Charities are under increased scrutiny by diverse stakeholders, including government, private donors, clients, the media and the public. With such scrutiny comes increased pressure on charities to report non-financial performance information in their annual reporting, which goes beyond minimum legal requirements. This means that charities now need to focus on measuring and reporting impact, which is much more difficult to undertake. Many small to medium-sized charities, however, lack the capacity to meet these increasing demands due to resource constraints, which has seen under-investment in support functions, such as the finance team.

Research shows that many such charities are using outdated technology and still relying on manual processes, which sees finance teams being bogged down with routine tasks and spending twice as much time gathering data as analysing it. This is not sustainable, however, as charities now need to be flexible and agile to respond to new challenges and ensure they are continuing to meet the needs of stakeholders.

Good accounting and reporting underpin good accountability, which in turn supports the building of trust between the charity and its stakeholders, and trust is essential to ensure the continuing health of the charity, including its ability to access funding. Charities therefore need to invest in accounting information systems (AIS) that will ensure the quality of their accounting and reporting. Such systems can automate processes, drive efficiency improvements and improve accuracy and reliability of reporting. These modernised enterprise resource planning (ERP) systems have the potential to free up capacity to allow finance teams to focus on analysis and reporting on non-financial performance.

The challenge for many smaller charities is that having limited resources may mean trustees preferring to prioritise the needs of beneficiaries over expenditure on support costs, creating a “starvation cycle” within support functions. The pressure to justify expenditure per £1 spent on charitable activities is also a disincentive to investing in support functions and this also drives the starvation cycle.

There are three key pitfalls that smaller and medium-sized charities should avoid if they are to break the starvation cycle.

1. Not covering overheads from grants and contracts: many UK charities have admitted that they don’t fully cover their overheads and regularly cover funding gaps from unrestricted donations, with mostly nothing added to their reserves from grants or contracts to guarantee future sustainability. Charities should instead seek to move towards a full cost-recovery model to ensure that at least some overheads are covered by grants or contracts, thereby freeing up unrestricted resources to meet other resource needs.
2. Over-reliance on restricted income: another pitfall many charities face is placing an overreliance on restricted funding. Not only is this risky but such funding might not be contributing anything towards core costs. A diversified income portfolio, however, should ensure a mix of restricted and unrestricted income, the latter being freely available for use at trustees’ discretion.
3. Not making the case for investing in support: the pressure on charities to demonstrate how well they are utilising resources in meeting their charitable purpose can cause charities to be reticent about spending resources on support costs, fearing that such costs are harder to justify. Tied up within this fear is the perception that if expenditure cannot be fully justified then funders might withdraw their support. As ICAEW points out though, charities should understand their administration and other related costs and explain (to stakeholders) how such investment will increase efficiency and improve impact, transparency, governance and leadership.

Meeting the informational needs of external funders and other stakeholders requires investment in technology and having the right people in place. This is a necessity for the finance function to continue to be fit for purpose in delivering good accounting and reporting. This is important in demonstrating accountability and the building of trust, which in turn promotes the health of a charity through being able to raise funds and secure its future sustainability.