The ACNC’s publication [Link updated 25.10.2020] Charity reserves: financial stability and sustainability, a fact sheet for ‘charities and the public’, begins well:
The purpose of this fact sheet is to provide general guidance on reserves for charities: what reserves are, why they might be needed, and how charities can determine an appropriate level of reserves….
Then immediately takes a big step backwards, by shouting that by ‘reserves’ they mean
‘charity funds which, in a technical accounting sense, would commonly be called ‘operating reserves’.
‘Operating reserves’? The home of ‘technical accounting’, the Australian Accounting Standards Board (AASB), has no mention of such reserves on its site. Nor does, as an example of knowledgeable public accountants, KPMG.
You’d think that getting something so wrong in a highlighted box under a heading Important note: our used of the term ‘reserves’, would sound the death knell for the fact sheet. But because from then on they just use the term ‘reserves’, it matters little.
Something else does though.
It’s their lack of care in making statements about the use of reserves. These statements give the inference that the ACNC doesn’t appreciate the importance of cash management as distinct from reserve management.
They don’t tell you that reserves are not necessarily represented by cash. In at least one place they even equate the two:
The board decides to invest 65 per cent of the charity’s reserves in a low-risk deposit and keep the remaining amount available for unexpected expenses [the Example].
As they did in the media release :[25.10.2020: The ACNC appears to have removed this document] Charities cautioned to avoid cash crisis[emphasis mine].
In the case studies, cash that is something separate to reserves is not mentioned:
The board decides to release 20 per cent of its reserves to ensure that it will be able to meet crucial expenses such as rent and staffing costs during the transitional period [Cash Studies – Example 1].
The charity has a healthy reserves balance and decides that it will use its reserves to cover its programs’ expenses and staff wages for 3 months. If no funding has come through after 3 months, the charity’s committee will make the decision to terminate its programs. There will still be sufficient reserves to pay any redundancy entitlements [Case Studies – Example 2].
You may say, ‘It’s no big deal, I understand what they are saying’. You may, but ask any public accountant whether they still get the question ‘If I’ve made a profit, why don’t I have any cash?’, they’ll tell you that they do.
So there are still many in the ACNC’s audience who do not understand the difference between cash and profit, and therefore may have difficulty explaining how a charity (or their charity) has reserves yet is short of cash. A simple example: what if the charity had bought some property, plant or equipment with its cash? The level of reserves would be unchanged, but the cash would be reduced.
A knowledge of what underlies bookkeeping, the accounting equation, is required to understand the management of reserves. Assets – Liabilities = Equity. ‘Reserves’ are part of equity. They are not cash (that’s an asset). The kind of reserves the ACNC is talking about are built by a surplus, reduced by a deficit. Yes, you can plan to reduce reserves, but you don’t do that by spending them – that’s cash.
Because reserves are part of the charity’s equity, and because the surplus or deficit for the year gets added to equity, you can plan to reduce reserves (see the Examples above) by planning for expenses to be greater than revenue. But you still need to find the cash to pay those expenses.
So, donors, please look at the total of ‘Cash and cash equivalents’ and ‘Financial Assets’ as well as amount in the various reserves.
I’ll leave you with this saying: Revenue is Vanity, Profit is Sanity, Cash is Reality. To which can be added ‘& Equity is Continuity’. It’s as much a technical accounting saying as ‘operating reserves’, but maybe it will help you remember that reserves (‘continuity’) are something separate to cash.
- The Important note… says that ‘Our use of ‘reserves’ in this fact sheet does not include ‘restricted reserves’…or ‘revaluation assets reserves’. There are other types. ↑
- I could not find who coined the saying “turnover is vanity, profit is sanity, cash is a reality”. Quora thinks it’s not possible. ↑