The Fall of Kids Company: The Reserves Quandary

Each new article and TV report about the abrupt closure of Kids Company reveals an increasingly complex set of reasons behind the charity’s demise.  However, I want to address one of the first explanations cited for its shut down: lack of free reserves.  Journalists have pointed to Kids Company’s dramatic increase in grants and donations (from £13 to £23 million between 2009-2013) as prima facie evidence that the organisation should have had more reserves and the lack thereof amounted to financial mismanagement.  As someone who has worked for, and sat on the board of trustees of, several charities this is not necessarily true.

Charities come in different shapes and sizes and have many different financial models.  Income generally comes from grants, donations, contracts and/or trading.  These income streams can be restricted (meaning funds have to be used for a particular activity) or unrestricted (funds can be used in any way necessary to benefit the organisation).  For charities that rely heavily on grants, funds are often restricted to the direct cost of delivering a project or service.  Rarely do grants cover general overheads.  Thus, it is very difficult to generate surpluses from grants and therefore almost impossible to set aside reserves.  Donations can go either way – sometimes donors offer funds for a specific purpose, other times they simply want to support the mission of the charity. However, donors generally want to know their money is being used. I understand the hesitation some charity directors have about telling donors that large sums of money are simply sitting in a bank account waiting for a rainy day. They are not completely wrong to feel this way – a recent study reported in Civil Society Finance found that most people think charities should keep low levels of reserves.

Service contracts and other types of trading offer more financial flexibility. Charities may carry on trading activities which contribute directly to the furtherance of their charitable objects. In bidding for a service contract, a charity has the ability to propose a price that covers direct and indirect costs, which could include surpluses for reserves. The Charities Commission has stated point blank: ‘Charities are also allowed to make money on funding agreements.’ Some charities, like museums, trade through ancillary activities, such as running gift shops, in order to generate unrestricted income. As a general matter, trading is probably the easiest way to generate reserves.

It appears from Kids Company’s 2013 annual report that: (1) it held reserves of £400,000 and (2) little of its income comes from contracts or other trading. It also appears that the number of children served and the number of staff needed to provide these services grew in line with the amount of funding coming in – hence, the hand-to-mouth, money in, money out financial trap the organisation found itself in.  However, Kids Company was not without options for securing its financial future.  My reading of the situation is that its best bet would have been to start an endowment fund.  Kids Company was in the enviable position of having a number of high net worth supporters, including Coldplay, whose donations could have come in the form of an endowment. However, setting up and managing an endowment is not a costless exercise. An organisation will need an investment manager in order to ensure growth of the fund.  Given the range of corporates which supported Kids Company, it probably could have gotten plenty of advice and support in setting up an endowment from people in the know.

The other way the organisation could have built reserves is by becoming a service provider to the government via contract. There are lots of words being in exchanged in the press about what the government did and did not promise in the form of grants. What is clear, however, is that these grants were being given because local authority cuts in services meant that vulnerable children were not being helped.  Thus, instead of offering grants, the government should have been treating Kids Company more like a contractor.  This would have allowed it to tender for its service at a cost that covered direct and indirect costs, which could include an amount to be directed to reserves. Yes, contracting has more red-tape and administration involved, but it probably would have settled some of the government’s questions about how finances were being managed and helped Kids Company build more significant reserves. There can be grey areas between grants and contracts, but according to the Institute of Chartered Accountants (ICAEW) the ‘essential elements of a grant are that the funds must be freely given and the donor receives nothing in return.’ Furthermore, except under certain circumstances, there is no obligation to pay. Given the circumstances, it seems Kids Company was more a service provider than grant recipient.

All of this said, it does not appear Kids Company broke any financial rules in its failure to build larger reserves.  The Charity Commission recommends charities have a reserves policy, but does not set any level of required reserves. The organisation’s financial reports were independently audited by Kingston Smith LLP and given a clean bill of health. While low reserves does not equate to financial mismanagement, this is a cautionary tale: building reserves takes careful planning and clever thinking about a charity’s business model. The forms of funding available to enable a charity to look after its long-term financial sustainability are limited.  Ken Wilding, Director of Policy for NCVO commented: ‘From memory, our data suggests just over half the [charity] sector has less than 3 months’ worth of free reserves. A mix of donor attitudes, public contracting arrangements and of course [ironically] foundations reluctance to fund those with reserves make it difficult to build reserves.’  As Kids Company was one of the organisations held out as an exemplar under Cameron’s Big Society agenda, the sudden closure of Kids Company raises the question: Should government being doing more to create programmes and policies that enable charities to improve their long-term financial sustainability?

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