What’s the point of an in-depth reserves policy when everyone knows that the best way to manage reserves is to hold at least three months of forecast expenditure as cash! This piece of wisdom forms the basis of many organisations’ approaches to calculating and managing reserves and is, in some ways, a rather good rule of thumb. However, there are nuances that need to be taken into account in order to avoid underestimating reserve requirements, holding excess liquidity and incurring unnecessary risks, or adopting an unclear or inconsistent reserves policy that cannot be relied upon in times of market volatility.
There are many challenges in setting a robust reserves policy, not just in the writing of the policy itself but in identifying your organisation’s requirement for funding and the level of risk associated with this. While a prudent level of reserves is likely to be a function of forecast expenditure over the coming months, this can vary significantly from organisation to organisation. For example, for one charity with predictable and stable cash flows from donations and grants, three months’ expenditure may be excessive and lead to liquidity hoarding. For another organisation with unstable cash flows, or uncertainties such as a reliance on one large contributor or a number of unconfirmed grants, a much higher level of reserves may be necessary.
A question that is often asked is: what’s the risk of holding too much cash? Surely it is better to hold more cash than you need rather than underestimate your requirements and find you have not held enough. This is generally true, as one of the key treasury risks that any organisation faces is a liquidity crisis where funds are required but cannot be accessed, either due to wider market disruption or a deterioration in the creditworthiness of a counterparty. Either scenario can ultimately contribute to an organisation’s collapse if key payments cannot be made. While this is the worst-case scenario and is a key reason for charities holding large cash balances, there are risks associated with this approach that need to be addressed.
First, where is this cash being held? Any balances held in reserve will need to be invested somewhere, and a creditworthiness assessment will need to be undertaken to ensure the funds are not exposed to an unnecessary risk of default. Second, what is the level of return on these cash balances? Where inflation outstrips the return on cash investments, the real value of reserves will be eroded over time, and this can threaten the longevity of the organisation. Finally, what else could be done with those reserves? Increasingly, trustees and other stakeholders want to see reserves being deployed to further the charitable mission of the organisation rather than being locked up through overly cautious approaches. Of course, this shouldn’t lead to reckless spending of cash balances in pursuit of unsustainable objectives, but any reserves held for the long term need to have a clearly defined purpose and be aligned with the organisation’s strategy.
As CC19 requires charitable organisations to set and follow a reserves policy which explains and justifies their approach to holding reserves, these factors must be carefully considered and an appropriate response recorded. A 2026 FundRobin survey reported that 54% of UK charities had never formally documented their reserves policy. With the Charities’ SORP 2026 now in force and funders scrutinising reserves levels more closely, there's no hiding behind vague language. Charities have to clearly classify their reserves in order to explain which balances are held for liquidity purposes and which are intended for longer-term investment and service delivery.
Clear categorisation of balances allows charities to identify what portion of funds needs to be kept liquid, what portion is likely to be deployed in the near future, and what remainder is expected to be available for the long term. This distinction helps inform the appropriate investment strategy and the range of products available. Having a clear understanding of which reserves are restricted or designated helps to develop these plans, as restricted reserves should not be considered part of the wider reserve pool for liquidity purposes, while designated reserves are part of unrestricted reserves but are earmarked by trustees for a particular purpose, such as a potential capital project or planned investment. Other reserves can be categorised as free or unrestricted and can be used to support general charitable activity, as well as to absorb unforeseen financial shocks. Reviewing each of these designations regularly ensures that funds are being allocated efficiently and that liquidity buffers are neither eroded nor maintained at an unnecessarily high level.
Your reserves policy can be developed further by targeting measurable quantitative liquidity metrics where a charity wants to clearly evidence the basis for its reserves level. As mentioned earlier, many charities target a certain number of months’ forecast expenditure, but this approach can be made more sophisticated by targeting a minimum liquidity coverage ratio. This compares the amount of liquid resources (i.e. cash on hand) with expected cash outflows over a certain period, giving an easily identifiable minimum ratio that can be reported. Stress testing and scenario modelling can also be useful tools in determining a reasonable minimum reserves position. If the charity knows that there are certain key cash inflows expected, such as large grants or donations, determining the impact of a late or partial receipt of these inflows and setting the minimum reserve level accordingly can mitigate the risk of plausible downside scenarios.
Any quantitative methodology used to set reserves should be accompanied by a qualitative overview of the charity’s strategic objectives over the coming years and how these might affect the need for reserves. If there is material planned investment, expansion or organisational change that may require additional funding, targeted liquidity buffers could be increased to provide greater resilience during a period of higher risk. On the other hand, where plans are relatively fixed, and the organisation has predictable income flows, a lower reserves target may be perfectly appropriate and allow for more efficient deployment of funds.
A reserves policy should combine measurable financial thresholds with a forward-looking assessment of the charity’s plans and risks. Once a policy and target are in place, they should be kept under regular review rather than considered fixed. Adjusting the policy based on the organisation’s financial position, strategy and operating environment allows for a more proactive approach and demonstrates that financial decisions are being considered on an ongoing basis rather than being set arbitrarily.
Arlingclose can support charities in developing a robust reserves policy by combining analysis of liquidity, expenditure and financial risks with a forward-looking assessment of strategic priorities, helping trustees determine an appropriate and defensible level of reserves. For more information about this, please contact jscottsoane@arlingclose.com.
