure to meet charitable objectives. The greater the certainty of income both as to amount and duration, the greater the flexibility enjoyed by the trustees for planning and budgeting the charity’s activities. If funding is short-term and uncertain, the trustees will need to ensure that they do not commit to future expenditure that they may not be able to meet – bearing in mind that some costs have to be met whatever the charity does (e.g. premises costs and paid administrative staff – sometimes called ‘core costs’). All charities need to build up a level of reserves to enable them to meet their commitments and other fixed costs should their income fall – bearing in mind that charity law requires any income received by a charity to be expended within a reasonable period of receipt so that trustees need to be able to justify the holding of income as reserves.

Charities also need to operate according to the nature of the income they receive or that they expect to receive. Charities have different sorts of funds and in order to manage these it is important for the trustees to understand the funds structure. Nearly all charities have a fund which is available to the trustees to apply for the general purposes of the charity as set out in its governing document. This is the charity’s “unrestricted” fund (sometimes called a “general” fund) because the trustees are free to use it for any of the charity’s purposes. The trustees may earmark part of the charity’s unrestricted funds to be used for particular purposes in the future. Such sums are described as “designated funds” and  should be accounted for as part of the charity’s unrestricted funds. The trustees have the power to re-designate such funds within unrestricted funds.

Funds may be received subject to specific trusts and are referred to as restricted funds. Restricted funds may be income funds that may only be spent in the furtherance of particular aspects of the charity’s objects or they may be endowment funds, where the assets donated are required to be invested, or retained for actual use, rather than expended. Trustees may not use restricted funds to cover general charitable expenditure unless this is allowed by the donor, e.g. a grant that allows a specified percentage to be used to cover core costs.

Where activities or projects are funded from restricted income, the charity needs to keep within the cost budget allowed by the grant/donation, as any overspend can only be met from unrestricted funds. The charity has to account for any underspend to the donor: in the current economic downturn it is not unusual for the donor to ask for the balance to be returned, rather than giving permission for the amount to be transferred to unrestricted funds. Where the charity has a restricted income fund or funds the trustees must ensure that all costs are identified to the correct project, and avoid any overspend.

Policies

The charity should have clear policies on financial management, in particular:

Reserves: how much should be held in ‘free’ reserves (unrestricted funds) and what are these reserves needed for? For example, charities that rely on voluntary income may seek to build up unrestricted funds that are not committed or invested in tangible fixed assets to hold between 3 and 6 months’ expenditure; and

Designated funds – these are unrestricted funds that are earmarked by the trustees for specific purposes. What is the purpose and amount of the designation and, where funds are set aside for future expenditure, what is the likely timing of the expenditure?

Information and reporting

Trustees of charities of all sizes need access to accurate and up-to-date financial information to enable them to make proper decisions and to ensure that all expenditure is within the budget. Trustees' meetings should be used to communicate information concerning the finances and financial management of the charity. All decisions by the trustees concerning their charity should normally be taken collectively and significant decisions and action points noted in writing.

An essential feature of financial management and internal control is accounting records that are accurate and up to date and maintained in sufficient detail to show the source of all receipts and how money has been spent. In any case, trustees have legal responsibilities (like those of company directors) to keep accounting records and to prepare an annual report and accounts with the appropriate level of external scrutiny. Trustees must also safeguard their charity’s assets and take steps to ensure the charity is protected against financial abuse. Accounting records must be kept for at least six years (or a minimum of three years if a company charity).

The SORP requires the trustees’ annual report to provide a summary of the objects of the charity as set out in its governing document, to explain the charity’s aims including the changes or difference it seeks to make through its activities, to explain its main objectives for the year under review and strategies for achieving the stated objectives, and details of significant activities undertaken. Some trustees establish key performance indicators (KPIs) that are specific to the charity against which actual performance and achievements can be measured. KPIs provide both a focus for managing the charity, and the basis for meeting the reporting requirements of the SORP.

The Charity Commission explains the legal requirements for disclosure about funding in the trustee annual report in the publication Charity reporting and accounting: the essentials April 2009 (CC15b).

For charities above the audit threshold that undertake significant fundraising activities, the report should give details of the performance achieved against fundraising objectives set, commenting on any material expenditure which might enhance future income generation, and explaining the effect on the current period's fundraising return. The report should also comment on factors within and outside the charity's control which are relevant to the achievement of its objectives and which would include factors relevant to the generation of incoming resources. And in the financial review the trustees should set out the principal funding sources and how expenditure in the year under review has supported the key objectives of the charity.

Charities below the audit threshold are not required to provide this level of detail, but it is good practice to describe how income is generated in order to support the charity’s activities.

Guidance, articles and Helpsheets

The Charity Commission provides a number of publications on financial management and funding under the heading Managing charity resources, including:

The Charity Commission also published a research report in November 2010 entitled Strength in numbers: small charities’ experience of working together, on the advantages of collaborative arrangements for small charities.

Charity Commission publications on pensions relevant to financial management and funding:

  • Charity Reserves and Defined Benefit Pension Schemes - looks at the risks attached to a charity's involvement in a defined benefit pension scheme for its staff. It also looks at the accounting implication of membership of the scheme, the role of the various regulators and the potential liabilities for trustees.
  • Defined Benefit Pension Schemes - questions and answers on Defined Benefit Pension Schemes following recent changes in pensions legislation and to help charities manage their pension schemes in the economic downturn

Community Accountancy Self Help

  • Cash-online aims to provide people with the basic financial skills needed to run successful charities and voluntary organisations. Cash-online is published by Community Accountancy Self Help and provides links to a number of useful publications, including Cashfacts, a series of factsheets covering all aspects of financial management relevant to small charities.
Internal control

One of the duties of charity trustees is to ensure that the charity's resources are protected in order that the charity can fulfil its aims. The trustees need to ensure that the charity’s assets are properly used, that its funds are spent effectively and its financial affairs are well managed. Even small charities with relatively simple structures and low-risk activities need to protect their assets and get the most out of their resources. Trustees therefore need to establish checks and procedures, referred to as ‘internal controls’, to help them:

  • meet their legal duties to safeguard the charity's assets;
  • administer the charity's finances and assets in a way that identifies and manages risk; and
  • ensure the quality of financial reporting, by keeping adequate accounting records and preparing timely and relevant financial information.

Not all controls will be relevant for all charities; it is for the trustees to decide which controls are appropriate to their charity. The controls put in place by trustees should be proportionate to the risks involved. But whatever the size of the charity, it is important that all those working in it, whether trustees, staff or volunteers, take the issue of internal financial controls seriously. Making controls work should not be seen as just the responsibility of one or two trustees or senior staff members, or as applying to some but not others.

Internal financial controls

Internal financial controls are one part of a charity's overall control framework. The aims of internal financial controls are:

  • to protect the charity's assets;
  • to identify and manage the risk of conflicts of interest, loss, waste, bribery, theft or fraud;
  • to ensure that financial reporting is robust and of sufficient quality; and
  • to ensure that the trustees comply with charity law and regulation relating to finance.

No system of controls, however elaborate, can guarantee that a charity will be totally protected against loss, waste, bribery, theft or fraud, or mistakes or mismanaged conflicts of interest. However, a good system of internal financial control does provide protection for the charity's assets and is the best defence for the trustees against the charge of failing to protect the charity's assets and funds.

The following are key elements of a good system if internal financial control:

  • 'tone at the top' - the trustees lead by example in adhering to the charity's internal financial controls and good practice;
  • regular review of controls - the trustees should ensure that a review of the effectiveness and appropriateness of the charity's internal financial controls is conducted at least once each year;
  • segregation of duties - or trustee oversight where the charity is too small to enable segregation of duties;
  • monitoring activities – checking actual performance against planned performance, such as comparing income and expenditure to a budget. The budget needs to be realistic and the reasons for significant over-/under-performance followed up so that the budget can be flexed or corrective action taken, as necessary.

Guidance and articles

The recipe for keeping risk in context

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Does your charity deliver its promise? Trustees should review risk in context to ensure alignment of governance, risk, controls and assurance with strategic plans. This is the model proposed by the internal audit profession.

Developing KPIs in charities

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Kate Sayer examines why key performance indicators should be output measures of activity from which managers can learn and improve.

Financial reporting for trustees

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It is vital for trustees to understand the financial reporting regime under which charities operate and report.