Managing charity financial distress: key takeways from our roundtable

Following on from our March webinar on Managing Financial Difficulties, Bates Wells and FRP Advisory hosted a Financial Management Roundtable on the 10th June which explored the challenges facing charities in the current funding environment. There was a particular focus on trustee duties in distress, early warning signs of financial difficulty, and practical approaches to managing emerging issues.

The discussion drew on perspectives from charities, social lenders, Bates Wells and FRP Advisory, and highlighted the importance of timely information, active trustee engagement and early conversations with creditors, funders and advisers. You can find some of the key takeaways from the roundtable below.

1. Trustee duties in financial distress

The roundtable opened by considering how trustee duties change as a charity moves towards insolvency. Participants discussed the importance of understanding both the balance sheet and cash-flow tests for insolvency, and of recognising that the cash-flow test is often the more immediate concern in practice. The discussion emphasised that trustees should not wait until a crisis has crystallised before taking action: early monitoring, realistic financial information and open conversations with creditors can help preserve options.

• Solvency tests: trustees need to understand whether the charity’s assets, at realisable value, exceed its liabilities (balance sheet test), and whether the charity can pay its debts as they fall due (cash flow test). Deferred payment terms agreed with creditors may help maintain solvency if there is a realistic prospect of repayment.

• Shift in duties: where trustees know, or ought to conclude, that insolvent liquidation cannot reasonably be avoided, their primary duty shifts towards protecting creditors’ interests. Ignorance is unlikely to be a defence, particularly for trustees with relevant financial expertise.

• Personal liability: wrongful trading, preferences of creditors and transactions at an undervalue were identified as key risks. Trustees may also face disqualification where their conduct falls short of expected standards.

• Engagement and records: all trustees should remain engaged, attend meetings and avoid resigning simply because the situation is difficult. Good records, clear minutes, cash-flow forecasts and advice from professional advisers are important protections.

2. Governance, financial information and lender confidence

Participants from FRP Advisory, Charity Bank, Triodos Bank and Unity Trust Bank discussed what good governance looks like when a charity is under financial pressure. The consistent theme was that trustees need reliable, current financial information and must be able to challenge it. A board that receives outdated or incomplete information, or lacks the capability to interrogate it, can quickly lose the confidence of lenders and other stakeholders.

• Forecasting: financial forecasts should be robust, regularly updated and based on clear assumptions. Trustees should understand the financial position and not rely on stale information.

• Board challenge: lenders will look for evidence that trustees are providing effective oversight and are willing to ask difficult questions of the senior leadership team.

• Restricted funds: the discussion highlighted restricted funds as a significant area of risk. Trustees should ensure that restricted funds are ring-fenced and not used to support general cash-flow without a clear and lawful basis.

• Communication with lenders: stopping the flow of management accounts or failing to respond to lender correspondence can be a serious warning sign. Early, transparent communication gives lenders a better opportunity to support.

• Board and management capability: where difficulties arise from financial mismanagement, lenders may expect changes at board or management level, or additional expertise to be brought in.

The group also discussed the importance of culture. Trustees should be encouraged to ask questions and should receive appropriate financial literacy training where needed. Participants noted that smaller charities may have closer oversight, but may also be more exposed to fraud or sudden cash-flow shocks because they often have limited reserves.

3. Spotting warning signs

The roundtable identified a number of early warning signs that may indicate financial or operational difficulty. These signs are often not viewed in isolation, but together they may suggest that a charity’s position is deteriorating or that trustees are not receiving the information they need.

• Reduced communication: missed loan repayments are an obvious warning sign, but a shrinking flow of information to lenders, creditors or advisers may also indicate that the organisation is struggling.
• Leadership changes: the sudden departure of a chief executive or finance director, particularly where financial information is limited, may point to deeper issues.
• Financial deterioration: repeated operational losses, falling KPIs, changes in accounting periods, weakening reserves or a failure to update forecasts may all indicate that the charity’s business model needs to change.
• External pressures: adverse press or social media coverage, poor regulatory reports, delayed local authority contract renewals or the withdrawal of a major funder can quickly compound existing difficulties.

• Failure to adapt: participants noted that many difficulties arise where charities continue with the same strategy despite sustained losses, rather than considering cost reductions, changes to delivery models or merger options.

Participants agreed that warning signs should be assessed by both likelihood and impact. One participant described changing their organisation’s risk register to focus more closely on high-impact risks, with a documented financial impact attached to each risk.

The final part of the discussion focused on how charities can manage difficult conversations about cost-cutting, restructuring and potential mergers. Participants recognised that these conversations can be particularly hard in charities, where staff and trustees are often personally committed to the cause and where reducing headcount may feel inconsistent with organisational values. However, trustees must act in the charity’s best interests and should be willing to take difficult decisions where needed.

• Redundancy and restructuring: charities may need to act while they are still solvent, including by issuing redundancy notices where appropriate. Funding redundancy costs can itself be a cash-flow challenge, but participants noted that support may be available through, for example the government scheme.

• Funders and suppliers: early conversations with funders, suppliers and other stakeholders can help unlock support or flexibility. Emergency funding may assist in the short term but should not be treated as a substitute for a sustainable plan.

• Staff communication: honest and regular communication with staff can reduce uncertainty and help preserve trust. Some organisations may consider temporary measures, such as reduced working patterns, where staff understand the financial position and the operational rationale.

• Merger options: the group noted that merger activity has increased in the current market. There is nothing wrong with deciding to merge where that is the right decision for the charity and its beneficiaries. Eastside People was recommended as a company that can help with charity mergers by identifying potential merger counterparties.

If you would like to discuss anything outlined in this article, please get in touch and our team of experienced Charity lawyers would be happy to help.

The material in this article is provided for guidance and general information only and is not intended to constitute legal or other professional advice upon which you should rely. In particular, the information should not be used as a substitute for a full and proper consultation with a suitably qualified professional. Please do contact the Bates Wells team if you require further advice.