The UK Charities Market – Going through unprecedented disruption
The Shape of the Market
Charities play a major role in a broad range of industries, ranging from the arts and entertainment, education and training, healthcare and social care to a host of community activities of all types.
With the exception of the very large charities, voluntary organisations tend to be less formal in their internal structures and working arrangements than private sector business entities. Staffing resources are a mix of paid staff and volunteers, but in general charity workers are less well paid and their jobs are less secure because of widespread dependence on short term funding, but roles are characterised by huge job satisfaction and career progression opportunities.
Most formal charitable activities are conducted through companies limited by guarantee. Having no shareholders, normal equity raising strategies are not available to them, whether it is for initial capital, as they develop or in times of financial difficulty. However, they have the alternative of a potential donor base to exploit for all of these purposes, as well as a wide array of grants from government and other charitable sources.
An inherent governance issue is the division of management and financial responsibility between a charity’s board of trustees and its executives. The former being volunteers and the latter paid staff can inevitability create a cultural divide within organisations, which can hamper effective decision making and can mean that the early identification and resolution of problems is difficult.
The voluntary sector was affected badly by the introduction of the GDPR data privacy regime in May 2018. This caused huge numbers of potential donors to be deleted from databases as many charities took the conservative view to follow consent rules, as opposed to using legitimate interest. Research carried out shortly afterwards found that 53% of charities had seen their email database shrink to some extent as a result of complying with GDPR, with 18% of charities seeing their database drop by more than half. Postal databases were also affected, with 37% of charities saying theirs had shrunk to some extent. Rebuilding this vital revenue generating data has been a major challenge.
The NCVO warned even before the second national lockdown that two in five charities reported deteriorating finances. Furthermore, one in seven believed it was likely that they would be forced to close. We have used the Company Watch system to analyse the latest financial statements filed at Companies House for a representative sample of 247 charities to identify the financial characteristics of the sector.
This revealed a mix of one significantly negative but many more positive statistics. Company Watch uses complex analytics to generate a financial health score (H-Score®) for companies out of a maximum of 100. An H-Score of 25 or less indicates that the company concerned has a one in four risk of going through a formal insolvency process or a significant financial restructuring over the next three years.
Out of our sample of 247 charities, only 47 (19%) are in the Company Watch warning area with a score of 25 or less. Across the whole economy, the expectation is that a quarter of businesses are be in the warning area. Equally encouraging is that 148 (60%) of the charities have an above-par score of over 50.
The position for ‘zombie’ charities with negative balance sheets, where their liabilities are greater than their assets is also positive.
Only 20 of our sample (8%) of the sample) are in this position. A higher number have negative working capital, where their short-term liabilities exceed their ‘quick’ assets (items easily turned into cash). 34 (14%) charities fail this test. 15 charities fall into both these adverse categories.
What is more concerning is the number of charities, who reported a deficit of expenditure over income. Almost a third (77) posted a loss. In some instances, this may be part of a deliberate strategy, based on careful analysis of the adequacy of their reserves. But it is an aspect of charity finances needing careful ongoing monitoring, especially in the context of the impact of the pandemic.
Companies House data
It should be stressed that because of filing delays at Companies House, our analysis is based almost exclusively on accounts for periods ending before the Coronavirus pandemic struck the UK, so any negative financial effects of the crisis are not reflected in this research.
The Impact of the Pandemic
As the social and economic consequences of the pandemic continue to rise, more people are relying on the support of charities. NCVO research in November 2020 showed that even before the second lockdown was announced, 57% of charities were expecting an increase in people requiring help.
Identifying people in need
Covid-19 has increased societal inequalities and this has expanded the range of people that the voluntary sector needs to help. Identifying those who are most in need has become a challenge. The British Red Cross has warned that data has been key when responding to the crisis; understanding it and making it useful is what can make a real difference. This has increased the need for skills in data science within the sector. The Red Cross has reacted by creating a COVID-19 Vulnerability Index, which brings together public data alongside the charity’s own operational insights to map communities. Displayed as a map of the UK, it combines a range of information – from age, ethnicity, housing conditions and distance to the nearest supermarket, to health inequalities. The data is open source, available to everyone and is already being used by local councils and charities.
The restriction on many traditional fundraising mechanisms caused by the pandemic has hit income right across the charity sector, whether it is the cancellation of fundraising events, the closure of retail units, performance and exhibition spaces or the enforced hiatus in street and doorstep collections. In addition, many potential donors have seen their disposable income slashed by staff cuts and reduced pay through the furlough scheme. The general mood of uncertainty has also contributed to a drop in donations.
Maintaining volunteer engagement has been a major issue in the sector. The NCVO reported in October 2020 that 25% of voluntary organisations had experience a decrease in the number of volunteers.
The sector has benefited from many of the economy-wide support measures introduced by the government to combat the financial effects of the pandemic, most notably the furlough scheme which has helped to keep staff resources intact. The measures to protect tenants from enforcement action by landlords to recover rent arrears has also helped in some cases. More specific assistance has come from the government pledge of £750 million for voluntary, community and social enterprise (VCSE) organisations. This is in addition to the government’s total investment across grants, capital and repayable finance from the Culture Recovery Fund of more than £1.2bn across over 5,000 individual cultural and heritage organisations and sites, many of them operating within the voluntary sector.
The charity sector is experiencing a period of unrelenting change. This is driven by factors such as:
- the rapid digitalisation of the economy
- growing demands for a demonstrable impact and for transparency and integrity
- an increasingly complex regulatory environment
- environmental events (both in the UK and worldwide)
These factors are forcing charities to adapt and to respond in ways that protect their operations, while also continuing to focus on the needs of their beneficiaries.
If there is an organisational focus area that has become undeniably more challenging due to the effects of coronavirus, it is the charity sector’s operations. Furloughing employees has required a significant management effort extending beyond human resource functions, diverting focus from other operational activities. Re-integrating them into organisations will require careful and caring handling. Unsurprisingly, charities state that business continuity, people and wider organisational risks are their top risks.
Income and financial sustainability
Many organisations within the charity sector have had to reduce, in some cases drastically, their forecasted income for 2020 and 2021, cancelling or re-inventing their flagship fundraising events and methods to account for social-distancing requirements and the uncertainty that Coronavirus has created. Even before crisis, many charities were revisiting how diverse and sustainable their sources of income were, especially in the light of pressure on central and local government resources.
Compliance and Regulation
Over the last few years, a key regulatory area of focus for the charity sector has understandably been the General Data Protection Regulation (GDPR). This complex regulation will continue to require management attention as the expectations of the Information Commissioner’s Office continue to evolve, particularly in relation to the technical measures required for personal data protection. Additionally, there have been other recent and important changes in the regulatory landscape and expectations of regulators. In October 2019, a new Code of Fundraising Practice was released by the Fundraising Regulator and the Charity Commission. This code requires robust charity governance in the wake of recent high-profile news stories, as well as the need for trustees to have effective oversight of their charities. Furthermore, the Charity Governance Code, updated in December 2020, focuses on integrity and on equality, diversity and inclusion. These are aspects of many charities’ ongoing activities that will require significantly increased focus and investment.
Digital transformation is a common trend across the voluntary sector. Many are either advanced, in the middle of, or planning their digital transformation programmes to enable more effective engagement with donors and beneficiaries, as well as streamlined ways of working. As a result, technology is becoming ever more pervasive within operating models. This increases the need to focus on cyber security and the resilience of IT systems and infrastructure, which are relied upon to safeguard information and data, and to maintain business continuity.
There is also an increasing need to ensure that outsourced IT service suppliers are managed well, contractual arrangements are fit for purpose and that the outsourced supplier adheres to the key policies of the charity. A clear example are data protection policies, where non-compliance by the supplier may result in reputational damage to the charity, regulatory sanctions and fines.
The charity sector has seen unprecedented disruption during the pandemic, many being pushed to the brink of extinction and, sadly, some beyond it. Its recovery will take time and its success will depend very much on exactly how the government withdraws its various support lifelines during the remainder of 2021.
It is also undergoing a period of dynamic change, which calls for skills not always possessed by trustee boards and executive teams. Those running charities should not be afraid to reach out to independent experts for help. This is in no way an admission of failure, instead it is a pragmatic way to make sure their charity not only survives, but goes on to thrive in the medium and long term.