How NGOs can improve their financial reserves

It’s been a tough time to be a finance director at a British development NGO. Charities’ budgets, like many of their staffers, have endured a bruising 12 months. A pandemic increasing need and sparking a recession, Brexit, falling public donations, and government aid cuts have created a “perfect storm” for the sector, according to Bond, the network for British international NGOs. And like businesses — but without enjoying their level of support from the government during the COVID-19 pandemic — if charities run out of money, they will have to close. That’s why Bond’s chief operating officer, Graham MacKay, is urging NGOs to increase their financial reserves and to get thinking about a strategy if they do not have one in place. “The sector's never going to be out of the woods. I've been in the sector long enough to live through a few difficult periods, and none of them as difficult as this,” MacKay told Devex. And like wider society, the future for the sector remains uncertain — meaning NGOs should assess their financial cushion sooner rather than later “and plan for the next difficult period in another five or six years’ time,” MacKay added. This assessment is closely matched by Sameera Mehra, head of global alliance development at Charities Aid Foundation. “Charities are facing significant structural challenges such as financial instability, gaps in funding for the Sustainable Development Goals, an overreliance on foreign [aid] funding, Mehra wrote to Devex. She also highlighted a “shrinking civic space due to onerous legal and regulatory measures” and a perception among the public that NGOs are “ineffective, poorly governed and not reflective of local values.” Financial reserves — unrestricted funds not in day-to-day use — are important because “they create the financial base of an organization,” MacKay said. “If that’s really thin, then it's difficult for an organization to be resilient in tough times. The fatter they are … [NGOs] will be more financially resilient,” he added. “Crossing your fingers is not a great financial strategy.” “A good reserves policy and internal financial management can help ensure organizational sustainability and resilience, especially important when there are unexpected events, such as Covid-19, that can severely impact an organisation's bottom line and survival,” Mehra said. But a Bond study of charity finances — sampling 156 organizations — found the mean level of unrestricted reserves was just “11 weeks of total spend, with a median of 8 weeks.” A report authored by MacKay, outlining the findings, noted that “Having reserves below eight weeks may make it difficult for an organisation to survive a financial shock.” Financial reserves are not just about riding out short-term pain, according to MacKay, but also serve other purposes. “It gives you as an organization the confidence to invest, to take chances, smooth out programming, [instead of] switching programs on and off,” he said. This was echoed by Mehra. “Financial reserves give organizations greater control over their programs, ensuring that they are responsible to the needs of constituents rather than prioritizing donor demands,” she wrote. It can take five to six years to build up substantial reserves, according to MacKay. Having further studied in depth the accounts of a subgroup of 28 organizations with “higher average levels of reserves than the wider sector,” he recommended NGOs use two methods to raise unrestricted funds: cost recovery from grants or contracts, and donations, both of which can be used to create an unrestricted surplus. Key to deciding how to go about this is “understanding your own business model and how you get the income,” MacKay said. “There's a range of different ways you can do this, but you need to pick the right one for you and follow it as best you're able for what you can do.” For instance, it makes sense for an organization increasing cost recovery from the contract consultancies specialized in — such as one group MacKay studied in the survey — to continue using that method to improve financial reserves. The point here isn’t to diversify income, MacKay points out. “You have to understand what you're doing and what works for you,” he said. It comes back down to business basics, according to MacKay. “Find your good source of revenue, and manage the costs down,” he said. “What you're trying to do is you're trying to create a gap between the income and the costs.” MacKay acknowledged that “clearly, it's not easy for organizations to do. Otherwise, everybody would be doing it. … But you need to find something that does work.” “Crossing your fingers is not a great financial strategy.” --— Graham MacKay, chief operating officer, Bond Finding the money — hard as it can be — isn’t the only barrier. Charities have “a ton of pressure,” both internal and external, against building up financial reserves in a similar way to private businesses, according to MacKay. “It might be organizational culture, it might be the board have not prioritized it, it might be [that] the donors put in rules that may make it really very difficult for you,” he said. The Bond survey of NGOs found donor attitudes were the second-most common barrier to building up financial reserves. “Real or imagined, there's a genuine worry that if people seem to have too big reserves, they won't be able to attract donor funds because donors think they don't need the money,” MacKay said. Mehra agreed there was a “perception that charities are not supposed to make profits and need to break even.” She wrote: “This thinking can limit the ability of charities to create the surpluses needed to build reserves. The funder/government mindset around this can be a big barrier.” “I would encourage donors to think positively about the financial needs of the organizations they are giving money to,” MacKay said. “The donor should have an interest in the financial resilience of organizations, and higher reserves tends to go with better financial resilience.” If a donor does have an interest in the financial resilience of organizations it funds, then “thinking positively” about the money from grants that contribute to core costs of an organization is “really important,” MacKay continued. “So it's not just about donors having more words, but they can also make it practical in the conditions of the grants they give to organizations.” Despite the challenges of raising reserves, MacKay doesn’t see it as optional. But he said it’s also entirely possible with the right approach. “There's lots of different reasons why, theoretically, you may not be able to run a surplus,” MacKay said. “However, if you're determined, there's absolutely no reason why you can't.”