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Insolvency is something we usually associate with a business. In general terms, it happens when a legal entity, for example, a limited company, finds itself with money issues and therefore cannot meet its obligations. A charity can also find itself unable to meet its financial obligations. In those circumstances, very much like a business, it is insolvent.
Technically speaking, the definition of Insolvency for charities is the same as any other legal entity. It occurs when the organisation cannot pay its debts as they fall due, or its liabilities exceed its assets. Assuming the charity cannot be returned to a position of solvency through administration, an Insolvency Practitioner will be appointed, the assets will be liquidated and the charity will be struck off the register.
Often when a charity is struggling to meet its financial obligation it is down to one or more common factors. These tend to be:
Donations are the lifeblood of a charity. Unfortunately, several things can result in a reduction of this usually vital source of income. People tend to give less when times are hard. So rising inflation, cost of living increases, and the general economic outlook can hit a charity very hard. Sometimes a charity can find itself competing for funding with other, better-known, organisations or, at a more local level, there can be a surge in sympathy for a particular cause. Very occasionally bad publicity or associated problems can also impact donations.
This is very much an area where the third sector (i.e., not private, or public) institutions suffer just as much as any other. Offices need to be paid for, the cost of utilities is no lower for a charity, and so on. When these costs become unmanageable or rise unexpectedly it often leads to financial problems.
It is relatively common for a charity to invest money in a variety of ways, for example, share portfolios or property, with the aim of increasing that investment to achieve more of the charity’s goals. If these fail or stagnate it can be a real issue.
Another cause of difficulties can be problems surrounding the management of money. Mismanagement is as much a danger to a charity as it is to a business. Trustees have a duty to manage the resources of a charity responsibly in the same way a director of a limited company has.
The same two tests apply as they do to a business
1. The balance sheet test that will ascertain if the assets are greater than the liabilities
2. The cashflow test that defines if a charity can meet its obligations as they become due
The main stumbling point for a charity is likely to be the cashflow test because of its necessary heavy reliance on donations. That said, it’s important to consider all funds not just the immediate donations and investments. For example, unrestricted funds that may be used for any purpose if it is legal and meets the charities charter, and restricted funds that have been designated for a specific purpose, often by a donor or as the result of a specific appeal.
The trustees of a charity are governed by 6 main duties. If there are any financial problems the Trustees will need to show that they met one of these in particular, which is the requirement to manage the charity’s resources responsibly. This is sometimes known as the ‘Duty of prudence’ and it is essentially about using sound judgement. Included in this area are things such as not over committing assets and showing due care to avoid inappropriate risks or bad investments. There should also be a process of accountability and Trustees are expected to act with skill and good judgement, including recognising when they need the guidance of others with more experience or specialist knowledge. You can find out more about the main 6 duties of Trustees on the .Gov website
The role of the Treasurer Trustee is particularly important as they will, according to governmental guidance, be responsible for:
It is very important to remember that all Trustees are jointly responsible for the charity. So, although a designated Treasurer may well directly deal with the finances, every Trustee is responsible for them.
Well, as the title of this article says, well-meaning but unskilled isn’t going to be enough when it comes to charity finances. They should be both robust and well planned. That means:
Wanting to help and being committed to your cause are both wonderful things, but they are no substitute for expertise and qualified professionals. Where possible, appoint experts to the board, or budget for them as needed.
Running a charity is not easy but it will be considerably harder if you don’t have a considered, financial focus supported by good planning. With a few hard years for the economy forecast, bringing in the donations and keeping up the good work may be harder than ever, so the more you know about your finances the better.
We are here to help if you are a trustee of a charity and think you may be facing insolvency. If you are worried, call us or click here to book in for a free consultation.
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