Charity accounts can be a bit of mystery, even to accounting experts. But what will a good set of accounts contain? And what makes charity accounts different?
Judging charities on their financial performance alone is obviously is missing the point. Charities are not owned by anyone and do not aim to provide a financial return to shareholders. Charities provide information on their achievements in their annual report, so that people can understand their performance and impact.
1. Reserves policy
In terms of the finances, the accounts won’t just focus on the result for the year as they might in a for-profit company, so having a clear reserves policy in your trustees’ report is key. This policy relates to unrestricted funds available going forward. This needs to take account of the risks faced by the charity. Many charities express this as a number of months’ costs. This is something for each charity to work out for themselves based on the risks they face - here is no magic formula. A robust and clear rationale is critical.
2. The SORP
Charity accounts differ from company accounts in several ways. For instance, the audit threshold is lower at £1 million of income for a charity versus £10.2 million for companies. The Statement of Financial Activities (SOFA) replaces the Profit and Loss Account and this will show columns of restricted and unrestricted income and expenditure, plus a total, and compared with a company of similar size, charity accounts disclosures are far more detailed.
More about the detailed requirements can be found in the Charity Statement of Recommended Practice (SORP). The SORP requires charities to state their purpose, how they think they can achieve this and how successful they have been, including any lessons learned and their future plans. So demonstrating the difference you’ve made is crucial.
3. Fundraising performance
Fundraising can require significant investment, in terms of time and money, and some activities are higher risk than others. Ratios of fundraising cost to income can be useful but should always be considered in context, for example:
- The fundraising costs reported in the financial statements are likely to be generating income in the following financial year or years. This may not matter too much for a mature charity, but it will make a difference for a young charity or one embarking on new fundraising, in the investment phase.
- Income from legacies will fluctuate from year to year with little direct relationship with spend.
- Different forms of fundraising have different margins. For example, charity shops may have relatively small margins, but income is steady and unrestricted. Major donations might represent a much greater return, but they are unpredictable and often restricted.
4. Support and governance costs
Often the costs relating to running a charity are viewed as being ‘bad’ costs, but if a charity is to use its resources well, understand its performance, pay the wages of its staff etc, it needs to spend money on administration. If not, resources may be wasted on activities that do not generate good charitable impact. These costs are classified as support and governance costs.
5. Pay transparency
Another important consideration is transparency around the pay of the senior team. The aggregate pay of ‘key management personnel’ or senior management team are needed in a note to the accounts and an explanation in the trustees’ report of the charity’s remuneration policy. In addition, bandings with the number of staff paid at a rate greater than £60,000 need to be included.
6. Pension liability
Finally, charities will often be concerned about pension fund deficits. Significant pension deficits will make the balance sheet look as if the organisation is in poor financial health. It should be remembered that a pension liability on the balance sheet is an actuarial estimate. It is more important to understand what the actual contribution payments are. It is these that will need be paid out by the charity, so an understanding of their impact on future cashflow is critical.
Partner at Sayer Vincent