Financial pitfalls: What charities and trustees need to know

Managing an organisation’s finances effectively is essential to its long-term sustainability. But how can charities and community organisations recognise the early warning signs of financial difficulties, avoid common pitfalls and make informed decisions about their financial future?

A recent workshop, Financial Pitfalls and How to Avoid Them, delivered by McTear Williams & Wood, explored the financial responsibilities of charity trustees, the warning signs of financial distress and the practical steps organisations can take to protect their financial position.

Understanding trustees’ financial responsibilities

Financial management is a collective responsibility. Trustees have a duty to protect their charity’s assets, act in its best interests and ensure it remains financially sustainable. Financial oversight should not sit solely with the treasurer; all trustees have a role to play in understanding and scrutinising the organisation’s financial position.

This includes receiving and reviewing the right financial information, asking questions and ensuring appropriate financial controls are in place.

Recognising the early warning signs

Financial difficulties do not always happen overnight. There can be warning signs that an organisation is becoming financially vulnerable, and recognising these early can give trustees more time to consider their options.

Some of the signs highlighted during the workshop included:

• Income: Increasing reliance on one major funder, losing key grants, declining donations or fundraising events becoming less profitable.
• Cash flow: Cash balances reducing month by month, difficulties meeting payroll, delayed VAT or HMRC payments, suppliers being paid later than usual or increasing reliance on overdrafts.
• Operations: Growing deficits, reserves being depleted, high staff turnover, delayed maintenance or investment, and borrowing to meet day-to-day costs.

Another important consideration is the difference between restricted and unrestricted income. Money awarded for a specific purpose cannot automatically be treated as available to meet general running costs.

Cash flow, budgets and reserves

Having a surplus in the accounts does not necessarily mean an organisation has enough cash available to meet its immediate commitments.

The timing of grant payments and expenditure can create cash flow pressures, even when the accounts show a surplus. This is why cash flow forecasting is particularly important, rather than relying solely on management accounts.

So what is cash flow forecasting?

Cash flow forecasting is the process of estimating how much money an organisation expects to receive and pay out over a future period, usually month by month. It helps charities anticipate when money will be available, identify potential shortfalls and ensure they can meet commitments such as salaries, bills and supplier payments.

Importantly, it helps trustees spot financial problems early, rather than waiting until cash reserves are running low.

Trustees should also understand their organisation’s reserves position. An appropriate reserves policy can help an organisation manage unexpected financial pressures, while operating with little or no unrestricted reserves can leave it vulnerable. Equally, holding excessive reserves can raise questions from funders.

More about cash flow reserves: Cash reserves are funds a charity holds back to provide a financial safety net against unexpected costs, income shortfalls or periods of financial uncertainty. They help an organisation continue meeting its commitments when income is delayed, reduced or withdrawn.

Regularly reviewing cash flow, budgets and reserves helps trustees understand the organisation’s financial position and identify potential problems.

Avoiding common financial mistakes

The workshop highlighted several common mistakes that can make financial difficulties worse:

• Waiting too long before seeking professional advice.
• Relying on overly optimistic budgets.
• Assuming next year’s fundraising will resolve current financial problems.
• Ignoring recurring deficits.
• Failing to challenge assumptions behind financial forecasts.
• Poor governance around financial decisions.
• Having no contingency plans or documented financial controls.

If financial problems are not addressed, the consequences can include increasing pressure from creditors, HMRC arrears, loss of confidence, staff departures, funding being withdrawn and, in some circumstances, insolvency.

What can trustees do to protect their organisation?

There are practical steps trustees can take to strengthen financial oversight and reduce the risk of problems developing.

These include:

• Reviewing cash flow regularly.
• Understanding the difference between restricted and unrestricted funds.
• Maintaining realistic reserves.
• Stress-testing budgets to consider different financial scenarios.
• Diversifying income sources.
• Ensuring financial expertise is available at board level.
• Asking challenging questions about financial performance and future plans.
• Seeking professional advice at an early stage.

Trustees should also make financial scrutiny a regular part of board meetings. Useful questions include:

• Do we have enough cash for the next six months?
• What assumptions underpin our budget?
• Are we spending unrestricted funds too quickly?
• What would happen if our largest funder withdrew?
• Are our reserves sufficient?
• What financial risks have changed since our last meeting?

These questions can help boards identify potential vulnerabilities and make better-informed decisions.

Trustee protection: Charities should also check that they have appropriate Directors’ and Trustees’ Liability Insurance in place, if this is not already included in their existing insurance cover. This can help provide protection for trustees in relation to claims arising from decisions made in their role.

Don't wait until it's too late to seek advice

Trustees should consider seeking professional advice if their organisation is experiencing repeated monthly deficits, cash flow forecasts indicate problems within the next six months, there are concerns about paying staff, a major source of funding has been lost or there are questions about the organisation's long-term viability.

The workshop, organised by Norfolk Community Foundation, also explored three case studies involving the relocation and downsizing of premises, restricted funds and an orderly organisational wind-down, demonstrating some of the financial challenges charities may need to consider.

McTear Williams & Wood offers free initial advice to charities and trustees who have concerns about their organisation's financial position.