Learn all about charitable funds and their presentation in balance sheets and statutory accounts.
If you are a senior charity leader, you already know that managing the finances of a charity requires a solid understanding of the basic financial concepts and terminology. One essential aspect of charity accounting is the presentation of funds in the balance sheet.
Over the course of my career, I have noticed that many arts leaders that have made their way to the senior team of a charitable organisation haven’t received bespoke financial training. They might have been lucky enough to receive some mentoring or informal inductions, but they have never been fully familiarised with the company’s statutory accounts, and what information they should look out for when reading the Balance Sheet.
More often than not, leaders who don’t have a financial background are much more familiar with the company’s budget and income and expenditure report, as managing a budget is typically one of the main responsibilities that are assigned as you progress in your career. However, the Balance Sheet and its intricacies tend to be one of the last things you learn about.
A crucial bit of information that the Balance Sheet shows are the charitable funds of the organisation. In this blog post, I will provide executive managers in UK charities, who may not have a financial background, with a clear understanding of what charitable funds are and how they are presented in the balance sheet.
Why is Understanding Charity Funds Important?
As arts leaders in charitable organisations, understanding the funds of your charity is of paramount importance. Here are several reasons why.
Financial Stewardship
Arts leaders have a responsibility to act as effective stewards of their charity’s financial resources. By understanding the various funds within the organisation, leaders can make informed decisions regarding resource allocation, budgeting, fundraising, and financial planning. This understanding ensures that funds are used in alignment with the charity’s mission and objectives, maximizing the impact of each pound spent.
Donor Expectations and Accountability
Charitable organisations heavily rely on donations and grants from individuals, foundations, corporations, and government entities. Donors often have specific intentions and restrictions on how their contributions should be utilized. By understanding the different types of funds, arts leaders can ensure that donor expectations are met, and funds are allocated appropriately, thus maintaining the trust and confidence of their supporters.
Financial Sustainability
A comprehensive understanding of funds enables arts leaders to assess the financial sustainability of their organisation. By analysing the balance between unrestricted and restricted funds, leaders can make strategic decisions about resource diversification, revenue generation, and long-term financial planning. This understanding also helps in building adequate reserves and managing cash flow effectively, ensuring the organisation’s stability and resilience during challenging times.
Effective Decision-Making
Understanding the funds of a charity enables arts leaders to make data-driven decisions. They can evaluate the financial impact of proposed projects, programs, or initiatives by considering the availability of funds and their restrictions. This understanding allows leaders to prioritize activities, allocate resources effectively, and pursue opportunities that align with the organisation’s financial capacity and strategic goals.
Building Relationships and Partnerships
Arts leaders often engage with external stakeholders, including potential donors, sponsors, and collaborators. A strong understanding of funds enhances their ability to communicate the organisation’s financial position and funding needs. It enables leaders to articulate the impact of investments and demonstrate the responsible management of resources, which can attract support and foster meaningful partnerships.
What is a Balance Sheet?
A balance sheet is a financial statement that provides a snapshot of an organisation’s financial position at a specific point in time. It presents a summary of the organisation’s assets, liabilities, and equity, aka: what it owns, what it owes, and its value. In the context of charity finance, the balance sheet offers crucial insights into the financial health and stability of a charitable organisation.
The balance sheet follows a fundamental accounting equation: Assets = Liabilities + Equity. This equation ensures that the balance sheet remains balanced, hence its name. Let’s explore each component in more detail:
- Assets: Assets represent the resources owned by the charity that have economic value and can be measured in monetary terms. These include cash, investments, property, equipment, inventory, and receivables (sales invoices that are yet to be paid). Assets are categorized into current assets (e.g., cash and short-term investments) and non-current assets (e.g., property and long-term investments). The balance sheet lists assets in descending order of liquidity, with the most liquid assets appearing first.
- Liabilities: Liabilities refer to the organisation’s financial obligations or debts to external parties. They represent the claims on the charity’s assets by creditors and other stakeholders. Liabilities can be categorized as current liabilities (e.g., unpaid purchase invoices, short-term loans) and non-current liabilities (e.g., long-term loans, mortgages). Similar to assets, liabilities are listed in order of maturity, with current liabilities appearing first.
- Equity: Equity, also known as net assets or fund balances, represents the residual interest in the organisation’s assets after deducting its liabilities. Basically, it answers this question: if the company liquidated and sold all of its assets, and then paid all of its debt, how much would we have left? In the context of charities, equity is often referred to as accumulated funds. It encompasses the organisation’s unrestricted funds, restricted funds, and any other reserves or endowments. Equity reflects the charity’s financial position, and positive equity indicates a surplus of assets over liabilities.
The balance sheet provides really important information to stakeholders, such as donors, trustees, regulators, and executive managers. It helps them assess the financial stability, liquidity, and solvency (aka the ability to repay debt) of the organisation. By analysing the balance sheet, stakeholders can gain insights into the organisation’s ability to meet its financial obligations, the composition of its assets, and the levels of debt or reserves.
It’s important to note that the balance sheet represents a specific point in time and may not reflect the dynamic nature of a charity’s financial activities. To gain a more comprehensive understanding of the financial performance and changes in financial position, stakeholders should also review other financial statements, such as the statement of financial activities (SOFA). This is what commercial companies call Profit and Loss statement.
What are Funds in Charity Accounting?
In charity accounting, funds refer to the various categories of financial resources that a charity holds. Here are the funds you will typically see in a charity’s Balance Sheet.
Unrestricted Funds
Unrestricted funds, as the name suggests, are not subject to any significant restrictions on their use. Charities can allocate these funds for any purpose that aligns with their charitable objectives. These funds provide flexibility and support day-to-day operations, program development, and other essential activities.
Restricted Funds
Restricted funds are donations or grants that come with specific restrictions on their use. Donors may specify that the funds should be used for a particular project, program, or purpose. These funds must be utilized in accordance with the donor’s intentions, ensuring transparency and accountability. The charity would sign a funding or grant agreement to obtain the fund, and you are usually expected to report on how the funds were spent after the project has ended.
Designated Funds
Designated funds are often set aside under the Trustees’ instructions for a particular purpose within the organisation, but they do not carry the same level of restrictions as restricted funds. The are internally signposted to fulfil a specific intent, but there isn’t a legal or contractual obligation to do so. For example: the Trustees of a charitable theatre company might decide to designate £8,000 to refurbish the venue’s seating plan.
General Funds (aka Free Reserves)
General funds, also known as free reserves, represent the surplus or accumulated reserves that a charity holds that aren’t restricted, or locked into assets. In other terms, it is the amount of money the charity has that isn’t restricted or designated for any purpose. General funds act as a financial cushion, providing stability and resilience during challenging times. They are an essential component of a charity’s financial sustainability, and leaders of a charity should agree on a reserves policy where they aim to accumulate a certain level of general funds to cover operating costs during difficult times. For example, a charity might make it their reserves policy to have their General Funds be at least three months’ worth of overheads (salaries, rent, utilities).
How Are Charitable Funds Presented in the Balance Sheet?
In the balance sheet, funds are presented under the liabilities section. They reflect the financial obligations or commitments of the charity to the various stakeholders. The funds are typically categorized based on their restrictions and purposes.
How are Funds Presented in the Statutory Accounts?
The statutory accounts of a charity provide a comprehensive overview of its financial performance and position. The presentation of funds in the statutory accounts follows accounting standards and guidelines specific to the charity sector.
Within the statutory accounts, funds are presented in the statement of financial activities (SOFA) and the balance sheet. The SOFA outlines the income and expenditure for the reporting period and clearly distinguishes between unrestricted and restricted funds.
Charitable Theatre Funds: an Example
To make it easier for you to wrap your head around charitable funds, I thought that it would be helpful to present an example of how a charity – specifically a theatre company in the UK – presents its funds in its statutory audited accounts.
I have gone to HMRC’s website and downloaded the marvelous Gate Theatre’s audited accounts for 2021-22, and looked at their Balance Sheet and Fund analysis.
As you can see, the Balance Sheet presents the assets and liabilities first, and the difference between the two, called net assets. The net assets balance with the funds, which are divided into Restricted and Unrestriced. Within the Unrestricted Funds, you can see which ones have been designated to specific purpose, and which are free reserves.
If you open any charity’s audited accounts and scroll to the notes to the accounts, you will also be able to see the funds analysis, which is a breakdown of how the funds have moved within the financial year.
This section shows the brought forward balance from the previous year, and how the funds have grown (income received) or depleted (funds being spent). You will also be able to see what the restricted funds are for as they will be divided by project/purpose, and any transfers between funds.
Conclusion on Charity Balance Sheet Funds
Understanding the presentation of funds in the balance sheet is crucial for executive managers in UK charities, even without a financial background. By comprehending the different types of funds and their purpose, managers can make informed financial decisions and ensure compliance with donor restrictions. The accurate and transparent presentation of funds in the balance sheet and statutory accounts contributes to the overall financial health and accountability of a charity.
Related articles:
- How to Read Management Accounts: A Guide for New Managers
- Creating a Theatre Production Budget: The Full Roadmap
