Understanding income risk
Following our last article on Reserves policy and their link to strategy, resilience and income risk, this article focuses on how to assess income risk.
Put simply, this means asking yourself lots of questions to understand the risk around each income source.
Starting with donation income from your supporters, trusts, foundations and corporates - do you understand how that figure has been arrived at in the budget?
How much has already been received, how much is promised and how much is purely speculative (based on past performance/expectations etc.)? How much is from regular direct debits or standing orders and therefore has a lower risk attached to its probable future receipt?
In the budget, there will be an amount of target income budgeted for the fundraising team to raise. Of the amount included, to assess the risk, you need to know how they have performed in the past and therefore the likelihood of reaching their fundraising target for this year.
Is it at a similar level or perhaps an unrealistic stretch? Another aspect will be to think about the team itself - have there been staff changes which need to be factored into the equation?
Is the income target in the budget one that the fundraising team have signed up to being achievable, or has it been arrived at as the figure needed to balance the budget?
Over the years, we have seen situations where the budgeted income was over-ambitious and therefore was never likely to be achieved. The fundraising target and the extra stretch should not be in the budget – but should be a separate target which is monitored by the board and senior management team. The budgeted income should be one that is realistic and probable in its achievement.
Many hospices have charity shops which have similar issues around risk and income generation. Just because a shop has been successful in the past is no guarantee to its future income levels and profitability.
The donated goods may tail off, volunteers that help keep costs down may leave, the staff may change which could impact on the future success of the shop or the locality changes which influences the footfall and usage of the shop.
With legacy income, income risk analysis involves trying to gauge and assess future income levels. This starts with a review of the future pipeline lists the charity is already aware of, looking at historic levels achieved and producing an estimated income which is a balanced view of these estimations.
Any legacy income figure will always be a guestimate as it is not in any way predictable until the charity has already received notification that either an amount will be forthcoming or a cheque lands in the post.
This is a good example of how a best guess can be used to prepare the budget. But only once the final day of that budget period has passed will there be any level of certainty over the amount that has been received.
However even this may not be the final position, because legacies are an area which can give rise to an adjusting post balance sheet date and require accrual even when the income was received after the year end.
Therefore, with legacy income recorded in the management accounts and the final statutory accounts, it is important that the trustees and the senior management team understand the amount in the bank versus the amount yet to be received and in the debtors.
It is also important to note that a surplus being shown in the year could all relate to an amount accrued for as a legacy receivable recognised in that income for the year and not yet received.
We have seen instances where a legacy may take years to actually be paid and it can be in debtors for that whole time.
Therefore, a legacy income figure in the budget is usually a good guestimate based on history and expectations rather than anything of any certainty and so this could be an area where reserves are used to smooth legacy income in the reserves policy of the organisation. We cover this in more detail in our final article in this series on reserves.
Remember "cash is king" and a surplus in the accounts does not necessarily equate to cash. For this reason, one important point on reviewing and planning the strategy is not to assume that surpluses can be earmarked as funds available to be spent.
Even services such as NHS commissioned services may not be that predictable – the contract may only be for a year and renewed yearly. This again does not help with budgeting for the longer term and brings risk that the renewal may not happen at all or will happen with significantly lower amounts – we have seen a trend for 10-20% cuts over the last few years.
In such circumstances where the contract were not to be renewed, it is important to understand what would happen to the staff involved. Would they be transferred under TUPE to a new entity?
Or would they have to be made redundant if the service was cut? In managing the risk of this income stream it may be more about managing the costs if the worst happened and understanding the implications for the charity.
All of the above demonstrates that the budget will have a number of areas in the income streams where assumptions are being made, and the income that will actually be raised may be higher or lower than the plan set at the start of the year.
This is why the hospice needs to understand its income risk to make sense of its management accounts and any warning signs. It is also why the hospice needs reserves and a good reserves policy to help it manage this income risk in both the current year and future years and to inform the strategy and decision making.