Building Reserves to Cover Risk and Build Resilience InPublic Benefit Entities

We have spoken about this before. Especially post Covid, entities have focused on their free reserves, defined as unrestricted reserves minus assets, minus investments, minus designated reserves.

They have focused on how long a public benefit entity or PBE could continue in operation should its prime income sources dry up. This is usually given in terms of months of PBE activity.

In many PBE reports this is usually given as say 6 months but I have known many PBE's reduce this to even 3 months?

I'm not sure that reducing the level of free reserves to 3 months activity is sensible in the current Predicament!

Often the level of unrestricted reserves needs to be matched to the level of risks the PBE faces. This depends much on the quality of the PBE's risk management processes.

This latter point is often unaddressed but is crucially important for the future planning of PBE reserves policy.

It is therefore important for entities to set out policies about the levels of reserves they expect to hold now and in the future. This is also true of the wider public sector as well!

Your reserves policy needs to describe:

1. What level of reserves your PBE holds and why it is holding them?

2. How and when your reserves might be used up

3. When and how often you will review your reserves policy

It is often useful to set aside reserves for a specific purpose or even risk. In that case the teserve becomes a designated reserve which is in effect a subset of your general reserves.

In the charity accounting sector there is a clear focus on monitoring and reporting on the current and future level of reserves. This practice is not copied in the wider public sector where there is a tendency not to focus on reserves policies as much, both in the current financial reporting period and in future years.

This must change!

We must all become much more concerned with the levels of reserves we need to aim for given the risks we face!

The current consultation on private sector governance talks about resilience reports being prepared for the short, medium and long term. These will have to predict the future levels of reserves necessary for the survival of an entity.

A PBE must develop a reserves policy that:

• Fully justifies and clearly explains keeping or not keeping reserves

• Identifies and plans for the maintenance of essential services for service users

• Reflects the risks of unplanned closure associated with the PBE business model, spending commitments, potential liabilities and financial forecasts

• PBE's are required to publish their assessment of the risks that they face and how to manage them in their annual report

• Make sure that their reserves policy is put in place and operated

• Regularly monitor and review the effectiveness of the reserves policy in the light of the changing funding and financial climate and other risks

Understanding reserves

Reserves are that part of a PBE’s unrestricted funds that are freely available to spend on any of the PBE's legitimate purposes. They have been defined in detail earlier in this blog as free reserves.

They exclude items which cannot be immediately turned into cash like fixed assets ( Plant,Property and Equipment), Investments those reserves designated for a specific purpose or risk!

There is no clearly defined way of defining an optimal level of reserves for a PBE save for the fact that

deciding the level of reserves that a PBEneeds to hold is an important part of financial management and forward financial planning. Failure to do this may result in reserves levels which are either:

• Higher than necessary and may tie up money unnecessarily. Holding excessive reserves can unnecessarily limit the amount spent on charitable activities and the potential benefits a PBE can provide

• Too low, increasing the risk to the PBE'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

It is therefore a complex monitoring and delivery task to identify what level of free reserves should be held

The Charity Commission note CC19 is very useful here and must be read by all parties!

Essentially any free reserves policy of a PBE must be prepared in line with:

1. How many months it could operate for if all its income or at least a substantial part of it dried up.

2. How it's current and future free reserves can be matched to its current and future risk profiles.

It is essentially these 2 elements which will have a key effect on PBE reserves policy!

The wider public sector, especially local government, will have to follow suit.

It is only a matter of Time before current and future reserves policies will be an integral part of future public sector financial reporting.

PBE financial reporting will also need to be strengthened in this respect!