Greater Good South Africa

Tuesday, March 4th 2014

"Public benefit organisations have a duty to be responsible stewards of public funding and trust – this means managing their finances wisely."

Benefits of a reserve

A reserve is the balance of  the previous years’ operating surplus – or unspent funds.  Some organisations set aside a specific percentage of their operating costs for a reserve each month or year. 

The benefits of a reserve include:

• Protecting beneficiaries by making sure they receive services provided by the organisation, regardless of changes in funding cycles or funding delays. 
• Providing funders with assurance that the organisation has the capacity and financial health to make the best use of grants.
• Creating a safety net to protect the organisation in unforeseen circumstances, such as a major funder pulling out suddenly.
• Providing capital that can be used for future projects (e.g. building maintenance), borrowed against or used for the expansion of the organisation’s activities.

Sources of funding for reserves

Building up a reserve can be a challenge, particularly in tough economic times. Some funders would rather support beneficiaries directly than contribute to a reserve fund.

• Operate at a small surplus each year and invest any of the surplus, rather than spend it in the following year. Although this requires a level of financial discipline, it is a strategy that pays dividends in the future.
• Unrestricted funding such as legacies, bequests, individual giving and self-generated income are also good sources of funds for a reserve.
• Investment income (interest or dividends) generated by investing larger grants until the funds are needed for project implementation is also a great source of reserve funding. 

 

Investing reserve funds

The directors or trustees of public benefit organisations have a fiduciary responsibility to ensure that reserves are invested wisely. An investment approach which takes into account both inflationary risk and volatility risk is essential. The examples below show how investment decisions can make a major difference to the size of a reserve over time.

Organisation A puts it in the bank
Organisation A chooses an interest-bearing bank account. The interest on the R10 million (4%) in an inflationary environment like South Africa, is less than inflation at 6%. After 25 years, this reserve is only worth R6m in real terms. In other words, the purchasing power of the R10m reserve will be eroded by inflation and will be reduced to R6m, despite the interest earned.

Managing a reserve

It is important to get advice from a reputable wealth management company with the knowledge and expertise to implement the best investment solution for an organisation.

Cash-flow modelling is used to make sure an organisation has access to its capital if needed (short-term liquidity) as well as long-term growth (to stay ahead of inflation). Knowing what cash will be needed and when, the two major portfolio risks of inflation and volatility can be managed over time.  

• The Stable Portfolio –This is the part of the organisation’s portfolio where short-term funding needs will be drawn from. This portfolio is often made up of Money Market Unit Trust Funds as they are liquid and their value is stable; and is toped up from the best performing assets in the Prudent and Growth portfolios.
• The Prudent Portfolio – This portion of the portfolio is the reserve fund safety net. Market movements and fluctuations have little effect on this type of portfolio. Should the long term growth portfolio decrease suddenly, this portfolio would allow enough time for a recovery before having to use funds from the Growth portfolio for the organisation’s operational needs.
• The Long Term Growth Portfolio – This is invested for growth to make sure the reserve fund beats inflation over the long-term. This part of the portfolio is usually the most volatile but because it is invested over the long-term, this does not present a problem. 

 

Endowments

An endowment is an established pool of assets (for example rented property, cash, shares, bonds) used to generate income to fund the operations of an organisation. This reduces the organisation’s dependency on donors.

Fees and costs

All this wealth management expertise doesn’t come for free and different investment solutions will have different costs and fees. Some wealth management businesses apply a fee based remuneration model for advisory, administration and fund management services, while others charge commission (a percentage of the funds under management). Registered Public Benefit Organisations are sometimes offered discounted fees because of the charitable nature of their work.