Operating Reserves: Why Do Charities Need Funds Beyond Project Budgets?

A charity may secure enough funding to deliver its projects and still struggle to meet some of its essential commitments on time. A grant payment may be delayed, donations may temporarily fall, or an urgent repair may arise that is not covered by a project budget.

In these situations, it is not enough to know the charity’s total income and expenditure. The charity also needs to know when money is expected to arrive, which payments are due, and what resources it can use if a temporary shortfall occurs.

This is where operating reserves can help. However, understanding them requires a distinction between three different things: reserves, available cash and cash flow. Reserves are not necessarily a separate bank balance, available cash is not necessarily the same as the reserves figure in the accounts, and a delayed payment does not automatically mean that the charity has a lasting deficit.

First: What Are Operating Reserves?

In this article, operating reserves means resources that a charity plans to retain to support its work when financial risks arise or income temporarily falls short. The charity should set out in its policy why it holds these reserves, when they may be used and how it plans to rebuild them after a withdrawal.

This does not mean that all the charity’s funds can be treated as reserves. There is a difference between:

• Restricted funds: money given by a funder or donor for a specific purpose. It must not be used for another purpose outside the agreed conditions.
• Internally designated funds: money set aside by the board or authorised decision-maker for future spending, such as essential maintenance or a project that future income is not expected to cover.
• Funds available for general use: money that can be applied to the charity’s purposes, subject to its commitments and approved decisions.
• Cash currently available: money that can actually be used to meet near-term payments, provided it is not restricted or already committed.

A sum may be unrestricted but set aside for a forthcoming commitment. A charity may also hold assets that form part of its resources but cannot be converted into cash quickly without affecting its work. Reserves are therefore not the same as a bank balance, and a bank statement alone cannot establish their value.

The Charity Commission for England and Wales defines reserves as the part of a charity’s unrestricted funds that is freely available to spend on its purposes. Under its accounting framework, certain assets used in the charity’s work, funds designated for essential future spending and commitments not recorded as liabilities may be excluded. This definition relates to the framework in England and Wales; it is not automatically the accounting rule for charities in other countries.

Second: Reserves, Liquidity and Cash Flow Are Different

Distinguishing between these concepts helps charities avoid misleading estimates:

Suppose a charity has a cash balance of SAR 300,000. Of this, SAR 200,000 is restricted to a project and SAR 60,000 is needed for near-term commitments. The remaining SAR 40,000 may be unrestricted cash that is not already committed.

This example shows the cash available after known restrictions and commitments have been deducted. It does not, by itself, establish the charity’s reserves figure in its accounts or show whether SAR 40,000 is enough. That requires a review of the charity’s funds, assets, designations and commitments, followed by an assessment of the risks it is preparing for.

Third: Why Does a Charity Need Resources Beyond Project Funding?

A project budget covers the costs allowed by its funding agreement. It may include delivery and shared support costs, depending on the funder’s conditions. Some of a charity’s needs, however, may not belong to one project, or the project funding may not permit the charity to cover them.

A reserves policy may help a charity prepare for situations such as:

• A grant payment being delayed while salaries, rent or other payments remain due.
• Donations temporarily falling or an expected funding source not being renewed.
• An urgent cost that is essential to maintaining a core service.
• A gap between the end of one funded project and the start of another.
• Commitments that cannot be reduced quickly without affecting staff or beneficiaries.

This does not mean that reserves should make up for every funding shortfall. If a deficit recurs because regular income does not cover expenditure, the charity may need to review its costs, income sources and programme scope. Reserves provide room to manage risk; they do not replace sound financial planning.

Fourth: How Can a Charity Estimate What It Needs?

There is no single level that suits every charity. The needs of a charity with regular, diverse donations differ from those of one that depends on a single grant paid in instalments. They also depend on the nature of the services, whether spending can be delayed, how much notice the charity would receive if funding stopped and the effect an unplanned closure could have on beneficiaries.

The Charity Commission for England and Wales recommends setting reserves in light of each charity’s circumstances. These include forecasts of income and expenditure, the stability of funding sources, and future risks and commitments. It does not set one level or range that is suitable for all charities.

A charity can begin with these steps:

1. Identify essential services and commitments: Which costs cannot be stopped quickly without disrupting the work or harming beneficiaries?
2. Prepare regular cash-flow forecasts: When is income expected, and when are salaries, contracts and invoices due?
3. Assess funding sources: How dependent is the charity on its largest funder? How regular are donations? When do contracts end or come up for review?
4. Test realistic scenarios: What would happen if a major payment were delayed for two months or a grant were not renewed? What would the effect be on cash and services?
5. Set and document a justified target: Explain why the chosen level is needed, and review it when the charity’s resources, commitments or risks change.

A Simple Example of Estimating a Cash Shortfall

In this hypothetical example, a charity has essential cash commitments of SAR 80,000 a month. It expects a major funding payment to be delayed by two months. It also expects SAR 30,000 in reliable unrestricted income during that period.

• Essential commitments over two months: SAR 80,000 × 2 = SAR 160,000.
• Expected unrestricted income during that period: SAR 30,000.
• Cash shortfall in this scenario: SAR 130,000.

This figure indicates the liquidity the charity may need to manage this particular scenario, after checking which payments can be delayed and what other resources are available. It is not a standard rate, nor does it automatically equal the reserves figure in the accounts. The charity can test other scenarios before agreeing a target or range that reflects its actual needs.

Fifth: What Should a Reserves Policy Include?

Having accessible funds is not enough on its own. Without a clear policy, the charity may use reserves inconsistently or retain funds without a defined purpose. A policy should explain:

• The risks and services the reserves are intended to support.
• The basis used to set the target level.
• The difference between the target and the resources currently available.
• The circumstances in which reserves can be used, and who can approve this.
• How withdrawals will be recorded and their effect on plans and services.
• How the charity will rebuild reserves, where possible.
• How often the policy will be reviewed and who is responsible.
• How the charity will explain its reserves and the reasons for holding them to funders and other stakeholders.

The policy should be linked to the budget, risk management and work plan, and approved by the board or authorised body in line with the charity’s governing document and local rules. The Charity Commission’s guidance for England and Wales also says that a reserves policy should explain why funds are held, what they are for and when they may be used, and should be reviewed as circumstances change.

Sixth: How Can a Charity Manage Reserves in Practice?

Monitoring should compare the charity’s actual position with its approved target, rather than relying on the bank balance alone. The charity should review regularly:

• Unrestricted cash that is not already committed.
• Existing commitments and their due dates.
• Expected income and how reliable it is.
• The reserves figure under the charity’s policy and local accounting framework.
• The effect of any withdrawal on services and beneficiaries.
• Whether reserves need to be replenished or the target revised.

If some resources are invested, the investment should reflect when the money may be needed and the level of risk the charity can accept. Funds likely to be needed soon should remain sufficiently liquid; they should not be tied up in investments that are difficult to realise when required.

Seventh: Mistakes to Avoid

Some practices can undermine reserves management:

• Treating restricted funds as available for emergencies: their presence in the bank does not change the purpose for which they were given.
• Treating the bank balance as the reserves figure: without reviewing commitments, assets and the nature of the funds.
• Applying a standard percentage without analysis: such as setting a fixed number of months’ expenditure without assessing funding sources and risks.
• Repeatedly drawing on reserves to cover a lasting deficit: without addressing the cause.
• Holding more resources than needed without explanation: this can reduce the funds available for services and activities.
• Separating the reserves policy from cash-flow forecasts and the budget: reserves cannot be managed effectively without monitoring the timing of income and expenditure.
• Fundraising without explaining the need accurately: appeals should not imply a level of urgency or financial shortfall that does not reflect the charity’s position.

Conclusion

Operating reserves are not simply a bank balance or money left over after a charity’s needs have been met. They are part of financial planning that helps the charity prepare for risk, meet its commitments and maintain services when income is delayed or circumstances change.

Good reserves management begins by distinguishing reserves from liquidity and cash flow. The charity then identifies restricted and designated funds and existing commitments, tests realistic scenarios, sets a target that reflects its circumstances, and adopts a clear policy for using, reviewing and replenishing its reserves.

A well-prepared charity asks more than “How much is in the bank?” It also asks: “What can we actually use? What payments are coming due? And what risks do we want to be ready to manage?”