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DEEP DIVE: DEVELOPING FINANCIAL LITERACY (WITH NO FINANCIAL BACKGROUND)

Ria Patel

15 June 2021

Today, I am researching financial literacy. Admittedly, this is the topic I am most nervous about in this series. As a person with no background in finance, understanding the desirable financial skills for a trustee is, admittedly, a little intimidating.

The questions I aim to cover in this section of the project are:

  • What do you need to know in terms of basic finance?
  • What questions should I be asking to understand finance?
  • What are financial statements?
  • What are reserves and why are they important?

Through my research I learnt that financial management is fundamental for the sustainability of the charity. Although one person may take a lead in terms of finances, usually the treasurer, it is important that the whole board has some understanding of financial literacy. It is not just the treasurer’s job to carry out financial oversight alone, hold the charity to account, and ensure the finances are being managed well. The board and all trustees have legal responsibilities, which need to be adhered to:

  • The duty to ensure your charity carries out its charitable purposes
  • The duty to act in the best interests of the charity
  • The duty to manage your charity’s resources responsibly
  • The duty to be comply with your governing document and the law

More about these key four areas can be found here. These legal responsibilities are different from but related to financial guidance.

In order to understand finances for your charity, you may need to understand how the activities of your charity are funded and where its costs come from. This website has some good starting points. For example, finding out what your main sources of income are and what expenses they cover. Also, it is important to understand the charity’s cash flow profile as this will help you understand: if cash is received in advance or arrears; any contracts you have; and if costs are flexible or fixed, which will help determine whether you can expand or contract.

The link then goes on further to ask questions about planning, monitoring and skills and gives you good food for thought. Have a look to see what questions you should be asking in order to truly understand your charity’s finances and where you should start in terms of becoming financially literate.

Questions to be asked as a board

To begin with, what questions should trustees and boards be asking about finance? What should we be thinking about in terms of finance?

This useful page from the Government highlights 15 key questions that a trustee should be asking. The questions are broken into sections: strategy, making the most of our finances, governance, making best use of resources.

I think these questions are a great starting point and could lead to some healthy discussions. In terms of strategy they only have one key question:

  • ‘What effect is the current economic climate having on charity activities?’
  • But there may be others to consider like
  • ‘Are we taking action early enough?’
  • ‘Are we responding to changing needs, responsibilities, opportunities and risks?’

Innovation and adaptation is often key. A simple question that I like is ‘have we considered collaborating with other charities?’. Often through collaboration you meet a more diverse group of people from whom you can learn, create a more enriching environment, and allow for more effective work. For example, running joint training sessions may help save finances and expand ideas.

Graphic with 15 questions a trustee should ask from the Charity Commission Are we financially strong enough to continue to provide services for our beneficiaries? Are we making the best use we can of our property? What is our policy on reserves? Do we have adequate safeguards in place to prevent fraud? Have we reviewed our contractual commitments? Have we reviewed any contracts to deliver public services? Are we an effective trustee body? Do we know what the social and/or economic climate is having on our donors and support for our charity? Are we making the best use of the financial benefits we have as a charity? If we have a pension  scheme, have we reviewed it recently? Have we considered collaborating with other charities? What effect is the current economic climate having on our charity and its activities? Are we satisfied with our banking arrangements and our current and future investment policy? How can we make best use of any permanent endowment investments we hold? Are we making the best use of our staff and volunteers?

SORP

The best practice for financial management comes from The Charities SORP (statement of recommended practice, developed by the Charity Commission). At first glance this is a very lengthy document and appears to be quite dry. However, this key document provides a framework for the financial management, accounting and annual reporting for UK charities. More information on annual reporting can also be found here, from NCVO, and here, from SCVO. SORP takes you through many key areas of finance, some of which I will discuss below.

Financial statements

So, how do we actually understand financial statements?

Through my research I learnt that there are 3 key types of financial statements, which allow for trustees to understand the financial information needed to assess the current financial state of your charity. These are: income statements, balance sheets and cash flow statements. (I told you I was a beginner with finances!)

Income statements

Income statements can help trustees to learn about the operations of a charity, learn where the charity's money comes from and ascertain the security of these funds. They show the profits and losses of the charity, and show the net profit and loss over a period of time. Finances are likely split up in terms of income and expenses. Income relates to what a charity has earned or made and may further be split into individual donations, sponsorships etc. Expenses relate to any costs the charity has incurred and may be split into salaries, projects, marketing, etc.

In the income statement you will also find information about restricted and unrestricted funds. Restricted funds can only be used for a specific purpose, whereas unrestricted funds can be used by any purpose. More information on fund accounting can be found here. An annual income statement has to be submitted to the Charity Commission each year, but monthly/quarterly statements may be produced for trustees

Balance sheet

balance sheet shows the charities current financial status by summarising its assets and liabilities. It is a snapshot of a specific point in time rather than a period of time. This can help trustees to compare between the present year and the previous year and can give an overall picture of financial health, as well as ask questions about reserves, debtors, creditors, the net assets and liabilities. Balance sheets also have to be submitted to the Charity Commission every year.

What are assets and liabilities

Assets are resources a charity owns and they can be fixed or current. Fixed assets are tangible and often long-lived, which cannot be quickly turned into cash with each, such as land property and equipment. Current assets are those which can be reasonably sold or consumed via normal operations, for example, cash, money in the bank, short-term investments, prepaid expenses, etc.

Liabilities are a financial obligation the charity has to pay. So, these are payments the charity is obliged to make. Liabilities can be split into long-term liabilities and current liabilities. A long-term liability is one that is not due within 12 months and a short-term liability is one that you owe within 12 months, e.g. short-term loans.

Cash Flow Statements

Cash Flow Statements show the ‘flow’ or movement of cash through a period of time. This means you can see the changes in finances in terms of operations, investments and any other financial activities. You can find an example of a cash flow statement here. Cash can include: cash in hand, cash in the bank, short term investments and overdrafts. These are explained in more detail in the previous link. Cash flow statements allow for trustees to see how the charity manages its cash, its financial performance and understand liquidity and solvency. Cash flow statements can be annual, quarterly or monthly.

Above, I have outlined a lot of definitions and key concepts, but financial statements are hefty, at least in my opinion. In terms of understanding financial statements and how to read them further, there are lots of resources available online, including YouTube videos like this one. I’d recommend spending some more time looking at financial statements in depth to develop the practical skill of reading financial statements, so that you can become familiar with them and better understand how to use them.

Reserves

A financial reserve is unrestricted cash that is retained for the charity to meet any future contingencies, drops in income, growth prospects, to take advantage of new opportunities, etc. Thus, reserves allow for the charity to build resilience and act as a safety net for rainy days. This link clearly outlines the 5 types of reserves a charity should consider holding, and has some tips for trustees. The 5 types of reserves are income risk reserves, cessation reserves, working capital reserves, opportunity reserves and adversity reserves.

Most charities should have a reserves policy and it’s good practise for trustees to get familiar with theirs. A reserves policy should outline how much a charity needs in its reserves, why, how, where and when the reserves can be spent. The amount in reserves will depend on the charity and their financial situation. The charity's annual report should also include information on your reserves, to inform donors and other stakeholders of the reserves. You can find information from the Charity Commission on how to set up a reserves policy here.

Tax

How does tax affect charities?

It’s a common misconception that charities don’t have to pay tax, but they do unless they qualify for tax exemptions. For example, charities are normally expected to pay Corporation Tax, however due to tax exemptions available for charities they may not usually pay this. Similarly, voluntary organisations are exempt from Capital Gains Tax if they hold charitable status. There are other forms of tax that may also affect charities, like Council Tax, Insurance Tax, and those related to employment.

Finally, Gift Aid is a way for any monetary donations to charities within the UK taxpayers to be increased. Charities are able to claim back the basic rate tax paid by a donor on their donation. This comes at no extra cost to the donor but can increase the value of donations, generating more income for charities.

The Charity Tax Group has lots of information on tax for charities, and here is some information for Scotland, some of which applies to England.

This blog has disused a lot in terms of basic finance, from questions to ask, financial statements, reserves and tax. I hope it is a useful starting point in understanding trustee finance. However, there’s lots I haven’t discussed. Three things that I haven’t discussed but will discuss in my podcast, due to be released on Thursday, are budgeting, risk management and the impact of COVID on financial management! In the meantime, check out this essential guide from CFG.  Thanks for reading and stay tuned for my podcast and follow-up blog on this topic.

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